Proposed UK Pension Reform Could Cut Benefits for Millions

Government proposal suggests lowering the rate at which it increases payments to compensate for inflation.

The UK government has issued a pension reform Green Paper that includes proposals that could significantly reduce retirement benefits to millions of Britons.

The Green Paper contains proposals calling for companies to lower their pension indexation, which is the annual rate at which they increase payments to compensate for inflation. It is suggested that this could be done by allowing plans to reduce indexation to the statutory minimum, or to allow plans that base their indexation on the Retail Price Index (RPI) to switch to the Consumer Price Index (CPI).

“There may be a case for rationalizing indexation so that there is a level playing field across the sector,” said the UK’s Department for Work and Pensions, which issued the Green Paper.

Although the UK Government switched its indexation from RPI to CPI for pension purposes in 2010, some 75% of private pension plans in the UK still base their indexation on RPI.

Because the CPI has been lower than RPI in nine of out the last 10 years, and 22 years out of the last 27, up to 2015, allowing pension to move from RPI to CPI would likely have a considerable impact on retirees’ benefits.  According to pension consultants Hymans Robertson, switching from RPI to CPI would take away £20,000 in benefits over an average pension participant’s life. The group also said that moving to statutory indexation was an even more extreme measure that would “ride roughshod over schemes trust deed and rules.”

The statutory minimum applies to defined benefit pensions (also known as final salary pensions) accrued after April 1997, and before 2005, and which must be increased each year by inflation capped at 5%. Pensions accrued after 2005 must be increased by inflation capped at 2.5% each year.

Despite calling for pension reform proposals, the British government maintains a relatively positive outlook on the future of British pension funds. While “recognizing that the system may not be operating optimally in all areas, our main conclusion is that there is not a significant structural problem with the regulatory and legislative framework” of defined benefit pension plans,” said the Green Paper’s executive summary.  

The Green Paper will review the powers of The Pensions Regulator, and encourage a debate making a fair compromise between the needs employers, members, the Pension Protection Fund, according to the Department for Work and Pensions.

“People need to have confidence in their pension and it is vital that they feel that they are secure,” Richard Harrington, the UK’s Minister for Pensions, said in a release. “With recent high-profile cases highlighting the risks inherent in defined benefit pensions, we want to ensure that these important pension schemes remain sustainable for the future and that the right protections are in place for members.”

After the 2008 financial crisis, record-low interest rates and reduced expectations for future investment returns have increased estimates of deficits in UK. pension funds, and pension liabilities have grown more than their assets have. 

“This has led to a number of commentators to declare that there is a fundamental problem with DB schemes,” said the Green Paper. “The Government understands people’s concerns; however, it does not recognize this view of the pensions system,” and “we also expect the vast majority of members to receive their benefits in full.”

Despite the government’s relatively positive view of the state of the pension fund system, it does acknowledge that there is room for improvement. “This Green Paper seeks to identify where there may be particular problems or issues in order to start an informed discussion on the best way to improve the management and oversight of the risks inherent in providing [defined benefit] pensions.”

In the UK, the average defined benefit pension in payment is a little under £7,000 per year, which is equal to approximately 25% of the median gross earnings of full-time employees in the country, according to the Office for National Statistics. There are approximately 11 million people relying on defined benefit plans, which hold around £1.5 trillion of assets.

The number of Britons participating in private sector defined benefit schemes has been in steady decline, as active memberships have fallen by more than 50% over the past 10 years, according to the UK’s Pension Protection Fund. And the proportion of defined benefit plans open to new members has dropped to 13% in 2016, from 35% in 2006.

By Michael Katz