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A consumer&#39s view

The Government needs to think the unthinkable if it is to deal with the pension time bomb. This may include telling the nasty truth that in future, people will have to work longer or face retirement on much lower incomes than is the norm today.

Reform of pension legislation is becoming ever more pressing as the cost of providing a decent income in retirement rises and employers increasingly move away from final-salary schemes.

Two recently published papers reveal just how urgent the need is for a complete rethink. Today&#39s pensioners may moan but those with a good occupational pension may well prove to be a lucky one-off generation.

Longer life expectancy, lower inflation, interest rates and investment returns are combining to make the cost of providing a pension linked to earnings prohibitive. Perhaps the most startling of these factors is the rapid increase in life expectancy, highlighted by actuaries Bacon & Woodrow in its latest bulletin.

“In the late 1980s and early 1990s actuaries typically increased the assumed expectation of life for a 65-year-old male to slightly over 15 years. However, new data published in 1999 indicated that such a person&#39s life expectancy had by then risen to almost 20 years and was set to continue rising steeply for those employees who would not be retiring until well into the 21st Century.”

Bacon & Woodrow points out that the cost of providing a pension has increased over the last 15 years by 80 per cent, of which 50 per cent is attributable to falling investment yields and 30 per cent from increased life expectancy.

Since most employees do not understand the real value of a final-salary scheme, it is relatively non-contentious to remove this benefit and replace it with something worth less – a defined-contribution scheme.

The alternatives – to stump up the extra cost, reduce the pension or raise the age at which the pension becomes payable – are either unacceptable to the employer and shareholders or would be howled down by angry employees.

As Bacon & Woodrow points out: “If mortality continues to improve to this extent, current levels of benefit may well become unaffordable. Reducing benefits is an unattractive option.

“Switching a scheme from defined-benefit to definedcontribution provides the employer with a way out but does not solve the underlying problem. It merely passes it squarely to the employee. Logically, the long-term answer must be to raise the age of retirement.”

Meanwhile, HSBC actuaries dare to think the unthinkable. “Low inflation is not such good news,” they point out in their recent report. “Unfortunately, sustained low inflation can significantly increase pension costs. A 1 per cent reduction in annual investments returns compounded over 30 years increases the sum req-uired to fund a given pension by approximately 30 per cent.”

In a typical piece of actuarial understatement, HSBC goes on to say: “Employers and trustees of final-salary schemes may well have seen an increase in the required contribution rate. Members of money-purchase schemes who reach retirement in future are likely to find that their accumulated funds will secure less pension than they expected.”

Do Messrs Blair and Brown admit this when they sing the praises of saving in a stakeholder pension? Clearly not.

A research paper produced by the Institute of Actuaries spells out how all the Government&#39s plans to persuade people into stakeholder pensions could backfire when people realise how little their savings will buy in terms of a pension.

Under current inflation conditions, a man aged 30 contributing 10 per cent of salary a year to a money-purchase pension scheme and following a typical investment strategy might expect a pension of around 24 per cent of his final salary on retirement in 30 years time.

By contrast, a pensioner retiring today with the same contribution pattern over the last 30 years could expect a pension of over 60 per cent of final salary. The sooner the Government comes out and admits that, far from allowing workers to retire early, many people in future will have to continue working for a significant number of years after the age of 65, the better.

As the Bacon & Woodrow bulletin concludes: “Logically, the long-term answer must be to raise the age of retirement. This would include but also go beyond a reduction in the number of people taking &#39early&#39 retirement. “Implicitly, Government thinking seems to be progressing along these lines.”

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