How should people save for their retirement? In the state of nature, before government provision and before work-based pension schemes, you saved up what you could - if you could - and then when the moment came to stop working, you bought an annuity. This gave you a guaranteed fixed income for the rest of your life. It was better than relying on family or charity or the poor house.
After decades of increasingly sophisticated pensions provision, we are moving back towards that state of nature. Not quite, because there is at least a state pension. Nonetheless, it is beginning to look as if the conditions that obtained in the 40-year period from 1955 to 1995, when virtually all employers were able to provide a scheme that gave a pension worth between one half and two thirds of final salary, will never return. The work-based pension schemes of this type that still exist are finding it increasingly hard to keep going. Indeed for obscure technical reasons to do with the movements of financial markets, the difficulties have become dramatically greater in the past few weeks.
At risk is a growing proportion of the population. It comprises two groups. One is the 4.1 million people currently paying into work-based pension schemes. And in even greater peril stands every young person starting work. This second group will probably never experience the generous pension benefits that their parents and grandparents have enjoyed.
Many others, however, need not worry. Not the 11 million people currently drawing their pensions or with deferred arrangements. They have run their course and safely crossed the finishing line. Nor should the self-employed be concerned, who have had to make their own private arrangements. Nor of course should anybody working for the Government give the matter a second thought. As long as the rest of us pay our taxes, they can relax.
This weakening of society's ability to make private provision for old age is partly explained by forces of nature, so to speak, and partly by the hand of man, by which I mean by actuaries, auditors and regulators, who are now being confronted by the perverse results of their prudence. As to natural developments, that we live longer is well known, but the statistics remain startling. Since 1981 the life expectancy of a man retiring at age 65 has increased from 13 to 17 years.
This benign trend puts up the expected cost of providing a pension by nearly a third. A second favourable event that has nonetheless posed problems for pensions provision was the disappearance of inflation in the mid 1990s. The consequent decline in interest rates means that a larger capital sum is required to provide a given level of income than it was, say, 15 years ago. As a result, many work-based pension funds have sprung a leak. Where once the costs of paying pensions was fully covered by value of the funds that had been accumulated, deficits have appeared which employers and employees have to make good. This has made companies much harsher in their attitudes towards their employee pension schemes. They have begun to close them to new entrants.
Not that this of itself has removed any deficit that had already shown its face. It was seen as a way of preventing matters getting worse. Vain hope, as it has turned out. For the obscure technical developments to do with the movements of financial markets that I mentioned above, are, unfortunately, an essential aspect of the story.
The question is this. What will be the cost of paying pensions that may not begin for many years in the future, and then will extend until the beneficiary and his or her spouse have both died? Assumptions about salary, inflation and longevity have to be made. But while these are not so easy to calculate, the next steps are even harder. For what should be assumed about the performance over the long term of the financial assets in which pension funds invest? What will be the lasting trends in shares, in property and in fixed-interest securities? These are the questions about which the actuaries, auditors and regulators have been laying down the law.
They have given cautious responses. Don't make bullish assumption about equities but prefer the apparent certainties of bonds. Calculate solvency on a strict basis and tell shareholders. Extinguish any deficits quickly - which can only be done by increasing contribution rates.
This brings us to the most disturbing part of the tale. The very prudence of actuaries, auditors and regulators is having unwelcome consequences. For employers and pension fund trustees have felt obliged to invest in the safest things they can find, which are government securities whose terms are linked to inflation. They have piled into these stocks, driven up their prices and thereby created a dangerous bubble effect. This in turn makes it more and more expensive to provide the pensions that employees have been promised.
So the cost of eliminating risks is proving so onerous in terms of contribution rates for employers and employees alike that both parties are turning away from work-based schemes. What was once a very good system of saving for old age is gradually being closed down. The fascinating question is whether the Government will feel impelled to intervene and change the rules of the game. Just issuing more stock to prick the stock market bubble, as it may announce it is going to do later this week, won't be enough.Reuse content