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9. The Pensions Crisis

Everyone, particularly if they have several decades of work in front of them, has to believe that there will be the resources available to support them when they get old. For this reason the Government has announced that the few million people who still work to the age of 65 will now have to work to 68 starting in 2024. An increase of 3 years in the retirement age in 16 years time will make no difference to a population in which life expectancy is increasing by one year every five years. However minor changes like this make many voters believe that the problem has been fixed. All those who are engaged in the commercial side of the pensions industry and banking sector also have a vested interest in persuading the population that their future is certain.

The first private pension schemes were established more than a century ago but they were very much a minority provision. The first State pension started in the early 1900s. However the State Pension in its present form and the National Health Service were established after the war. The basic idea of the State Pension was that those in work would make National Insurance contributions, as would their employers, and the money that the Government received would be redistributed to those who were unable to work and to those who had reached the age of retirement. When the system was established the average man lived for about two years after he reached retirement age. By the 1960s it was apparent that the system would eventually collapse. The only surprise is that it took almost 40 years for a public debate to start. The Conservative Government in the early 1980s appreciated the size of the problem and broke the link between the value of the State Pension and the national average wage. This decoupling allowed the Government to hold down its expenditure because the Government increased State Pensions in line with its own official inflation rate rather than the true rate of inflation. This meant that there was an ever increasing gap between pensions and the national average wages. The increasing gap has had to be closed for the poorest in society by the use of means tested benefits. This use of benefits will have to increase dramatically over the next twenty years as more and more people reach retirement age without the benefit of belonging to a private pension scheme.

When the State Pension was introduced after the Second World War no one ever dreamt that life expectancy would increase to its current level. Life expectancy for both men and women will continue to rise. The official data tells us that in 2002, life expectancy at birth for women born in the UK was 81 years, compared with 76 years for males. This contrasts with 49 and 45 years respectively in 1901. Between 1981 and 2002, life expectancy at age 50 increased by four and a half years for men and three years for women. For those aged 65 and over the extra years of life were three years and two years respectively. By 2002, women who were aged 65 could expect to live to the age of 84, while men could expect to live to the age of 81. Official projections suggest that life expectancies at these older ages will increase by a further three years or so by 2020. One factor that is being studiously ignored in all discussions about pensions is that a child born to a healthy well fed woman lives much longer than one born to a poorly fed mother with less than perfect medical care. When the post war babies reach their 80s they are not going to go away. The average life expectancy could easily jump to 90 for men as opposed to the current 77 in the next twenty years.

Although life expectancy keeps on increasing the amount of healthy active life that a person enjoys has not increased by anything like the same amount. A person may stay alive for longer but the human body still wears out. The result is that there has been a major increase in the number of people who need assistance in their old age. There will also be hundreds of thousands of additional people who will suffer from problems like senile dementia and require 24 hour care. The requirement for heart bypasses, cataract operations and hip replacements will soar. How this extra health care will be funded is unclear.

The International Monetary Fund issued a warning in 2006 over Britain's health care bill, saying the Government may have massively under-estimated the future growth of NHS costs. The Washington-based organisation said that huge tax rises or spending cuts would be inevitable in the years ahead if the Government was to satisfy the growing financial demands of the health sector. In its annual survey of the British economy, the IMF said that while the Government's accounts had improved after Mr Brown raised North Sea oil taxes, they failed to take on board the potential costs of an ageing population and that this would have 'significant' implications for health spending. It added that 'the average person aged 65 or over costs the UK health system about five times more than the average person under 65'. Long-term estimates for the annual NHS bill - which is 90 billion this year, or about 7.8 per cent of Britain's gross domestic product, were over-optimistic.

