Surplus to requirements
7 May 2001
Bradbury case: Ombudsman determines on employer duty issues in the employer’s imposition of a cap on pensionable pay
21 February 2014
14 February 2014
26 November 2013
20 January 2014
17 December 2013
The question of who owns an occupational pension scheme's surplus has once again reared its ugly head in the form of the recent House of Lords ruling in the case involving the National Grid pension schemes.
Two National Grid pensioners objected to the use of the pension scheme's surplus to fund redundancy packages subsequent to privatisation. They argued that it was the scheme members and not the employer who should benefit from any surplus. After a long and acrimonious battle that went through the Pensions Ombudsman and the Court of Appeal, the House of Lords eventually ruled against the pensioners, although they may yet take their claim to the European Court of Human Rights.
The complaint was brought about as a result of National Grid's post-privatisation redundancy programme. The scheme rules permitted members aged 50 or over who had been made redundant to take an enhanced early-retirement package. The company used a provision within the scheme regulations to instruct the trustees to fund the redundancy pensions using part of the plan's existing surplus.
This followed a similar high-profile case involving the British Airways pension scheme and it would appear that there are more on the horizon.
It has been announced that after a 10-year contribution holiday, the administrators of the Post Office pension scheme will be putting the employer contribution on hold for a further three years. This has caused outrage among some Post Office pensioners, particularly in light of last year's 1.1 per cent pension increase. Petitions have already been drawn up and street protests are planned for next month. Stirring stuff indeed, but why do scheme members feel that it is they who own the scheme surplus?
Many take the view that because they pay a percentage of their wages into the scheme every month, they should be the ones to receive any surplus cash (via an augmentation of benefits) from the fund. But this begs the question of what would they feel if the scheme were say, £10m in deficit? Would they want to own that too?
It cannot be repeated often enough quite what an excellent benefit membership of an occupational pension scheme is. An average final salary pension scheme with, for example, a 6 per cent employee contribution rate, is typically worth around 20 per cent of pensionable income. In order to fund an equivalent pension and lump sum themselves, members would need to set aside about 20 per cent of their pensionable income throughout their careers.
Using this example, the contribution rate of 6 per cent itself attracts tax relief, so the real cost to the member is closer to 3 per cent. This represents an excellent return by any standards, especially when you consider that there tends to be a generous life assurance element and dependents' benefits as part of the scheme.
What is more, when you join a final salary pension scheme all you expect from it is what its title suggests - a pension at the end of your career based on your service and salary. It is not an investment-based pension. For the average employee, the value of a final salary scheme does not go down if investment returns plummet, but the cost of poor investment returns is borne by the employer.
To illustrate this point, let us consider the current state of the Football League's pension and life assurance scheme. After a recent valuation showed a £13m fund deficit, many football clubs will soon be receiving a letter telling them that they need to fund this shortfall. While it is difficult to have sympathy with footballers earning massive salaries, it would be equally difficult to argue that they should make up the shortfall themselves - it is only equitable that the employer meets the cost so that the guaranteed benefits can be paid. So conversely, is it not unfair to expect that any surplus be handed over to scheme members?
The situation facing footballers' pension schemes has come about in a relatively short space of time and was caused by a combination of factors such as rising wages, poor investment returns and a fall in annuity rates.
Funding a final salary pension scheme is a very tricky business, the scheme cannot be more than 105 per cent funded, in other words, the fund must be able to pay all of its liabilities plus 5 per cent at any given time.
In an ongoing pension scheme there are, of course, some people paying money in (active members), some people receiving money (pensioners and dependents) and some people who are waiting for benefits to be paid in the future (deferred members). Any surplus is very much a "paper" surplus and it is very difficult for the scheme's actuary to put an exact figure on it. It is even more difficult to predict what will happen between valuations, which was the case for the footballer's scheme. Had there been a surplus in the previous valuation and it was reduced by means of an improvement to benefits, then that would make the present state of the scheme even more parlous.
Because of high-profile appeals, final salary schemes could be usurped by money purchase schemes. This is the case for new staff joining British Telecommunications after 1 April this year. Money purchase schemes are similar to personal pensions in that a pot of money is built up during an employee's career and must be used to purchase an annuity at retirement. So what is wrong with that? Try asking anyone who has retired on this basis recently if they were happy with the annuity rate they received. As the old mantra of the financial services goes, the value of investments can go down as well as up, but in most cases this is not so for the benefits of a final salary scheme.
Ultimately, it is up to the trustees of the scheme (who include member-nominated representatives) to satisfy themselves that it is being run in accordance with the best interests of its members and that there will always be a solvent scheme to provide for them.
Andy Blake is principal pensions officer at the British Medical Association