e) The contribution gap (difference between the combined Employer-Employee contribution into defined benefit and defined contribution schemes) has grown.

f) Group Personal Pensions (GPPs) are now the prevalent type of pension arrangement in these smaller firms. 44 per cent of firms offer such arrangements, with 25 per cent only offering a GPP.

g) Among firms currently not offering pension schemes, 42% expressed considerable interest in Multi-employer schemes.
h) 37% of the firms surveyed have also established stakeholder schemes, either alongside other arrangements or as stand alone schemes.
i) While a few firms are marginally increasing employer contributions into defined contribution arrangements, few employees are increasing contributions.

j) The survey also found that only just over a half of defined contribution schemes offer fixed interest bonds or index linked bonds as an investment choice and around 20 per cent offer no default investment option for either employer or employee contributions.

Bad press given to pensions over the last 2 years, largely due to the effects of falling investment returns and demographic changes, has undermined the promotion of pension saving, has undermined the perceived value of schemes and has discouraged the setting up of new schemes.
This bad press has largely left interest in pensions at a low level (14 per cent) in firms not offering a scheme, as against the situation in firms offering a pension scheme, where 60 per cent report greater interest.
The survey finds that are a growing number of employees of all ages taking on greater investment risk, supported by generally low levels of contributions. Worse still, we then have, through the absence (and decline) of occupational provision, a further large grouping of our citizens becoming dependent on State guarantees that deter savings but which, over the longer-term, are probably unreliable or unsustainable.

But on an organizational level, there is some good news. A report in the Business Section of the Evening News states the encouraging fact that the pensions shortfall faced by the UK’s biggest companies fell by nearly a quarter during the past year as firms doubled their contributions to the schemes.

According to actuarial consultants Lane, Clark and Peacock, the deficit faced by FTSE 100 firms with final salary pension provision fell to £42 billion from £55bn during the year to the end of July. The report credited the fall to higher stock market returns and a doubling in the amount firms paid into the schemes. However, it warned that contributions still needed to rise further as companies held an average of only £84 of assets for every £100 of liabilities they faced.
REASONS FOR THE PRESENT FOCUS ON PENSIONS:

Why have pensions suddenly become a problem? Four things have come together to turn what used to be a UK advantage into a significant business burden:

1) The three-year bear market in shares has transformed expectations about investment returns in future. Most experts concede that the effect of the downturn has been to bring a dose of reality into investors’ expectations.

Most pension fund managers recognize that the double-figure annual returns of the past owed much to inflation and that, in a lower inflation environment, future returns will be comfortably in single figures. Many have followed the example of the Boots pension fund in diversifying out of equities.

2) The downward shift in expected returns has coincided with an upward shift in life expectations among retired workers. Actuarial changes of this kind do not normally happen suddenly. In this case, however, greater longevity appears to have taken some pension trustees by surprise.

3) The abolition of the dividend tax credit when Labour took office in 1997, has hit funds at a time when they can least afford it.

4) Pension shortfalls have been given added prominence by the new FRS-17 accounting rule, which requires firms to provide a snapshot of pension liabilities versus assets, with a presumption that action will be taken to gradually remove any shortfall. (Brown,2003)

IMPLICATIONS OF THE CHANGE FROM SSAP-24 TO FRS-17:

SSAP 24 is the former UK Accounting standard that deals with the accounting for, and the disclosure of, pension costs and commitments in the financial statements of entities that have pension arrangements for their employees. It requires employers to recognize the expected cost of providing pensions on a systematic and rational basis over the period during which they derive benefit from the employee’s services. FRS 17 Retirement Benefits replaces SSAP 24.

FRS-17 is the new accounting standard to be put into place for UK Retirement Benefits from January 1, 2005. The proposed adoption of FRS 17 has attracted significant debate over the last year or so. The main point of contention concerns the long-term implications for Defined Benefit pension schemes.

The new regime is an improvement in many respects. It will lead to greater transparency and consistency in accounting practices and will make for easier comparison of pension costs between companies.

However the adoption of FRS 17 is not without problems. The previous SSAP 24 standard allowed the principles of ‘smoothing and spreading’ the value and payments of the pension fund amounts on the financial statements. But under the FRS-17, this has been replaced by a far more prescriptive valuation assumption and there is little room for actuarial discretion. Assets are measured using Market Values. Liabilities are discounted at the yield available on AA Corporate Bonds. Under the FRS-17, the pension scheme surplus or deficit must be recognized immediately on the Balance Sheet.

The sharp fluctuations of capital markets combined with the mismatch that UK pension funds invest a large proportion of their portfolio in equities while their liabilities will now be valued using bond yields is expected to create large swings in the funding positions
of pension schemes.

