Time to face the truth on pensions

ALAN Pickering, the erudite former chairman of the National Association of Pension Funds, is fond of saying that you cannot modernise the world of pensions without first modernising the world of work.

What he means is that longevity - the fact that we all live much longer than we did when final-salary pension schemes first came into being - is the major factor making them unviable. Their financial health will not be secured and people's legitimate expectations about their pensions will not be met until we begin to work longer and retire later.

Today's news that Woolworths is raising the retirement age for new employees from 60 to 65 but keeping open its final-salary scheme for these recruits is therefore highly significant. It may not be the first company to take such a step, but its high profile means it is more likely than most to encourage imitators.

A bit depends, though, on how much flak it attracts. Trade unions in other rows over pension provision have fought attempts to raise the retirement age. They take the view that the crisis in pensions can be simply solved with more money, and that the bulk, if not all, of that money should come from company profits. If only it were that simple.

More money would help, of course, but even if it were available - and generally it is not - it would defer, not solve, the problem. When the old age pension was introduced, a man of 65 was expected to live to 68 - in other words he needed funding for three years, having worked for 50. Today, however, a man retiring at 65 can expect to live 13 years or more - and the more is causing turmoil in the staid world of actuaries because it is rising so fast.

Even this understates the true extent of the problem, because very many people retire well before 65 - partly because they want to but also because it is hard for men over 50 who are made redundant to get another job. The real employment blackspot is not among the young being helped by Chancellor Gordon Brown's new deal. It is among the over-50s who are shunned by head hunters and employers and left with no choice but to retire. The fact is, however, that a man of 52, or 55 or 58, does not need a pension; he needs a job.

But someone who does retire at 55 has probably worked only 35 years and will need funding for a further 23. Even if the stock market were more helpful and Gordon Brown had not upped the tax on pension funds, the sums would still not work. No one can save at that rate. People's expectations are too high. Failure to realise this is distorting the whole debate about pensions.

Politicians conclude that the crisis has arisen because pensions are too risky, so put their efforts into creating a system that is allegedly risk-free. This too is doomed. There is no such thing as a risk-free pension because it is not in man's gift to know what is going to be an appropriate investment policy for the next 40 years. All risk controls achieve is inefficiency and increased cost.

A sensible policy would be to start telling citizens that we need to learn longer and earn longer if we want to enjoy rather than endure retirement. There is little sign that any political party is ready to take this step.

Greenspan test for markets

EQUITY markets are rising because people sense recovery is coming. Bond markets are rising because people fear we are heading for deflation. This is highly unusual. Indeed, bond and equity markets are expected to move in different directions and when they move together it signifies that significant groups of investors believe quite incompatible things. It is hard to see how the economy can be recovering and at the same time be sinking into deflation.

This phenomenon is at its most acute in the US and this week all eyes will be on Federal Reserve chairman Alan Greenspan when he announces whether US interest rates are to be cut again and if so by how much.

His words and actions should give succour to one camp or the other - to the growth hopefuls, or to the deflationists - but he cannot please them both, so whatever he says should cause some upheavals in the markets.

No cut or a modest reduction will imply that his fears of deflation voiced several times in recent months are receding. But if he goes down that route it will hit the bond market hard and could easily deflate the speculative bubble that has grown fast in recent months - to the discomfort, no doubt, of many.

Alternatively if he cuts interest rates heavily, bond markets will see that as vindication of their fear of deflation and the logic is that equities should take fright because the benefits of cheap money for companies are outweighed by the loss of purchasing power.

One way or the other, Greenspan promises to set a stirring test for market sentiment.

Unreal borrowing deal

THERE are times when you cannot but marvel at the working of financial markets. US carmaking giant General Motors said it plans to issue $13bn (£7.8bn) of bonds to be used in large part to help cover its pension fund deficit of around $30bn, and its shares went up.

Several things about this don't quite pass muster. Think of a pension deficit as a long-term loan from the pension beneficiaries to the company. So by issuing bonds GM is swapping one long-term loan for another. But it has to pay interest on the loan raised in the market, so it only makes sense if it thinks it can invest the money and earn a higher net return than it is paying in interest. We don't know yet what the coupon will be, but it must be over 5%. If we are in for another bull market, beating that will be quite easy but if not it may end up costing shareholders money.

Where things really part company with reality is that American accounting allows companies to assume they will make a return - in GM's case 9% - on pension fund assets whether they make it or not. They are allowed to show this as a profit for the business, not the fund. So the bond issue will boost GM's profits by 9% of the extra money going in (minus the rate of interest).

One analyst reckoned this earnings enhancement to be 37 cents a share, not far short of a 10% uplift on the $4.44 he was forecasting. It is fantasy land, but the shares went up.

But that $13bn of bonds is almost half GM's entire stock market value and does not cover even half its pension fund deficit. The company is utterly in hock to its employees and to its pension fund. If I were a shareholder I would worry what was in it for me.

NPI lesson

NEWS of more job cuts at NPI reminds me of Andrew Lyons, the executive who six years ago sold National and Provincial Building Society to Abbey National, then moved across to National Provident and within 18 months sold it to AMP - all the time proclaiming there was no business as worthwhile as a mutual.

AMP paid £1.3bn for a business it could not give away today. Not bad, given that the reason for the sale was that NPI had decided it was too weak to survive on its own.

It has not turned out happily for NPI policyholders either. They have learned the hard way that the £300 or so windfall collected on takeover is as nothing compared with the damage to the value of their policies when a group closes to new business, as is happening now.

Such closure normally means lean times for existing policyholders as there is no new policy money coming in to help cover costs while the overall investment policy has to be slanted for actuarial reasons towards low-yielding bonds rather than equities. There are more than 400,000 NPI policies still to mature. The disruption and relatively low returns likely from here on will do nothing to rebuild customers' faith in the savings industry.