Companies could slash UK pension promises to 11 million employees, potentially knocking thousands of pounds off the incomes of people in retirement, if proposals in a government consultation paper are approved.
Unions are likely to react furiously to the proposals, which would allow companies to save £90bn by providing annual increases in their retired employees’ pensions based on the consumer price index, rather than the retail price index.
As CPI is generally lower than RPI, the impact on pensioners is likely to be significant over time. Analysis by advisers Hargreaves Lansdown suggests that for every £1,000 in pension income in 1988, under RPI it had increased to £2,586 this year, but only £2,105 under CPI.
The changes are flagged a green paper issued by the pensions minister, Richard Harrington. It cites estimates from pensions consultancy Hymans Robertson that a shift to CPI would “take away about £20,000 in benefits over an average DB (defined benefit) scheme member’s life”.
Currently, 75% of pension schemes in Britain increase payouts to members each year using RPI rather than CPI, and usually the scheme rules and legislation prevent companies from lowering their promises.
But the paper asks: “Should the government consider a statutory override to allow schemes to move to a different index, provided that protection against inflation is maintained?”
In some circumstances, where a company is facing significant financial challenges, it could suspend pension increases altogether, the paper adds.
“Allowing all schemes to move from RPI to CPI would have [a] significant impact on members’ benefits. CPI has been lower than RPI in 22 years out of the last 27 (and nine years out of the past 10) up to 2015, and so [it] would in all likelihood represent a reduction in members’ benefits,” the paper acknowledges.
The change would affect 11 million people in defined benefit schemes, also known as final salary schemes, where the level of pension in retirement is a proportion of the person’s salary. Most private companies have closed these schemes, replacing them with pensions where the payout is entirely dependent on the performance of stock and bond markets.
Harrington said: “We all have a responsibility to ensure the system works in the interests of everyone – employers, schemes and scheme members. This green paper sets out the evidence we have available about the key challenges facing DB pension schemes and highlights a number of options that have been suggested to us to improve confidence in the system.”
But the former pensions minister Steve Webb, the director of policy at pensions company Royal London, said: “The most worrying proposal is to allow certain schemes to ‘suspend’ annual pension increases if money is tight. With rising inflation, annual indexation is an important part of protecting the living standards of the retired population.
“There is a significant risk that relaxing standards on inflation protection with the best of intentions for exceptional cases could be exploited and lead to millions of retired people being at risk of cuts in their real living standards.”
Tim Sharp, a pensions expert at the TUC, said: “Pension reforms should be judged on whether they improve workers’ standard of living in retirement. It is hard to see how measures that transfer wealth from pension savers to shareholders would achieve this.
“We shouldn’t cut members out of decisions to water down pensions, which are, of course, deferred pay.”
The paper makes it clear that the shift from RPI to CPI is only under discussion and, in a surprise rebuke to the pensions industry, says Britain’s final salary schemes are more affordable than widely believed.
It notes that deficits in pension schemes have narrowed from a peak of £400bn to £196bn and “the evidence that DB schemes are unaffordable is far from being conclusive and should be considered with caution”.
Companies that complain they cannot afford their pension schemes seem to be able to pay out large dividends to shareholders, the paper notes. “In 2015, FTSE 100 companies paid about five times as much in dividends as they did in contributions to their DB pension schemes,” it says.
“The 56 FTSE 100 companies with a DB pension scheme deficit paid 25% more in dividends (£53bn) relative to their deficit (£42bn). Therefore, in theory, these companies have the ability to immediately repair their pension scheme deficits were they to feed their dividends into deficit repair contributions (DRCs).”