Pension plan sponsors will almost certainly face higher costs as a result of last year’s market meltdown. Plan surpluses may now be a thing of the past and many companies will have to put more money into their plans to make up for market shortfalls. Are future pensions at risk? Canadian observers may want to take a look at what’s going on in Britain. The situation there offers a cautionary tale for anyone concerned about protecting future retirement income.

Employers in Britain have been rushing to abandon their final salary pension plans, provoking a pension crisis that’s causing considerable alarm. Major employers. including British Telecom Group plc, Marks and Spencer Group plcand Abbey National plc, have already closed their final salary plans to new members.

What has advisors worried is that some companies are now shutting down their defined benefit plans completely, switching existing pension plan members to a defined contribution arrangement that will probably give them considerably less than they’d expected to get at retirement.

Employees of Big Food Group, a frozen food retailer formerly known as Iceland, have threatened to sue the company for breach of contract because it plans to close its final salary pension scheme to existing members as part of a three-year restructuring intended to boost its share price. Meanwhile, 2,000 employees at accountants Ernst & Young in Britain were said to be “incandescent with rage” after being given just three months’ notice that the firm’s final salary scheme was being axed and they were to join new employees in the company’s defined contribution plan instead.

Such drastic action is not typical. But in mid-June, Britain’s Association of Consulting Actuaries reported that fewer than four out of 10 final salary schemes were still open to new members — and almost half of those left were contemplating closure. The ACA surveyed its members, who advise almost 3,000 final salary schemes in Britain, and said the results “are startling in underscoring just how rapid the move away from final salary pension arrangements has been over the past few months.”

The ACA notes that switching to money purchase arrangements wouldn’t be a problem if final salary schemes were being replaced by DC plans attracting equivalent contribution levels. But there’s evidence that money purchase contributions are generally falling far short of those that were going into final salary schemes, the ACA says. Lower contributions to DC plans could mean much lower pension income for employees.
According to Amicus, Britain’s largest private-sector union, a typical money purchase scheme will generate a pension about 40% lower at age 60 than a typical final salary scheme.

While poor market returns are undoubtedly a factor in the current crisis, a controversial new financial reporting standard issued by the Accounting Standards Board has been getting most of the blame. Known as FRS 17, it was to have been fully operative for corporate yearends after June 2003 and would require the financial statements of corporations to recognize pension fund actuarial gains and losses fully and immediately, instead of amortizing them over a period of 15 years. As well, pension plan surpluses or deficits, based on the current market value of assets and liabilities, would have to be shown on corporate balance sheets.

As pension plan surpluses morphed into deficits, the proposal caused an uproar. As a result, the ASB now plans to delay the deadline for compliance until 2005, by which time the International Accounting Standards Board will probably have announced an international standard for pensions that most European Union-listed companies will have to follow.

But while corporate pension plan sponsors in Britain have been granted a reprieve, it seems FRS 17 was probably just a convenient scapegoat for what has been going on. Amicus and the Trades Union Congress charge that final salary schemes are disappearing mainly because contribution holidays for employers are over.
Jim Tucker, a partner in KPMG LLP’s corporate recovery practice in Britain, says, “The real issue is that many companies are facing additional cash burdens that they may not have been anticipating.”

Companies that have downsized recently may have particular problems, he says. They may only have a small number of existing members to fund a scheme that is supporting a large number of pensioners or deferred members (who will retire in the future). These companies may have pension costs out of all proportion to the size of their payroll, Tucker says.