The basic conclusion of the report was that 'healthcare spending could rise by about six percentage points of GDP between 2007 and 2050 which is significantly higher than the Government's projection of 1.5 percentage points'. The difference between the two positions is equivalent to more than 50 billion in today's terms. Based on the current size of the economy this would equate to an extra 17p on the basic tax rate. The IMF forecast had serious long-term implications for both health care and the national economy. They underline the question of whether public funding will be sufficient to keep the NHS fully operational. This data should have also raised fears in financial markets, where investors buy government bonds based on Britain's long-term prospects. An unexpected drain on the exchequer to meet health costs could damage prospects for future UK growth. In this report James Morsink, head of the IMF's European department, said the Government had "to be even more forthright in terms of describing the underlying uncertainties and what we see as the upside risks for health spending". As one might expect a Treasury spokesman said: 'The Treasury's projections on health spending over coming decades are based on official population projections and cautious assumptions regarding future trends in healthy life expectancy. The IMF's projection is based on various assumptions including technological change which are highly uncertain, and which may, in reality, lead to cost savings'. With such an irresponsible attitude to a statement of the obvious by the British Government is it any wonder that the UK economy is in such serious difficulty.

Elsewhere in the same report, the IMF said the economy was still threatened by overvalued house prices and energy costs. It also advised the Government to take more action on pensions, and said there was a 'compelling' case for increasing private savings funds and raising the retirement age. All these warning fell on deaf ears.

If a company pension fund maintains someone as they get old then it saves the State the need to do so. The Exchequer even gains tax revenue from this income stream. Until a few years ago the Government was encouraging people to take early retirement. Providing these people were working for a company that had a pension fund it was a way of creating new jobs. Getting people out of the labour force and into retirement kept the employment numbers up or more accurately the unemployment numbers down at no cost to the State. From the perspective of many companies it also made sense. It is often possible to employ two twenty five year olds instead of one sixty year old. The pension regulations still allow this to happen.

In the early 1980s the Conservative Government allowed companies to withdraw the surplus from their pension funds. This was welcomed by companies as it allowed them to show windfall profits. The Government benefited because this was money that went into circulation and could be taxed. This is one reason why so many of today's pension funds are under-funded.

When he became Chancellor one of the first things that Gordon Brown did was take more liquidity out of the pension system. In turn this forced companies to increase the contribution that they had to make to their pension funds. The whole pension industry is tightly regulated by the State. The Government establishes the requirements for company pension funds so there is nothing voluntary about the way that they are operated. This means that the pension provisions made by companies are a form of 'tax' on the general population. A large monopoly supplier like a bank or a utility company can make whatever provisions they like. It just goes onto the cost of goods and services that they offer. However companies that operate in a free market cannot keep on raising their pension contributions forever. This is why many final salary pensions have had to be closed. Many of the funds that are still in existence are in breach of the Governments regulations and will eventually fail because companies cannot maintain their commitments to the funds. In the long term even the most solvent pension funds (except monopolies) will fail as life expectancy continues to increase in a World where there is no profitable place in which to invest money. The Chinese have been very careful to prevent foreigners investing large amounts of money in their country and then taking out the profits.

Traditionally the argument would have been to put spare cash into a more profitable vehicle than a bank. Unfortunately the stock market is uncertain and property has reached its ceiling and will now have to fall substantially in value. Manufacturing no longer offers a safe investment as so much manufacturing capacity has been transferred to China and India. There is a lot of spare cash in the Western world and nowhere to invest it. Property ceased to be a good investment in 2007 so very recently spare cash has been used to speculate on commodity prices. There will be many more huge losses as the financial markets try to get around this conundrum. Recent history is littered with examples where banks and other funds have invested money in projects that never stood any chance of success like the Channel Tunnel and the Channel Tunnel Rail Link.

The banks have large amounts of money to place somewhere and yet there is nowhere profitable to invest it. This is one of the reasons why property values have increased so rapidly in the last ten years. The banks had money to dispose of and there were few commercial projects in which to invest it. Giving it to individuals with no security to buy property in the hope that they would meet the payments seemed like a good option. With artificially low interest rates this plan was logical and worked. As soon as interest rates rose this money had to be at risk. The operation could only function because Western Governments were prepared to hold down interest rates by misrepresenting the underlying rate of inflation and to turn a blind eye to the irresponsible lending practises of so many institutions. When a whole block of banks, building societies, and pension funds go bust as a result of the inevitable fall in the property market it will be interesting to see how the Government attempts to excuse its involvement. People's savings are not as safe as they would like to think because there is a limit to the number of banks that the British Government can support and the amount of debt that it can underwrite.

