The basic aim and purpose of a pension scheme is to make provision for old age and is a very personal and individual affair. Current schemes appear to have lost sight of this.
They clearly divide into the main areas of those in work and able to make self provision; their dependent partners; those whose earnings do not allow adequate provision and finally the welfare dependents.
These borderlines have become confused and together with the loss of clear objectives have led to pensions becoming a responsibility and burden, aggravated by increased longevity. Longevity projections are causing panic, increased costs, reduced benefits, and pessimistic reactions not justified by actual numbers.
Current Pension schemes divide into two main areas unfunded and funded, which further divide into defined benefit and defined contribution.
Unfunded (pay as you go) schemes do not make commercial or common sense and are unsustainable.
They are the basis of the State and Public Sector schemes, which are now showing the basic failings.
In the UK the current in work / pensioner ratio is around three and population projections suggest this will drop to two by 2035; Public Sector are worse at 1.4 reducing to 1, (the effective pension yield factor).
As contributions are spent as soon as received, at a factor one, contributions must equal pension benefits.
Other Pensions schemes are funded, based on contribution savings being invested and growing over a long working life period of some forty years. Even at inflation growth levels the factor is 2.4 and with a good schemes rise to 5 or more, they are also unaffected by demographic changes e.g. population increases.
Defined Benefit schemes give a guaranteed pension as a proportion of income dependent on number of years service, with the financial and other risks borne by the provider. Defined contribution schemes give no guarantees and are subject fully to market forces giving uncertainty and instability and poor returns.
DB schemes now only occur in Public sector (under attack) and decaying large Company schemes
Private schemes have become increasingly dependent on the Financial markets. Up until the turn of the century whist markets were buoyant and returns were high, such schemes prospered and became over generous. However markets became more speculative; greed set in and large funds were attractive.
They therefore need firm foundations to withstand the storms of the financial markets and careful management maintenance and control to ensure they don’t collapse.
Pensions in Europe are more generous than in the UK, mainly due to the policy doctrines pursued there; a greater concern for the elderly and morefamily responsibility. However they appear in a worse state than the UK, due to the higher payment levels, demographic population changes and use of unfunded schemes.
Sweden are now suggesting a notional defined contribution scheme where imaginary funds are deemed to accumulate and grow to give defined benefits. Apparently this is under serious consideration in the UK.
This move into fantasy land, reminds one of children’s nonsense stories and the Emperor’s new clothes.
In America the approach appears one of more hard Business, level headed and realistic. The Public Sector Funded Defined Contribution schemes appear extremely successful (see nasra.org)
Their Public Sector report funds of 2 trillion dollars in both active members and retired funds; investment funds provide 60% of total income and this alone meets pension payments without eroding capital in the retired funds. Target growth rates are 8% but over the past 25 years have averaged 9.25%. Pension benefits are high and the large funds buffer them from market changes.
These show what can be achieved in a well managed scheme and suggest a good role model. (next blog)
Savings Annuities Unions
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