Pension

The Royal Mail has said that the final-salary pension is no longer viable. Strikes loom. The solution lies way beyond the control of either side in the dispute.

A final-salary pension refers to when your pension, post retirement, is a function of your salary just before you retired.

Getting unaffordable

And you get the pension, no matter what. It is ring-fenced – at least in theory, although neither rings nor fences are what they used to be.

Such schemes are becoming increasing unaffordable, and the Royal Mail is the latest to warn that its scheme could be shut down. This would affect 90,000 employees, many of whom might respond by saying: “But I took this job, and accepted lower pay that I could have got elsewhere, precisely because of the final-salary pension.”

Such people are furious and with good reason. Strikes loom.

But moving beyond the rights and wrongs of the parties involved in this affair, you need to look further afield to find the real cause.

Why is it happening?

There is more than one factor at play here.

For one thing, we are living longer, and that means we spend more time retired. A final-salary pension is not so expensive when workers die a few years after retirement, but it is not like that now. In one sense, you might say that lower pensions are the lesser of two evils: the other evil a being shorter retirement and indeed life.

For a second thing, we are living longer. Now, the astute may have noticed that ‘thing one’ and ‘thing two’ are the same, but there is a reason to mention them twice. We are living longer and spending more time retired, and thus demand across the economy is less as people with pensions tend to consume less. That is hitting company profits, which hits their equity values, which hits stock market performance, which is not so good for pension companies. Also, as a function of this, the ratio of the retired to the working population is rising, reducing output per capita across the economy.

Thirdly, interest rates are at record lows – ridiculous record lows. When you retire, and your pension company starts paying you a salary, it invests money into bonds. So the money it can afford to pay out is a direct function of interest rates. And when interest rates are 0.25%, and inflation is on an upwards trajectory and is likely to pass 2% within a year or so, there is not much income in bonds.

So it’s a double whammy. Because of greater longevity, pension companies have to set aside more money in their funds to make it last longer in order to pay pensions, but because real interest rates – that’s inflation minus the rate set by the Bank of England – are minus, the money they set aside actually falls in value ever year.

Ironically, low-interest rates and their close cousin quantitative easing (QE), a policy set by the Bank of England to support the low-interest rate environment, are supposedly good for equity prices, so they should boost growth in the value of a pension before retirement, but reduce income from that pension post retirement. Then again, QE or not QE, given that the FTSE 100 today is worth less than its price on December 30, 1999, the stock market performance this century has been woeful.

For a fourth thing, we are living longer, that is to say, we are living longer globally, meaning that we save more when we approach retirement, and demand is less across the global economy as a result. That is the underlying reason why interest rates are so low.

Or to put it another way, the fact we are living longer is everything.