During the recent economic downturn it has become apparent that the cost of retirement provision has become very expensive. Coupled with an era when asset values have declined, this has led to increasing concerns: Governments, employers and employees alike have now realised that there will not be sufficient savings to enable employees to retire as early as in recent years and maintain their standard of living. Indeed, the need to further increase State Pension Age has already been highlighted and many of the closed Defined Benefit Pension Schemes (“DB”) are now seeking additional employer contributions to fund enormous deficits.
Costs have not only been driven up by asset valuations declining but over the last few years actuaries have determined that mortality tables need to be strengthened. This is to reflect the fact that people are on average expected to live longer and will therefore draw their pensions over an extended period. Obviously this will also have an impact when assessing the financial implications of a personal injury claim.
Why has this come about?
There are several reasons why the retirement landscape is changing so significantly.
The first is increased longevity which means that providing a pension based on only a small proportion of your total life is an unreasonable expectation. For example, if an individual starts work at age 21 and retires at age 55 (the new minimum retirement age to draw pension benefits from 6th April 2010), that will represent an employed period of 34 years service. If the same employee lives to age 90, that means they will enjoy 35 years of retirement whilst drawing a pension. It is totally unrealistic to provide for a pension over such a short period of time and then expect to draw it for another 30+ years. Periods of absence from the workplace due to redundancy or career breaks only increase the pension problem.
Secondly, many DB Pension Schemes which used to be sponsored by individual employers are now closed. These types of arrangement used to provide very valuable pensions for employees, usually with the most significant share of the cost burden being borne by the employer. These Schemes were often referred to as Final Salary (“FS”) Pension Schemes and generally provided for approximately two thirds of salary as a pension at normal retirement date, accruing over 30 – 40 years of service. For example, an employee earning £24,000 per annum might have expected to receive a pension of £16,000 per annum at their normal retirement age of 65.
The DB or FS Pension Scheme has in many cases been replaced by Defined Contribution (“DC”) or Stakeholder types of arrangement. Under this type of pension provision an employer usually pays a fixed percentage of salary each month to a pension provider, which is subsequently invested in a range of investment vehicles. The DC member may decide to switch the contributions into several different investments but upon reaching retirement age, they will normally convert the accumulated fund into an annuity or pension.
With this type of Scheme, if an employee aged 65 had a fund of £100,000, their pension would be approximately £3,652 per annum. The annuity factor I have used in this example is £27.38 : £1 per annum of pension. I have assumed the annuity is purchased with a 50 per cent spouse’s pension and Retail Prices Indexation; in other words, broadly the same type of pension that might have come from a DB Scheme. As can be seen from this example, an individual would need approximately £438,000 to buy the pension of £16,000 per annum, as previously described. From this analysis it is possible to see that buying a DC pension annuity is extremely expensive and it will require significant levels of contribution over an employee’s working lifetime to accrue a fund of this magnitude.
The value of an individual’s DC fund is determined not only by the level of contributions but by asset values, most of which are influenced by stock market levels. In times of economic recession the value of DC funds will in most cases have fallen quite dramatically. This often leads to people deferring their retirement plans because a lower level of pension will result from the reduction in asset values. Many individuals therefore wait until the underlying assets have had an opportunity to recover before electing to draw their retirement benefits.
People just cannot now afford to plan to retire at an early age because employers are now spending less on pension contributions per employee e.g. 6 or 7 per cent of salary per annum (instead of approximately 23 per cent of salary which was often contributed to DB schemes) and the individual is taking sole ownership for their investment decisions. This means that a smaller amount of money is being dedicated to pension provision and therefore lower pensions prevail. Even when individuals do take considerable care in making additional contributions, they find the total amount that is needed is substantial.
What could this mean for an employee?
The overall impact is that the concept of retirement is likely to change. It is now possible to draw a pension and carry on working for the same employer. Older employees will become a common feature in the workplace and with sophisticated advances in technology, people will be able to make an excellent contribution using their experience but perhaps working from home. Many people seem to be resigned to the fact that they will in fact “never retire”, as they need to earn money to maintain their lifestyle and do not think that their private pensions, State Pension or savings will in aggregate provide enough. Certainly this trend is already in evidence. As those currently in their 60’s and 70’s tend to enjoy better health and mobility than previous generations, they envisage undertaking part- time work or consultancy projects in order to meet the shortfall in their household budget, which in turn leads to them remaining part of the workforce for longer.
What might this mean in the context of a PI claim?
In terms of assessing the loss of earnings element of personal injury claims, there will be a need to reflect longer or plural careers, on either a full or part-time basis. Over time this will become common practice, particularly amongst today’s younger employees who will probably never have been members of a DB Pension Scheme and therefore will only have DC assets to retire on. However, whilst Claimants are still members of a DB pension scheme, it is necessary to recognise the value of this benefit.
Several employment reports which I have recently been involved with have included a claim for prospective earnings from Non-Executive Directorships, self employed businesses including consultancy and part-time earnings, all beyond retirement from a chosen career. The sums claimed can be relatively significant, as individuals are able to generate fees based upon their skills developed from many years of work experience. This trend is likely to continue, not only because of the cost of pension provision but also net income will reduce with the anticipated increases in taxation.
In summary, an employee’s extended working life, whether it is full time or part-time coupled with a longer period in receipt of pensions, could add considerably to the loss of earnings element of future claims.