Newer companies whose pension funds are small will not be affected much by this volatility. However, it will be important to some of the older and larger companies whose mature pension funds can be a significant percentage of the market capital of the company. Therefore, the potential volatility introduced into the balance sheet may be huge. FRS 17 will serve to increase the focus on the funding of pension funds and their level of investment risk.

Some industry professionals argue that this effect is purely a change in accounting rather than underlying cash flows and as such is of little importance. Equity analysts, credit analysts and rating agencies are all likely to take a keener interest in pension provision.
A company having a healthy pension plan in surplus with a good investment portfolio will be looked at more favourably than a company with a deteriorating portfolio or a significant funding deficit.

To address this issue of balance sheet volatility, the most obvious solution is to closely align pension fund assets to the way in which their liabilities are measured. For example, it may be done by increasing exposure to UK fixed interest and particularly to the non-gilt market at the expense of equities. The non-gilt market has grown rapidly in recent years and at a market cap of £215bn it is now larger than the government market itself. Exposure to the credit sector can be expected to produce superior returns alongside the benefits of diversification.

It is well known that the typical UK pension fund currently has an allocation of 75% to equities compared to a 25% weighting in fixed interest. While no one would suggest that pension funds make a sudden dramatic change to their asset allocation, there is plenty of scope for a modest increase in fixed interest exposure. This would also be in line with other indicators such as the increasing maturity of pension schemes and the recent fluctuations in equity market performance, which suggest a similar shift. Such a strategy change could potentially present some conflict of interest between company management and pension trustees.

Other potential solutions to the volatility problem involve the use of Derivatives and Interest Rate Swaps. The aim is to offset the asset-liability mismatch in the pension fund with an opposite position on the company account. Unfortunately, the benefit of these approaches is not symmetrical and therefore limited. While a transfer of profits on company investments can meet a shortfall in a pension fund, a surplus in the pension fund may be deemed to belong to its members and therefore it cannot protect against a loss on the company account.

At this stage, the full impact of FRS 17 still remains unclear, however, it is likely to bring changes to the way that pension funds are both perceived and managed. These can be expected to further increase the pressure on trustees of large defined benefit pension schemes to increase their allocation to fixed interest securities. (Martin, 2001)

One point to be noted is that dividend payments to shareholders could be drastically reduced from 2005 with the full introduction of UK pension standard FRS-17 and international financial reporting standards. It has already resulted in the appearance of huge deficits in schemes for those adopting the standard early. It is likely to happen as companies try to plug holes in their pension deficits by using the Retained Earnings or Distributable Reserves on their balance sheets. These amounts were earlier used for paying dividends and share buy-back schemes. Therefore if a company has an FRS17 deficit larger than its distributable reserves, it will probably be unable to pay dividends to shareholders.

For some companies this would have a substantial impact on share price. Large deficits could halt some companies' ability to pay dividends for several years.

The new standard thus takes a snapshot of a company's pension scheme on a particular day, rather than looking at a longer-term view of the scheme. (Grant, 2004). Arguments in favour of the adoption of this standard meanwhile, are that it forces companies to match their assets with their potential liabilities. It will also safeguard the interests of the pensioners, who were given a raw deal in the past as proved by the House of Maxwell and similar frauds, where removals from the Pension Funds were camouflaged.

Moreover, the change over to FRS-17 in 2005 requires a top up of existing pension deficits in many firms. In fact , 46 per cent of firms i.e. nearly half, believe that the need to top up pension schemes is going to adversely impact on their profitability.

Rolls-Royce, for example, has a pension fund deficit, based on the FRS17 accounting rule, of £1.1 billion, four times the company’s 2002 pre-tax profit of £255 million. Its problem has been emerging for some time - the company closed its main fund to new entrants as long ago as January 1999. Despite this, the scheme required additional funding of £35 million from the company during 2002. (Brown, 2003)

FURTHER IMPROVEMENTS: IMPLICATIONS OF IAS 19

There has been a move towards further improvements in reporting standards. As part of a European-wide adoption of International Financial Reporting Standards, from 1 January 2005 listed UK companies will be required to account for pensions in their consolidated accounts under the IAS-19 standard. At the end of April, the IASB issued an Exposure Draft (Actuarial Gains and Losses, Group Plans and Disclosure) setting out some proposed changes to IAS-19.

