Issued: 21 October 2003
We have all heard about the flight from DB to DC but based on my experience, final salary schemes have been closed to new entrants and staff offered new low contribution DC Stakeholder arrangements, all of them unit linked contracts. Very few people have joined the Stakeholder (fact). If it is bad for DB, it is probably even worse for a DC member in a unit linked arrangement. The real flight is from DB to nothing!
Everybody will sympathise with the dreadful plight of the members involved in final salary deficit wind-ups. (I do just wonder whether Gordon Brown could have helped bail out some of these people from the ACT "wheeze" dumped on pension funds in 1997?)
However, look at what has happened with unit linked DC plans. If you take an example of somebody who has a unitised equity plan they would have seen their equity values plummet over the last three years. The FTSE100 index stood at around 7,000 in December 1999 and now (15 October 2003), it is just under 4300, a drop of around 39% or so. Over the same period annuity rates have worsened by about 21%. Looking at annuity rates for a male aged 65 escalating at 3% based on having £100,000 in January 2001 it would have been possible to have secured of an annuity of £7,100 per annum. However, three years on, with the reduction of fund values and the worsening of annuity rates, the annuity secured falls to £3,355 per annum. This means a reduction of 48%. The policy holder will get a pension approximately 52% of what he had been expecting three years earlier. These are just the sorts of figures you see in DB wind-ups.
Perhaps we need some panic headlines in the financial press about the disaster situation for those near retirement who have unit linked DC plans.
We are told that lifestyling will sort out the situation, but don't believe that. People may not know when they are going to retire and this applies to a very significant percentage of the population. A lifestyling strategy, is then flawed from the start. To get around this many plans move people into bonds relatively early and it could be argued that this could result in a significantly lower investment return, but the real risk issue is if somebody thinks s/he is going to retire at 65 and decides to implement lifestyling, say, seven years or so before retirement date and then they are downsized. They are completely mismatched. Lifestyling is a lottery. You need to be lucky.
Then we have the next lottery - drawdown. A colleague of mine has a unitised equity fund, which about three years ago was worth just over £1m. He decided to take drawdown at 60, but he has seen the capital value of his "pot" reduced by £350,000; he has seen annuity rates worsen and is now saying "with a capital loss like that, he can’t afford drawdown. Also the fees are expensive."
Take somebody with a potential pension of around say, £5,000 (and this makes all the difference between having jam on their bread as opposed to having no jam), then a 40% reduction or so in their pension is really very serious stuff.
Yet we don’t see headline stories about the serious dangers of unitised plans. Everybody seemed to laugh at with-profits. This is why the article in the Financial Times on the 22 September 2003, "Unit-linked products seen as biggest losers" was salutary. I would like to quote from this article:-
- With profits pensions have performed better in the past decade than unit linked products.
- The moneyfacts study showed an even sharper contrast between unit linked and with profits pensions over a 20-year period.
- Somebody who took out a unit linked pension in 1983 paying £100 per month would now have a pension worth £42,688 but a with profit contract would have produced £81,502.
I have to say I am saddened by finance directors, who are intellectually stimulated but fooled by unit linked possibilities coupled with lifestyling and drawdown. They then expose their staff to the serious risks of inappropriate choice. These finance directors along with the so-called experts think they have all the answers.
I think it is about time that such people "get real". We see horror stories of people seeing significant cut backs in their pensions under final salary schemes being wound up but the same impact is taking place for those who have unit linked pensions, on a daily basis and it doesn’t hit the headlines.
Perhaps we could rename these contracts "Lucky Dip Pensions"?
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