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Final salary schemes - c
onsequences of being closed
to new entrants
This paper considers the consequences for a
final salary funds of its being closed to new entrants, the effects
on employer attitudes and behaviour and the possible consequences
for scheme members future pensions and employment.
Recent survey data and our own experience
indicate that the majority of final salary schemes are now closed
to new entrants and more may follow. Trustees and negotiators need
to consider carefully what the long term consequences of this will
be.
Higher Contribution
Rate
When a fund is closed there will be no new
entrants, who would tend to be younger in age than the average of
existing members, and the average age of the members will rise as
time passes. With any pension scheme the cost of any defined level
of member's benefits at retirement rises with age, as contributions
are invested for a shorter time. So as the average age of members
rises the average contribution rate will also rise. Depending on
the actuarial method adopted this higher cost may be recognised at
the time of closure or allowed to emerge at future successive
valuations.
In a closed fund the proportion of the
liabilities represented by pensioners and member close to
retirement will increase more quickly over time than if the scheme
were open. Trustees of such schemes will generally be advised and
will tend to adopt more cautious investment policies. Such
policies, typically a switch of investments from equities to bonds,
will lead to estimated investment returns being lower and to the
actuary advising that a higher contribution rate is needed.
Risks associated with future
deficits
Where deficits arise in a scheme, the general
practice is to express the deficit contribution as an additional
contributions percentage for the employer in addition to the
percentage contribution required for future service. As the number
of active members gets smaller relative to the size of the fund the
size of the additional contributions percentage for any deficit
will get larger and the resultant figures will weigh heavily on
employers perceptions of the cost of the scheme.
Likewise, where employers determine that they
cannot afford the additional contributions for a deficit and decide
to make an adjustment in the future benefits or member
contributions to offset that cost, the size of the adjustments will
become much greater.
Contribution rates in a closed scheme are in
essence more volatile. Even if the employer recognises that, and
they may well not have properly considered it, and suggest they are
prepared to live with it their employees may feel that they will
not and so feel threatened.
Widening cost gap vis a vis a DC
scheme
Employers who close final salary schemes
often offer a DC scheme instead to new employees. By their nature
such schemes involve a fixed cost to the employer. At the time of
closure there will be a perceived relationship between the cost of
the old scheme and the cost of the new scheme.
As time goes on the cost gap is likely to
rise on account of the factors driving rising costs in the final
salary scheme. That cost gap may be enlarged greatly if further
deficits emerge in the final salary scheme in the period following
closure. This will make it much more likely that employers actions
may be guided, whatever their original intentions, by the size of
the cost gap. In effect they may begin to treat the final salary
scheme more like a DC scheme by setting a limit on their future
contribution.
Dividing the workforce and
undermining opposition to future cutbacks
Employees may well object to scheme closures
on the basis that the new DC scheme involves a lower rate of
pension pay for new employees than for old employees. This may
emerge in terms of lower benefits or through new members being
required to pay higher contributions to their scheme in order to
achieve a comparable level of benefit. It goes against the
principle of people being paid the same 'rate for the job.'
New employees may resent the fact that their
'pension pay' is lower and come to feel that members of the final
salary scheme are unfairly privileged.
The effects of a different pension scheme can
divide the workforce and by doing so make it easier as time passes
for an employer to impose changes.
Job security may be
affected
Over time the higher pension costs of
employees in a final salary scheme, relative to employees in a DC
scheme may lead to a situation where the employer will seek to
contrive that any job losses required are concentrated on the final
salary scheme members.
Unions have always negotiated rates
for new employees
In some companies it is established to
varying extents that pension scheme benefits are negotiated. Just
as employees would feel threatened by a situation where the
employer brought in new employees on pay rates lower than those
which had been negotiated so also will they feel threatened
by new employees being brought in on pension terms inferior to
those established for existing staff.
Unions will feel they negotiate pay rates for
particular jobs and not just rates that are limited to particular
individuals who hold them. If pay is negotiated for a bargaining
group then unions are entitled to seek to negotiate pensions for
that bargaining group. While employers may argue that pension terms
for new employees are nothing to do with existing employees, those
existing employees may take a different view.
Should you have faith in employer
assurances?
While employers may say that existing
employees are not affected and that there are no plans to change
schemes for existing members they will never offer a guarantee to
that effect – only for the foreseeable future.
Unions may feel that the new scheme and
associated contribution are what the employer wants to pay for all
employees and will have limited faith in any assurance or statement
that existing employees will be protected or not affected. Such
assurances may be accepted in good faith but employees equally are
entitled to take the view that they are no more than a tactical
ploy in a strategy to reduce all employees pay over a period of
time.
