David Prosser: Final salary pensions do not have to be consigned to history


Outlook Had yesterday's announcement from Unilever that it is closing its final salary pension scheme even to existing members, been made a decade ago, it would have caused a storm – and certainly a major industrial relations dispute. These days, such closures are commonplace. They have already taken place at companies as varied as Barclays Bank, Morrisons the supermarket and Rentokil the pest control business.

The National Association of Pension Funds says 17 per cent of final salary schemes were closed to existing members as at the end of 2010, up from 7 per cent a year previously, but also that a third of those remaining were considering reforms. In the public sector too, the final salary scheme is under attack. Lord Hutton's proposals for pensions reform, published last month, made the case against this type of pension plan.

In other words, the idea that final salary pensions are no longer economically viable has become received wisdom.

Still, that doesn't mean the idea is right. Contrary to what you might assume, final salary pension schemes are not struggling financially just now. The Pension Protection Fund said yesterday that the 6,533 final salary schemes in the private sector currently have a combined surplus of almost £46bn over what they need to pay the benefits they have promised.

Moreover, while employers often say that it is the volatility of final salary scheme funding they dislike – the fact that surpluses can turn into deficits very speedily – as much as the cost, this doesn't always stack up. The careeraverage model that Lord Hutton proposes for the public sector, for example, also produces a guaranteed level of benefits and thus exposes the sponsoring employer to the volatility of financing such a promise, albeit a cheaper one.

Is final salary really such a bad model? It rewards workers who show loyalty to their employers over the long-term and the benefits it offers reflect the value added by staff over the full term of their careers. It's easy to understand, which is a boon for workers who are trying to plan for their retirement, and it aligns the interests of junior staff and senior executives.

That is not to say pension scheme design should be set in aspic. The single biggest problem for employers sponsoring defined benefit pension schemes is rising life expectancy: they now have to meet the cost of paying pensions to staff for far longer than was envisaged when the funds were set up. But that is relatively easily remedied: simply change the scheme's accrual rate.

Most final salary schemes work on the basis of sixtieths – staff need to contribute for 40 years to get a full pension worth two-thirds of final salary. To pay the same amount of pension out over a longer retirement, employers need only to adjust their accrual rates.

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