For most UK companies, the transition to IAS-19 has already been largely foreshadowed by the existing requirement to make pension disclosures under the FRS-17 standard. Whilst there are important differences, and the range of employee benefits covered by IAS-19 is wider than for FRS-17, the two standards are substantially similar in many respects, including the basic 'bond based' approach to measuring pension obligations. One of the proposed changes to IAS-19 will partly address, on an interim basis, a major difference that remained, by allowing companies to account for actuarial gains and losses using the approach adopted by FRS-17.

British firms should, therefore, already be familiar with most of the issues arising from the amended IAS-19 and having to comply with it should be a less significant event for them than for their continental European counterparts, where for many it means a radical departure from their existing accounting approach. Whilst companies reporting under UK GAAP have been required to make FRS-17 disclosures since 2001, many are still recognizing pension costs under the SSAP-24 standard, pending full implementation of FRS-17. SSAP-24 is due to disappear entirely from 2005, at which time UK companies listed on an EU exchange will be required to comply with international accounting standards.
For non-listed companies, the UK government has signalled that they will be permitted, but not required, to use international standards, with a review in 2008. This implies that whilst listed companies will have to use IAS-19 for their consolidated accounts, any non-listed subsidiaries who have opted to retain UK GAAP will report pension costs under FRS-17. For a listed company whose accounting year coincides with the calendar year, the first set of accounts to be prepared under IAS-19 will be that for 2005. However, at least one year’s comparative figures will be required. Therefore for many companies the effective date of transition to IAS-19 will be 1 January 2004. Companies which provide more than one year’s comparative information will have an earlier transition date, and in particular this may be the case for companies with a US listing which also report under US GAAP.

ESTABLISHING CRITERIA FOR A BETTER PENSION SYSTEM IN THE UK:

A well functioning public pension system should consist of the following six criteria:

1. Adequacy
2. Equity
3. Transparency
4. Stability
5. Protection of Incentives
6. Administrative Efficiency

1. ADEQUACY:

Of course, it is most important that the first test of any pension system worth its name must be that it is a means of providing an adequate income to the pensioner in his/ her old age. That is the very purpose of this device. An abject criticism of the earlier systems is that it was far too inadequate and did not address the pensioners needs. For example in 1988/89, it was found that about 27% of the pensioners were living in households whose income was 60% below the median income of the average British household. To address this issue, the Chancellor of the Exchequer took steps in November 2000 and announced the Minimum Income Guarantee Scheme (under which the pensioners were assured an income of 92.15 pounds per week (with 140.55 pounds for couples). It was also promised to raise the single rate to at least 100 pounds per week by April 2002. The basic State Pension was also increased to 72.50 pounds per week (115.90 pounds for couples) in April 2001, and 75.70 pounds per week (120.70 pounds for couples) in April 2002. In the wake of recent inflationary trends, and recession in the economy, it is debatable whether these had any impact. The average earnings for males was 453 pounds, and for families it was 1000 pounds. So the Government was giving the pensioners a pension which did not assure a reasonable standard of living. The adoption of these proposals indicate that the average pension payable to a single pensioner in 2003/04 will be 13.80 pounds, which is equivalent to only 2.7% of the income of a working male (500 pounds in 2003/04). This again is hardly adequate.

2. EQUITY:

Equity means equal rights and entitlements. Unfortunately under the present Means Testing System, the pensioners, especially the female ones are not assured a reasonable income. The Means Testing System ties the pension payable to the earnings of the household. The state pension payable is also dependant on income and saving levels. If the income or savings available to an individual is above a certain limit, MIG is not payable. Individuals who have saved through additional means as a means of protection in old age may find that they are excluded from MIG payments for the fault that their incomes or savings are higher than the limit set for MIG assistance.

3. TRANSPARENCY:

There were five basic elements to Pension income prior to the reforms of November 2000. The reform has added two elements (three if SERPS is phased out gradually) and renamed one element (i.e. Minimum Income Guarantee). This means that an individual is now able to chose from five possible second tier pensions (occupational, personal, stakeholder, Second State Pension and SERPS) and, if they want to make additional savings, three further savings vehicles, (personal and stakeholder pensions and ISA’s).

This complexity at the level of the Pension System is compounded by the complexity in individuals’ lives. Making the correct pension decision involves not only perfect foresight over future reforms but also over lifetime earnings. In particular, making the right decision about opting out of the second state pension requires information about the level of lifetime earnings, gaps due to unemployment and caring responsibilities. Given that no-one has this information this raises the possibility of people ‘mis-buying’ Stakeholder Pensions.

