So close to the 250th anniversary of his birth it seems appropriate to recall that it was Rabbie Burns who wrote “Fair fa’ your honest, sonsie face, Great chieftain o the puddin’ race! Aboon them a’ ye tak your place, Painch, tripe, or thairm: Weel are ye wordy of a grace. As lang’s my arm.“
Not being immersed in the culture of my adoptive home to the extent that I should be, I’m afraid I haven’t a clue what it means but it does alert us to the fact that things are different in Scotland. This lack of cultural awareness on my part wouldn’t stop me downing a wee dram of whisky and sticking my dirk into a haggis with the best of them, though I’d probably double check the meaning of dirk with one of my Scottish colleagues first.
Scottish pensions, like haggis, have always had a very distinct flavour, but a flavour which has evolved over recent years. Scotland’s view of itself as a centre for saving dominated by large “national” financial institutions has been rocked by recent developments which have seen much of the power shift southwards.
As the Scottish government doesn’t have full devolved power to set the pensions agenda much of the legislation and approach is consistent with that adopted for the UK as a whole but there are some areas where the approach is different or where regional variations have an impact.
The major area of divergence is in the Scottish Legal systems dark ages approach to dealing with pension assets on divorce.
Unfairness often arises when determining the value to be placed on the pension benefits considered in divorce proceedings. In Scotland the only value that the court can take into account is the Cash Equivalent Transfer Value (CETV), the amount available to transfer to another pension scheme, which is apportioned to reflect the pension earned during the marriage.
The basis adopted for calculating CETVs is determined by the trustees of the scheme, usually having taken the advice of the actuary. As each scheme is left to decide on its own transfer basis there is scope for a large degree of variation in how different schemes would value the same benefit. The Pensions Regulator has published guidance for trustees which encourages trustees to use a “best estimate” basis which specifically encourages trustees to strip out from their CETV calculation basis the “prudent” assumptions trustees are expected to use for assessing the funding position of the scheme. The assumption most commonly amended is the future return on scheme assets. Where the scheme has a high equity content in its asset mix this is seen as justifying a higher assumed rate of future investment returns than would satisfy the “prudence” test applied to scheme funding assumptions. This can result in trustees placing a lower value on pensions for CETV purposes than they would for scheme funding. It is the lower CETV value which, in this scenario, would apply for divorce purposes in Scotland.
As a consequence the CETV is often an inadequate or inappropriate measure of the value of the pension given up and this is an area which needs to be addressed as currently the non-pensioned spouse could be losing out on as much as 50% of the real value of the benefit.
Scottish pensions are also dominated by public sector provision. Not only is there a huge number of the population covered by the large local authority schemes but as an increasing proportion of services provided are out-sourced to small charity and not-for-profit organisations they also tend to participate in local authority or large multi-employer schemes. Around 50% of the workforce in a pension scheme in Scotland is employed in the public sector and with these additional bodies it’s easy to see the level of domination.
Final salary pension provision remains the norm in the public sector, however the private sector has struggled to maintain these type of schemes, and the pace of change is likely to be quickened by the events of late 2008.
One major Scottish local authority scheme has seen employer contributions rise from 9.9%.in the year 2000 to just short of 17% today. More worryingly it is anticipated that this rate will rise to just short of 23% by 2014. So over a 14 year period that’s a rise of 130% in the contribution rate that we tax payers will have to find. So how much is this costing us as tax payers? It’s estimated that on average private sector workers pay 91p in to public sector pension schemes for every £1 they pay to their own schemes!! How sustainable is that in the current economic climate?
But you’re told not to worry as from April 2009 these schemes will be reformed with changed benefits and higher staff contributions. Don’t be fooled – the effects of the benefit changes are minimal and most staff will see a reduction in costs with even the average contribution to the scheme rising from 6% to only 6.3%.
A clear 2–tier pensions system has evolved and I’ve got to question if there is the political will to really address this issue now or if it’s just considered better to kick it in to the long grass on grounds of political expediency. The public sector vote is strong and the increasing power of the grey pound and the electoral clout of the pension generation is a difficult trend to buck if you’re a politician. J K Galbraith, a Canadian of Scottish descent, made the following telling observation in a 1962 letter to President Kennedy: “Politics is not the art of the possible. It consists of choosing between the disastrous and the unpalatable.”
Outside the public sector many larger employers are controlled from outside Scotland so decision making on priorities rests elsewhere, be it elsewhere in the UK or overseas. When finances are tight there’ll tend to be a squeeze on pensions. Final salary exposure in Scotland is becoming increasingly limited with numerous schemes closed to new entrants or to all future accrual and are an unwelcome legacy to most firms. Open schemes tend only to be linked to employers in the traditional manufacturing sector, oil or financial sectors with even those becoming more limited in number.
Indigenous Scottish employers tend to be smaller on average than those south of the border with a strong SME sector. This sector tended to more quickly embrace money purchase pension provision with smaller numbers of employers dealing with an unwanted legacy of final salary provision. There seems to be a greater demand for local actuarial and pensions support for these types of scheme although the Scottish advisory market still tends to be dominated by large multi-national and national firms with few regional advisers available which seems counter to the position south of the border although there are signs that local demand is changing this.
Contributions to money schemes tend to be much lower than those to final salary schemes, on average about 1/3rd the level, so the knock on effect will be for employees to have to work longer in to old age than previous generations. Contributions on average are also well below the level estimated to provide a realistic level of retirement benefits and the complex and confusing pension taxation system undoubtedly acts as a disincentive to save.
The UK, and Scotland in particular, used to have a pension system that was the envy of the world, but I’m afraid that is no longer the case.
David Davison is a Director of Spence & Partners, actuaries and consultants.