Pension regulators hit companies hard

The new regulatory framework to protect employer-organised final salary schemes is proving to be unpopular, writes Dennis Turner

In no other policy area have so many government initiatives turned sour. It is fair to say that on pensions it has not got much right as far as the public and companies are concerned.

From the Chancellor’s abolition of dividend tax credits in 1997, through to the delayed response to Lord Turner’s proposals for reforming state pensions and the reluctance to bring the generous, but unfunded public sector pensions more in line with the private sector, the authorities have had to endure a barrage of criticism.

But for corporate UK, the legislation that matters is the Pensions Act 2004, the provisions of which are now starting to bite. Following the failure of several high-profile occupational pension schemes, the government created a new regulatory framework to protect members of employer-organised final salary schemes. It believed that, since pension schemes were private agreements between employer and employee, the taxpayer should not be expected to pick up the tab when a fund fails.

In trying to protect both employee and taxpayer, a system has emerged which, critics claim, is intrusive, expensive and onerous.

The magnitude of the problem can be measured by the difference between the pension promises and the value of the present pension assets. This deficit, according to the official figures for March 2006, is at least £440bn using the strictest test of solvency.

This estimate covers 5,800 schemes that account for 85 per cent of all UK pension liabilities. Independent consultants put the total shortfall for all schemes at £518bn. Some believe another £20bn should be added because life expectancy figures have been underestimated.

At the heart of the new legislation is a pensions regulator, who could become a significant presence in business life. Ensuring that funds achieve solvency in five to 10 years is one of the regulator’s key responsibilities and if firms try to achieve the Statutory Funding Obligation sooner it could well have an impact on dividend policy and capital expenditure, as well as salaries and benefits.

Pre-clearance of merger/takeover deals is the other important area of the regulator’s focus. Fund deficits have already proved a stumbling block in several major deals and the regulator now has the right of veto over any proposal involving a final salary pension scheme. The price of approval could well be an increase in scheme contributions, a situation that will affect equity transactions and other debt-financed takeovers, in particular.

As if this were not enough, the government has to reconcile the increasing fragility of private-sector pension funding with the gold-plated schemes still available in the public sector. The shortfall has been estimated at anything between £600bn and £1 trillion, but it is not subject to the same solvency tests as private schemes. It is funded out of general taxation, with contributions coming from those whose pension expectations have been seriously diminished.

The pensions issue, therefore, cuts across all aspects of economic and business life and few households or businesses will be untouched. Given where we are starting from, it is hard to see how the potential solutions can be regarded as a plus. There are some questions for which there are no easy answers. Pensions is one of them and the message of ‘work longer and save more’ will not get many votes.

Dennis Turner is chief economist at HSBC.