The unanswered questions about pension reforms

The changes to the rules around how defined-benefit schemes are wound up may well prove to be a case of too little, too late but they are welcome nonetheless. Given the delicacy of the task that was involved,
the Government seems to have made a pretty good fist of it, certainly if the approval of the industry and big employers is any guide.

Under the current rules, whatever assets are in the scheme must first be applied to trying to secure the pensions being paid to pensioners. Whatever is left is then used to provide pensions for the active and
deferred members. In badly insolvent schemes they may end up with nothing while the pensioners are unscathed.

Waterford Crystal scheme
In the case of the Waterford Crystal scheme – which brought all this to a head – the workers or active members stood to get pension of between 18 and 28 per cent of what they might have expected.

What the new proposals do is rebalance this within limits. The top-ups – if you like – for the employees will be funded by reductions in payments to the pensioners and by a contribution from the State.

No figure has been given for what the State’s contribution will be but it could be substantial. What has been disclosed is where the State will get the cash – from the pension levy; a temporary 0.6 per cent tax on pension assets introduced in 2011 and extended in the 2014 budget, albeit at a reduced rate of 0.15 per cent.

There is a fairness to the idea of a pension levy being used to sort out
defined-benefit schemes. It would appear to be in keeping with the notions of social and intergenerational solidarity that are at the core of a welfare state and so on.

Superficial fairness
The fairness is, however, pretty superficial. The first problem being that the pension levy applies to all types of pension and not just defined-benefit schemes. As a result people who have never been in a defined-benefit scheme and employers who never offered them will now be paying to bail out these schemes.

Likewise, people in well-funded defined benefit schemes will also have to contribute to bailing out the broken schemes.

This is only fair – and sensible – if you take a very wide view of what constitutes social solidarity and an equally wide view of the role that this sort of wealth transfer plays in the economy.

The argument here being that the cost of bailing out these schemes will ultimately fall on everyone via the taxation system and could be more expensive and harmful in the long term.

The Government can thus argue with some justification that what it is doing is both pragmatic and fair, but anyone who has followed the debate about debt relief for mortgage holders will see that they have put themselves in an interesting position.

We have heard a lot about moral hazard over the past few years. Most of it is guff and self-serving guff at that. Moral hazard is defined as creating a situation where somebody might take a risk or act in a way that they normally would not because the costs and consequences will be felt by someone else.

It is regularly wheeled out by banks and politicians as one of the reasons why there can be no widespread mortgage debt forgiveness, the concern being that
moral hazard would lead to strategic mortgage default, the cost of which will have to be borne by the 90 per cent of mortgage holders who are still servicing their mortgages.

No one knows if this would really happen, but nobody particularly wants to take the risk that it would. Instead we have a situation in which the banks are slowly grinding their way through their mortgage books with a starting position – in public at least – that there will be no write-offs.

Inconsistent logic
The parallels with the defined pensions scheme proposals – and the inconsistent logic – are clear. Why is it acceptable, from a moral hazard standpoint, to ask people
in defined-contribution schemes and well-run defined-benefit schemes to contribute to the cost of solving a problem they did not create, but people who are paying their mortgages cannot be asked to contribute to the cost of solving the mortgage crisis?

In theory, if you can have a pension levy you can have a mortgage levy. It will not happen, but moral hazard is not the reason.