Jobs as well as pension benefits are in jeopardy as equity market falls continue to impact on define...
Jobs as well as pension benefits are in jeopardy as equity market falls continue to impact on defined benefit schemes, the Actuarial Profession has stated.
Tom Ross, president of the Faculty of Actuaries, noted underfunding of pension funds is growing, caused in part by falls in global market returns.
Summing up some of the key trends in the last year, he said funding problems are creating serious risks for employees.
He said: 'Significant deficits expose employees to double jeopardy, both their job and their pension in fact, which is exactly what pension funds are there to avoid.'
Equity investment leverages a business, creating the need for cash injections to the pension fund at exactly the time the business itself could be doing badly, he noted.
He said: 'The level of equity investment in UK pension funds, commonly 75%, is causing real anxiety and reveals the nature of investment risks.
'Yes, it is true wage-linked pension liabilities cannot be perfectly hedged with long bonds but you can get close. A bond portfolio, admittedly with a big inflation-linked component, is the lowest risk investment. That is to say, inflation-linked bonds, not equities, have the highest probability of being able to meet the wage-linked liabilities.'
The demise of defined benefits, Ross noted, is understandable as shareholders want better value from their spend on employee compensation. Ross said: 'The typical employee can woefully underestimate the cost of their defined benefit pension. Older ones in particular often put a number on the cost that can be too low by as much as 50%.' Many 55 year olds with a 1/60th pension pay more than 30% of their pay to the scheme, according to Ross.
While the high costs may not be news, the recent falls in the equity and bond markets have brought home that both the cost and risks of defined benefit pensions, especially final salary benefits, have been higher than people thought, Ross said.
Some 80% of the employer's cost on a typical final salary scheme goes on perhaps just 30% of its members ' the ones who remain until they retire or who have large salary rises at the end of their careers.
Other aspects of final salary schemes are also coming to light that make the product less attractive. In fact many schemes are discriminatory, Ross noted, as they are age-related.
He said: 'People should be paid for the job they do and how well they do it, not simply for growing older. Logically, employer contributions should be linked to service or, what is increasingly happening, de-pend on how much the employee is personally prepared to contribute.'
He noted that critics of defined contribution schemes because all the investment risk is put on the employees, are also missing the point.
Investors can use vehicles such as these to build their own version of a defined benefit pension, according to Ross. He recommended achieving this through investments in inflation-linked bonds.
Ross added: 'A word of warning, however. The debate over DC versus DB is in danger of obscuring the critical issue. If contribution rates are reduced across the economy, which is the current trend, retirement incomes will fall too.'
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