Yet, despite evidence that housing associations have underestimated the amount of cash they need to pour into their employees' pension coffers, there is little sign that they are heeding the warnings. As a consequence, many may now face having to raise contributions to pension funds by tens of thousands of pounds.
The private sector has tried to head off the pensions crisis by abandoning "final salary" schemes – pensions with a guaranteed income linked to a staff member's final pay cheque. Employers say the scheme is cripplingly expensive and are instead beginning to offer new staff "money purchase" schemes which are dependent on the performance of investments.
Marks & Spencer, BT and Barclays are among the high-profile private sector firms which have taken heed of falling stock markets, increased longevity and changes in accounting regulations. They realise that not enough cash is going into pensions and are taking action by switching to less risky schemes. So why is that housing authorities do not appear to be taking similar action?
The nightmare to come
Many local authorities and housing associations are sitting on company pension schemes that could turn into a financial nightmare in years to come. Only a handful of registered social landlords have woken up to the potential enormity of the problem.
Too many housing associations have their heads in the sand about pensions
Ron Mendes, Baker Tilly
"Too many associations have their heads in the sand about pensions," says Ron Mendes, director of housing and local authority industry at Baker Tilly, which deals with around 10% of social housing's pensions market. "Funding a final salary scheme represents a big risk to an organisation. It can have a tremendous impact on the financial performance of the company."
Mendes says the problem is not necessarily with running a final salary scheme, but how housing associations plan to resource it. "Unless associations start planning now for how to sustain their pension, they could run into financial trouble later on."
So why panic? Salaries (of which pension contributions form part) are housing associations' largest overhead cost. If contributions to pensions need to be raised in order to meet tightening government regulations, or simply to meet the employers' obligations to existing pensioners, the obvious question is, where is this extra money going to come from? Most associations are dependent on tenants' rent for their income and this can only be raised in line with inflation. "Obviously, associations will have to make cutbacks on other services if they need to put more resources into pensions," says Mendes.
More than half of all housing associations are members of the Social Housing Pension Scheme (SHPS) – a final salary scheme – while most others either run their own final salary fund or contribute to local authority schemes. The final salary scheme is by its nature generous; employers agree to pay a percentage of their employees' salary into the scheme, irrespective of the company's financial state or the performance of the stock market. This means the employee has a guaranteed level of pension whether they live to be 65 or 105. That's good news for employees, but for employers it's an open-ended financial commitment.
The recruitment benefits of the final salary scheme outweighed the costs
Peter Jeffery, Anglia
For associations running their own schemes, such as Places for People and Riverside, a stand-alone pension scheme represents a considerable risk because they face the situation alone rather than collectively. Stand-alone schemes are also affected by the prospect of what, for employers, is an ominous new accounting rule. This is Financial Reporting Standard 17, which was introduced in November 2000 and comes into force in April 2005. It stipulates that a company has to report the details of its pension scheme in its profit and loss account. If a pension fund is in trouble, company stakeholders will be able to see in advance where it may have to be topped up from other revenue streams. FRS17 has caused a furore in the private sector. Indeed, it was this rule that brought the present pensions crisis to a head as more and more companies realised how far short they were falling in their pension commitments. Because of the antagonistic reception the rule has received, the government has delayed its original 2003 implementation date.
Safety in numbers
The pressures of funding a stand-alone pension scheme are already being felt in the social housing sector. Last April, the Notting Hill Housing Trust closed its own pension scheme in favour of joining the SHPS. Stephen Duckworth, projects director at the National Housing Federation, explains why we can expect to see more associations make similar moves: "FRS17 could make their bottom line appear volatile – investors and other stakeholders in the organisation will see that, which could affect their future funding."
But membership of the SHPS still entails risk; members of the scheme have already seen their ultimate payouts fall. Also, though the scheme is due to be reviewed in September, the results won't be known until March 2004. "Potentially, contributions could increase again," says Baker Tilly's Mendes. "But the main thing to emphasise is that associations need to be planning now, just in case. The worst thing to do is just wait and see what happens." Membership of the Local Government Pension Scheme likewise entails risk (see LGPS box, page 29).
Offloading the risk
Some associations have decided the costs of running a final salary scheme are too high to bear. Genesis, Home Group, London & Quadrant and Circle 33 have all chosen to escape the pressures of final salary pensions by taking up money purchase schemes.
Good risk management deals with risk as it emerges. The time to act is now
Terry Edwards
In a money purchase arrangement, the employee puts a percentage of their salary into their own fund (rather than a collective pool as with the final salary method) to which the employer contributes a specific amount as well. When the employee retires, the pension is based on that fund rather than a percentage of their income. So if the stock market falls in value, so does the fund. This means the scheme carries a set cost (and no risk) for the employer, but for the employee the pension has no guaranteed value.