Even the richest private pension funds are in jeopardy because the difference between the real and the Government stated inflation rates is not factored into the equation. If a person retires at 60 on a final salary pension and lives to 95 then a modest annual misrepresentation in the real rate of inflation will have very serious implications for the individual towards the end of that period. If the accumulated level of taxation across society continues to creep upwards then belonging to a very wealthy pension scheme will not guarantee security in old age. The reality is that today's younger pensioners, who are fortunate enough to have a final salary pension, will not have the standard of living that they expect when they get into their 80s and 90s.

Even more seriously the life expectancy of post war babies is not being factored into pension projections. There is a close correlation between the life expectancy of a child and its mother's health and nutrition during pregnancy. Children born after the war, with all the benefits of the Welfare State, will go on and on. This is the main reason why all the pension funds, excepting those for the employees of monopolies and public servants, will eventually fail. They were never structured or funded to support people who will spend as much time as pensioners as they did working.

Much is written about the need for the young to save for their old age. However this is a pointless action for any young person to take. If it is assumed that a retired person needs to have an income of 20,000 a year to live on then how much money would a young person have to save to have a comfortable retirement? The average young person now enters the working population at the age of say 20 and most expect to leave it at say the age of 60. This person can then expect to be a pensioner for another 30 years. There is no investment that will grow at a rate which keeps up with the real rate of inflation. At the very best money that is set aside in a pension fund will just maintain its value but it will not grow in real terms. This means that to receive an income of 20,000 a year when they retire a young person would have to save half their pre-tax income or almost all of their after tax income. With the cost of housing still at unrealistically high levels the average young person will need all of their after tax salary to remain solvent during their working life. The average British person has only enough cash to last a few months if they are unfortunate enough to lose their job. Living on the national average wage is not easy at present, but to suggest that a young person should try and save most of the money earned during their working life for their old age is nonsensical. This is a problem that is never addressed by any politician. Where is the average person supposed to find the funds to save for the future in a society where most of their income is already taken by the State? With the current real rate of inflation, and with nowhere to put money to get a good rate of return, even if a person had spare money to save it would be a waste of time.

There are Government bonds in which money is invested by pension funds but these tend to follow the general yields that are available in the marketplace. Government fixed-interest stocks today yield little more than 4.4% a year. Index-linked gilts barely yield 1.2% a year. These gilts yielded around 3% above the official inflation rate very steadily between the 1980 and 1997 and so their yield was just above the real rate of inflation at that time. When the current Labour Government came into office responsibility for setting interest rates was transferred to the Monetary Select Committee. The official rate of inflation then miraculously fell and with it interest rates. This fall in the return on gilts had serious repercussions for even the most inflation-proofed pensions.

Almost 70% of Britain's biggest equity pension funds have lost savers money in real terms over the past decade. Seventeen of the biggest 25 funds have returned less than the FTSE All-Share index over the past three, five and ten years. They have increased by an average of only 22% since 1998, while inflation has officially run at 33% or in reality close to 100%. In contrast, the biggest 25 UK equity unit trusts have returned 64% over 10 years, figures from Lipper, the financial data firm, recently showed. Only the very best have grown by over 150% during that period. Cuts in company dividends have also been hitting retirement savers' funds, as a chronic shortage of cash forces some of Britain's best-known companies to reduce dividends paid to shareholders or to even scrap them completely.

All this manipulation of the real financial data by the British Government means that someone who saves will find that there has been no real growth in their savings during their lifetime. There can never be pensions for today's young and even the healthiest pension schemes have to fail in the medium term let alone the long term as they can never keep up with the real rate of inflation and the increase in life expectancy. Soon the few companies that are still struggling to operate pension funds will eventually be driven out of business by Government regulations. Of course no one is going to admit officially that saving is pointless because the implications will be unacceptable to the general public.

Published: August 2008