Pensions Pose Major Challenge To Hard Pressed Manufacturers

Originally published in the Birmingham Post (Manufacturing Supplement) in March 2003

As if life wasn't tough enough the final salary pension scheme has reared its head as yet another worrying burden on the shoulders of manufacturing and engineering companies already caught in the grip of a long-term recession.

These companies tend to have very generous pension schemes with a guaranteed level of benefits based on the employee's final salary and service with the company. Such schemes are popular with employees as they provide the security of knowing what income to expect in retirement, but increasingly they are posing serious problems for employers who have to underwrite the pension promise.

The economic downturn and plunge in stockmarket returns have hit final salary pension schemes hard. Even schemes which have been generously funded in the past are finding that there is not enough money in the kitty. Employers are being asked to put more in and for manufacturing and engineering companies this may be the final straw. They simply do not have the profits to pay more to cover the pension promise.

The new accounting standard, FRS 17, has added more fuel to the fire. Companies have been forced to provide investors with a snapshot of the extent of their funding commitment on a particular day. This crude view, which makes no allowance for how the stockmarket will fair over a number of years or of changes in the company's pensioner profile, has provided some shocking news. Dramatic drops in the stockmarket over the last year have resulted in companies showing large pension deficits in the notes to their accounts. This has presented a misleading picture to potential investors who wrongly assume that the employer will inevitably have to make up the deficit. The reality is that if stockmarkets pick up, any deficiency in the scheme will go down without the need for any additional payments from the company. But the very fact of having had to provide the snapshot has sent some company shares into freefall – further tightening the economic screw.

So what can employers in this position do? Well, they are not alone. A shortfall in funding is very common now and their professional advisers should be able to offer them practical advice to help them. Instead of a big bill now, companies may be able to make up the shortfall over a long period of time. The typical period is 10 years, but the pensions regulator can agree a longer timescale than this and, indeed, last year approved payment over 18 years for one small manufacturing company.

Many companies are also thinking about the longer-term viability of their pension schemes. Newspapers have been full of stories about companies closing down their final salary schemes and offering a cheaper alternative such as a stakeholder, but this is not without risk. Any deficit in the scheme will be crystallised immediately which could put some companies out of business, and will not help industrial relations. There have been a number of high profile members' action groups set up to fight the changes. Such a change would be very messy (and embarrassing) to unravel if not carried out properly.

Winding up a scheme, especially a large old scheme, is a lengthy process in itself and is very expensive in management and trustee time as we have seen at first hand acting as an adviser to several companies in this position. There are also the winding-up costs to be factored in.

There are alternatives. An employer knows his own marketplace and what benefits will attract and retain the staff. The pension is just one benefit. Employers thinking of changing the pension package should look at all the options. They could retain the final salary scheme but reduce future benefits or close the scheme to future joiners. Members could be asked to pay higher contributions. After all, if the employer offers an expensive pension benefit it may not be able to provide other benefits, or it may limit its options for salary increases. Unions and employees understand this and may well be prepared to agree to changes. Recently BAe Systems promised to retain its final salary scheme, but is considering asking staff to contribute more. It is also looking at setting up an alternative with lower benefits.

Before making any changes, companies should take advice. Any amendments to the pension scheme will depend on the rules of the particular scheme and the contractual promises the company has made to its staff.

Changes also need to be communicated carefully to ensure that unions and staff understand why they are being made. This is not something to be done quickly. Employers should not give the impression that they are trying to steamroller changes through.

A small amount of effort can pay dividends. Staff who have worked for a particular employer for the whole of their working life deserve this much.