Unsound Money Is Crucifying Pensions

Deficits are mounting in pension obligations. It is a global problem over which pension trustees are helpless. It is also a problem that’s brushed under the carpet, with prospective and current pensioners generally unaware of the threat to their retirement. Investors in companies with defined benefit schemes, schemes which promise an inflation-adjusted entitlement based on final salary, generally ignore this important issue, as do most stock market analysts. Analysts know the deficits are there, but so long as they are buried in the notes to the accounts and not actually represented in-your-face on balance sheets, the assumption appears to be they can ignore them.

Company directors may not shout out about it, but they are bound to be very much alive to the problem. Last week, BT, the British telecoms giant, tried to save itself money by attempting to persuade a court to allow it to substitute the Retail Price Index for the Consumer Price Index in calculating payments to its pensioners, arguing RPI had become an inappropriate measure of inflation. The application was rejected. 

Mr. Justice Zacaroli said, “It’s impossible to say that RPI is wrong and CPI is right, or even that RPI is more wrong (or right) than CPI, as an estimate of the likely increase in the cost of living for pensioners.” BT’s pension deficit is estimated at £14bn, and it had hoped to save billions by linking it to the CPI, but the judge ruled the original agreement in 2002 to link payments to the RPI must stand.

The judge was certainly right in his assessment, more so than he probably realized. The concept of a general price level, which CPI and RPI are meant to represent, is actually unmeasurable, as the divergence between the two measures illustrates. The judge presumably thought both measures were valid but in fact neither are, being attempts to measure an abstract hypothesis.

Not that BT was being entirely honest in this matter either. Since indexation of pensions commenced, companies like BT chose the RPI for one reason: it included estimates of changes in mortgage costs, which over time had been falling. Therefore, the RPI stated a lower rate of price inflation than the CPI. Now that it has reversed, BT and other companies with defined benefit schemes should really have no grounds for complaint.

Unfortunately, pension deficits in defined benefit schemes are now the rule. In the UK alone, they are currently estimated to total £410bn. This is despite attempts over the years to alter private sector pensions to a defined contribution basis, which means pension shortfalls become the pensioners’ problem.

And we are not even talking about unfunded public pensions, which are covered out of current taxation. These additional liabilities in Britain are estimated to be about £1.8 trillion, which together with the deficits on defined benefit schemes amount to over 100% of GDP. Both the Treasury and Office for National Statistics completely ignore the problem, not even according it a footnote in the national statistics.^[i]