Greater numbers of workers are set to find themselves frozen out of generous final salary pension schemes or have their benefits watered down as employers consider drastic measures to plug mounting pension costs.
New announcements this week from several big employers added to growing concerns from unions that companies were looking to tougher ways to plug pension gaps in the face of ever-widening deficits.
Arcadia and the Co-operative Group became the latest FTSE-listed companies to propose changes to their final salary schemes, making them less generous.
The Co-op plans to replace its final salary scheme with one based on average earnings. Arcadia wants its workers to work for longer and raise contributions from 4 per cent to 6 per cent. The moves come quickly after Rentokil, the business services group, caused shudders among unions when it became the first FTSE 100 company to propose closing its scheme to existing members.
Previously, FTSE 100 companies had only gone as far as to bar new employees from joining their final salary scheme. Final salary, or defined benefit, schemes are considered “gold standard” as, unlike defined contribution schemes, employers bear the investment risks while promising to pay a set income upon retirement.
Pensions consultants say Rentokil’s move, while seen a drastic step for a large employer, was not likely to be the last as companies look to innovative ways to deal with rising deficits. “We are now getting more questions from companies that had typically closed their final salary schemes to new entrants,” says Kathryn Armitstead, a senior consultant with Watson Wyatt.
“These companies have taken the first step of closing their scheme to new members, but they have overestimated the effect of this move and now realise that they still have a significant problem with their deficit. They are asking, ‘What can I do now?’.”
Speculation about how many other private sector employers will follow Rentokil was given firmer underpinning this week when the National Association of Pension Funds released its annual industry report.
Headline findings from the NAPF report were released in mid-November but this week’s survey provided full detail of the industry’s intentions to cope with spiralling pensions costs.
According to the survey, 43 companies plan to follow Rentokil and close their schemes to future accruals in the next three to five years. This compares with just four respondents who closed their schemes to future accruals in the previous 12 months.
Whether companies choose to go down what has been called the “nuclear” route of evicting existing members will depend on many factors, including the weight of pension promises.
However, the survey gave strong indications that the trend of watering down of benefits was set to continue. It found that 63 private sector respondents expect to change early retirement terms on their final salary schemes in the next five years.
Forty-two respondents said they would increase the scheme’s pension age, as Arcardia has done, and the same number said they would change their definition of pensionable earnings and/or final pensionable earnings.
Twenty-seven said they were likely to reduce accrual rates. Others will call for higher employee contributions, as Provident Financial controversially did last month when its doubled its employee contributions to 14 per cent.
Bob Scott, a partner with actuarial consultants Lane Clark & Peacock, says similar measures might be more commonly used by companies as each had different circumstances, but he believes many may take extreme action.
“What has happened in recent years is that final salary schemes have become unmanageable,” says Scott. “Successive rounds of new regulations and legislation have not helped, and I fear that unless someone actually steps in to increase support for employers we could see a large number of schemes going down the Rentokil route.”
While the flurry of announcements this week has concerned unions, new rules coming into force will make it harder for employers to rush through unpalatable changes. From April 6 companies will be required formally to consult members on changes such as those proposed by Rentokil, Arcadia and the Co-op, two months ahead of their proposed implementation.
“The new rules won’t stop companies from making changes, but it will mean they can’t make unilateral decisions without first consulting members,” says Raj Mody, a consultant with Hewitt Associates. “Employers as good practice already informally consult workers, but these rules will in effect be another knot in the string that ties the company’s hand.”
Others in the industry say recent developments, with the closure of final salary schemes for existing members, were a sign that final salary pensions are heading towards extinction. “It is likely that what we have seen with Rentokil is the tip of the iceberg,” says Ros Altman, a pensions adviser.
“The bottom line is that these schemes have become more expensive than first envisaged and I expect that more members will be asked to pay more [contributions], and most will be asked to retire later if they want a full pension. However, I would expect that within five to 10 years these schemes will hardly exist in the private sector.”