Can Employee Share Schemes Bridge Pensions Shortfall?

For as long as most remember, UK employees, especially higher earners, have relied on company pensions as the primary means of accumulating long-term capital. These days are now well behind us, while the realisation of what has changed lies in the future.

Two significant developments now constrain the ability of employees to accumulate capital via pension plans. Firstly, the migration from defined benefit to defined contribution pension is giving rise to a much lower level of capital accumulation, at a time when the cost of purchasing a long-term income stream (a so called “annuity”) has increased exponentially. The much reduced scale of defined contribution capital balances compared to the capital value of defined benefit pensions is illustrated below.

Source: ONS

The second development, more relevant to higher earners, is the limit on the amount of money that can be accumulated within a pension fund. In 2009 Fred Goodwin left RBS with pension capital of £25m. He was by no means alone in being provided with a multi-million pound pension pot, whereas the Government now limits total capital accumulation in a tax favoured pension to £1m.

While the scale of Executive pension pots might seem out of reach to most, the proportional decrease in capital accumulation is shown by ONS data to be commonplace.

This raises the question of how those with higher earnings will bridge the gap in wealth accumulation between their generation and the one that preceded them. It is true most employees subject to the pension lifetime allowance or annual allowance are provided with a cash alternative, but there is little evidence suggesting this additional income is being used for capital accumulation purposes.

Can employee share schemes help bridge this gap and provide an alternative means of capital accumulation and if so, could this potentially help employees more widely? In the USA, the answer to the first part of this question has been an assured “yes” for the past 30 years, but it is only now that we are beginning to see a nod in that direction in the UK. 96% of FTSE250 companies now require Executives to hold shares for more than five years and the scale of the required shareholding has risen steadily in recent years. A median FTSE250 Chief Executive now holds shares worth 690% of salary, while Executive Directors reporting directly to the CEO hold shares with a median value of 255% of salary.

Clearly, the risk profile associated with holding shares in a single company is very different to the risk profile of capital accumulation in a pension plan. However, perhaps we have turned a corner and the trickle-down effect will be that a growing number of UK employees begin to make the connection between share plans and long-term capital accumulation?

Mark Childs

The author is a Director of the Total Reward Group and former Vice-President, Reward, of the Chartered Institute of Personnel & Development (CIPD).