4. PROTECTION OF INCENTIVES:

The rationale behind the Pension Credit scheme is to ameliorate the disincentive to save for those whose retirement income will be near or below the value of MIG. This however raises a number of issues. First, for the credit to be effective people have to understand how it is rewarding savings, and adapt their behaviour accordingly. This would require a thorough public information campaign. Furthermore, in order to adapt their behaviour correctly people would need to be able to project perfectly their income in later life and to calculate whether they are at risk of falling into means-testing. In reality, few people can and do have perfect foresight and the difficulty in predicting one’s own income in later life is made worse by the increased complexity introduced by the reform package.

5. ADMINISTRATIVE EFFICIENCY:

The extension of means-testing has had important consequences at the level of administration. The efficiency of delivering through a means-tested system depends upon the extent to which such benefits are actually taken up. The most recent DSS statistics suggest that take-up of income support is lower among pensioners than other groups (between 20 and 30% of pensioners entitled to Income Support are not making a claim), with single female pensioners making up the majority of those entitled to but not claiming Income Support.

PENSION SCHEMES AVAILABLE IN 2003
1. Basic pension
2. SERPS
3. Second State Pension
4. Stakeholder Pension
5. Occupational Pension
6. Personal Pension
7. Minimum Income Guarantee
8. Pensioner Credit
9. ISA

In the area of pensions in particular, reforms need to be assessed not only in terms of the level of provision but also their contribution to stability in the pension system.

Individuals require a degree of certainty in the long term in order to plan for their retirement. However, pensions have been subject to repeated reform over the last 50 years, creating uncertainty and insecurity for the older population and those of working age. As the gap between BP and MIG widens over time, the range of incomes affected by the Pension Credit will also expand. There are also issues about the sustainability of SHP, especially given the extension of means-testing by increasing the value of MIG. It can be argued that a rational response to uncertainty will be for people to hold assets in relatively liquid form (such as an ISA) so that they can adjust their holdings according to changes in the rules. Taking into consideration all these possible de-stabilizing factors, it is unlikely that the reformed pension system will remain in place over one’s entire working life. (Rake, Falkingham, 2001)

PITFALLS OF THE PRESENT SYSTEM:

In the past, the basic state pension was seen as the principal vehicle for ensuring a minimum level of income. However, since the mid 1980s the value of the basic state pension has fallen below the level of means-tested benefits so that the means-tested Minimum Income Guarantee has now replaced the basic state pension as the principal way of delivering an adequate minimum income.
The entire UK contributory pension system has relied on the long-term growth of the stock market to build benefits from joint employer-employee contributions, and it has also relied on the integrity of employers to act as honest administrators. For five decades it has worked pretty well, providing benefits at lower cost than the predominantly state funded systems common in Europe.
Bankruptcy of companies is an intrinsic part of the system, designed to cull unhealthy firms and bring markets into balance. Bankrupt companies almost always have massive holes in their pension schemes, and legislation insisting that pensions were at all times fully-funded would merely push more companies over the edge.

CONCLUSION:

The British pension system is inadequate. It is bewildering in its complexity. It is expensive. And it fails to provide an adequate standard of living for a large proportion of pensioners.

Both Government and current Conservative Party pension policy has only a short-term focus. The Government's raid on pensions funds, its major extension of means-testing, its failure to reform annuities and falling stock markets have led to an inadequate level of current pension saving.

Following are suggestions for a number of reforms to the state pension system. These fiscally neutral reforms would end the morally unacceptable situation whereby millions of people have to live on less than £100 a week in retirement.
A) Sweeping away a myriad of complex benefits, allowances and entitlements and replacing them with a universal pension system designed to allow everyone a comfortable living from the age of 70 onwards;
B) Increasing the Basic State Pension for a single person to £120 per week, without a corresponding increase in public expenditure;
C) Reducing the dependence of pensioners on means-tested benefits, thereby encouraging individuals to make their own provision for retirement and enabling the abolition of the requirement to invest in an annuity on retirement;
D) Abolishing the State Second Pension (although honouring existing commitments) and reducing private pension tax rebates to the level required to fund the improved Basic State Pension;
E) Treating everyone equally through the introduction of a universal basic state pension set at a level that will not force pensioners to rely on other state benefits;
F) Allowing those who wish to retire before the age of 70 to use part or all of their private pension to fund their years of retirement up to the age of 70;
G) Providing a safety net for those who have not made their own provision;
H) Raising the state pension age to 70 on a phased basis over 20 years, giving people enough time to prepare for the change. (Elphicke)
While it has been seen that the Pension System in the United Kingdom is in a state of constant flux, with changes occurring every few years, it still fails to assure a reasonable standard of living for the pensioners. The movement from SSAP 24 to FRS-17 will hopefully provide greater accountability and transparency in the methods of accounting and disclosure, preventing firms from committing Pension Fraud. Suggestions have also been given above which can address the needs of a fair and equitable system for all.