Solving the pension crisis

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I noticed this article in the FT last week:

BT, sponsor of Britain’s largest pension scheme, shocked investors last month by revealing that it would have to increase annual contributions to its pension scheme to £525m for each of the next three years, up from its current rate of £280m.

The sum, equal to almost a quarter of the telecommunications company’s projected free cash flow, stems from an agreement struck with scheme trustees in late 2006 that is legally binding.

BT has a market capitalisation of about £8 billion today. It’s going to pay almost 20% of that into its pension fund over the next three years, more than half of that being to make good a deficit. It’s far from alone in having such a deficit: most pension funds have.

The extraordinary thing is around 50% of pension funds are still invested mainly in equities. Gilts and bonds make up about 30%, property 7%, private equity and hedge funds under 5% and the rest is cash.

All this suggests that what BT is doing might be fine for it, but in a macro sense it is quite illogical. Almost all BT’s free cash flow is going into its pension fund, so reducing its capacity to invest and make profit, at consequent harm to its long term earning prospects. And if all FTSE companies are behaving in broadly the same way (and that is, I know a big assumption, because not all have the sort of pension commitment BT has) then we have the start of another crisis on our hands.

Put simply, BT is destroying profit earning potential to buy shares: second hand shares at that. The shares it will buy are already in the market: they will not generate new investment. Al they do is purchase a property right: a right to receive future income from stock exchange quoted companies in large part; companies just like BT.

Of course in the short term the excess demand for a pool of shares of broadly fixed amount (few companies issue new shares now except in time of crisis indicating poor performance and low investment return) means share prices must go up for a bit. And then the crushing realisation will dawn: there is no extra profit as a result of making these cash injections to actually provide an investment return, so the market will correct, share prices will fall, and the cycle will repeat ad nauseum.

All of which shows that shares are either inherently unsuitable as a mechanism for long term saving when too many funds are invested in them or, alternatively, that the way we’re funding pension funds makes no sense.

Remember of that £1.575 billion BT will pay a significant sum will go in broking fees and the subsequent churn on the resulting investments, and on extraordinarily high paid advice from the City which will produce results of about market average, at best, and somewhere along the way much will be raked off in similar ways. And all the time more will go to a limited few in the City and less to investment in BT, elsewhere, in real jobs and to pensioners. Because let’s be blunt: pension funds are a mechanism for transferring future wealth into current earnings for the City of London. that is their primary purpose right now as far as I can see.

So I was going to suggest a solution of the type Robin Blackburn created a while ago:

A bold strategy would simply require all private employers above a certain size - say a turnover of £10m - to pay 10% of annual profit into a national pension reserve fund. They would be permitted to make contributions in either cash or newly-issued shares. The pension regulator has already allowed cash-strapped corporations to contribute to the PPF by issuing new shares and it is an innovation worth following

I like this: isn’t it obvious that BT should now just issue it’s pension fund with shares in itself so the fund acquires 20% of its worth, with the opportunity to divest over time, and the problem is at least in part solved? If all companies with deficits did the same we’d go a long way to tackling the problem — and would undertake the most massive change in the wealth profile of the UK you could think of. Except the vested interests would yell and howl in protest to maintain their right  and deny that of future pensioners.

But then along comes China today proving that the a real alternative is possible:

Every state-owned company that has listed in China since 2005 must transfer stock equal to 10 per cent of the shares offered to the National Social Security Fund, according to a weekend government edict.

A similar requirement already covers listings of Chinese state-owned companies in Hong Kong and has made the state fund the largest institutional investor in the city’s stocks.

Now I know China has all its own problems: but this is a clear move in the right direction. In fact it offers a whole new hope for the way in which pension contributions are managed, outside bank control, without their being the opportunity for being fleeced by the City and without requiring the massive drain on cash that happens now.

Let’s create (as Robin begins to suggest) a national pensions agency. Quoted companies pay at least part of their pension contributions in shares: their pension funds are credited with part of the national pool of pension assets in exchange: they get a share of the index in effect as a return. Average results are guaranteed. And every company would have to do this: no ifs or buts. In unquoted large companies the same could be done: there would simply be a pool of ‘private equity’ style investments in them to be shared as well.

This is a viable national pension fund.

It shares future wealth.

It does not constrain current investment.

It does not reduce liquidity.

Now, why not?

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