Home Group switched in April last year to a money purchase arrangement after deciding its final salary scheme was impossible to sustain in the long run, despite the large size of the group. By 2001, Home was running five different final salary schemes as a result of mergers with other associations. The group wanted to simplify its pension arrangements and take better control of its costs.
Margaret Mossom, director of corporate affairs at the group, explains: "Mainly, we wanted to remove the volatility in employers' contributions because it's very important we can plan our costs. We've over 3000 staff and if you can improve control of your costs, you can more effectively manage other staff benefits, such as negotiating salary increases and providing training." Mossom is convinced that more employers will turn to money purchase schemes in the long term.
Forward thinking
Circle 33 and Genesis (see box) realised over five years ago that their final salary schemes were not viable in the long term. Ravinder Ahluwalia, pensions manager at Circle 33, says the group decided a money purchase scheme would better benefit employees. "At the time of the change [the early 1980s] we decided a money purchase arrangement would be more profitable and portable for our members. Still, some colleagues questioned the need for change. Now we are being commended for our foresight by other associations that are deciding how to take their pension schemes forward," he says.
But many other large associations remain unperturbed by the costs of providing traditional pensions. They believe the schemes help them to be more attractive employers to future recruits. Anglia and Places for People say they will use their final salary schemes to help boost their recruitment and retention rates. Peter Jeffery, director of human resources at Anglia, says one of the reasons he recently joined the group was for its pension provision. He believes it could be a major incentive to others thinking of joining. "At Anglia, we intend to market our final salary scheme more and more. At a recent executives' away day we decided that the benefits of the scheme outweighed the costs for two reasons: recruitment and growth," he says. "We don't want to put off local authorities from transferring their stock to us."
Unsurprisingly, champions of money purchase arrangements hotly deny the link between final salary schemes and improved recruitment prospects. Genesis, Circle 33 and Home all insist recruitment has not been affected by the type of pension provision they offer. Home's Mossom says that it would be simplistic to think money purchase necessarily meant a bad deal for employees. "You can't say that all final salary schemes are better than money purchase. The performance of a money purchase scheme depends on the type of investments you make – and the individual can choose what will work best for them." And what happens when the equity markets fall? "Shares are just one type of investment – there are others," says Mossom.
The Local Government Pension Scheme
Many employees in the sector rely on the Local Government Pension Scheme, which has traditionally been seen as a pretty good deal. It is a final salary scheme, which offers one-eightieth of final salary for every year worked and members can retire at 50 if they wish. The scheme is inflation-proofed and benefits are protected by statute. But unlike other public-run pensions, the LGPS is not backed by the state. Instead 100 local authorities each manage a fund that feeds into the scheme. As employee contributions have been set at 6%, this means that employers must meet any increase in the costs of the scheme. Presently, employer contributions stand at around 14%. For housing associations employing staff that have transferred to them from a local authority this could mean trouble. Terry Edwards, consultant to the local government pension committee, says councils and housing associations could see their contributions rise considerably. “Employers contributing to the scheme have reason to worry. Each fund is in a different condition so some employers will be more affected than others.” There is no legal obligation on housing associations to contribute to the LGPS, but under TUPE this has tended to be the case, with the result that former local authority staff have different pension provision from staff recruited by associations. Edwards says this situation could cause tensions: “If some staff have better pension provision than others, this means they are in affect getting paid more than their colleagues which could open the door to claims of discrimination on the grounds of age, ethnicity or age.” The LGPS is under constant review and the committee has sent out consultation papers exploring ways to make the scheme more flexible and ensure its sustainability – which could mean employers contributions will rise.Closing the open cheque book
Genesis closed its final salary scheme to new members six years ago in favour of a money purchase arrangement. Anu Vedi, who was finance director at the time and is now chief executive, says the group felt its traditional scheme to be like an “open cheque book”. “We realised we needed to cap our liabilities,” says Vedi, who points to increased longevity as the main reason for the group’s concern. He also believes there are major shortcomings with final salary schemes: “It will provide you with two-thirds of your final salary but only after 40 years’ service. And the days of sticking with one employer are over. Young people to day may change jobs six or 10 times in their career and with a FSS there can be a penalty for transferring out of one scheme and into another.” Vedi thinks a money purchase scheme has the advantage of portability. “An employee can take the scheme with them if they leave – it’s a more flexible system.” Even more than the lifestyle changes, the sheer costs of the scheme convince Vedi that more and more employers will be forced to close FSSs to new members. “I know that others are contemplating closing their final salary schemes. Associations need to remain competitive and cost effective. I’ve heard of an association that needs to increase its contribution from 15 to 25%.” Vedi says he hasn’t received any adverse feedback about the group’s pensions arrangements. “Some people worried about the impact on recruitment, but staff were pragmatic about the need to change and now we feel we’re ahead.”Source
Housing Today
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