The credit crunch has masked another, more insidious, crisis: the pensions crunch

The drama of the credit crisis has masked another crunch, equally damaging but more insidious and slower to take effect. I'm referring to the pensions crunch: greater longevity, adverse tax changes, neglectful politicians and lower investment returns were already taking their toll on company retirement schemes before the credit crisis. But the financial debacle has made a bad situation much worse.

The collective deficit on FTSE 100 pension schemes at the end of last year was £100bn, according to a new study by the actuaries Lane Clark & Peacock. The underlying reality might be even more horrible: changes to the accounting rules are afoot that will force firms to declare pensions gains and losses straight to their bottom line, instead of smoothing them out as they do now. That will make company profits much more volatile and will no doubt have finance directors squealing. Any figure purporting to show the present value of payments to be made 50 years from now will be flawed but, however they are calculated, pension fund deficits are not just notional; they affect companies' ability to do deals, to raise capital, to invest in the business and to pay dividends.

Despite the size of their pension shortfalls, companies are still opting to reward investors by doling out a divi rather than strengthening retirement funds. LCP found that of 62 FTSE companies with a deficit, 46 paid dividends greater than the pension shortfall and in 31 cases it was double or more the size of the deficit. Only five firms paid more in contributions than they paid shareholders.

Pension trustees are unlikely to be willing to tolerate this pecking order indefinitely, and that could trigger a vicious circle, since a reduced dividend at Company A will mean lower investment returns for the retirement schemes at Companies B, C and D.

What exactly are the UK's largest companies doing to protect their scheme members and lower their pension risks? The worrying answer is that we don't know. Companies are not required to reveal their strategy, to give details of pension assets or to say what, if any, measures to cut risk are in place. Much more disclosure is needed before investors can make an informed assessment. Until then, the information vacuum remains alarming not just for employees but also investors. Unless it accounts for pensions, the recent share rally is based on a false premise.

Built on Sands

Bank chief executives are – for good reason – about as popular as swine flu. One exception is Peter Sands, who has the helm at Standard Chartered, which increased profit by 10% to $2.8bn and announced a $1.6bn share placing to push growth in Asia. StanChart has not been perfect – it ran into trouble with a structured investment vehicle, Whistlejacket, and its loan losses and provisions at $1.1bn are more than double those in the same period of 2008 – but compared with some, it is a paragon. It has a strong balance sheet, solid profits and improved capital strength, so the sharp marking down of the share price looks a tad churlish.

The bank is betting that Asia will have a shorter, shallower recession than the west and is positioning itself to take advantage of that. Although the notion of emerging markets decoupling from the developed economies is limited, since the world is now so interlinked, Sands argues that the crunch has accelerated the shift in economic power from countries that borrow and consume to those that save and produce.

Sands has cashed about half of a £3m share award, and although it sticks in the craw for any bankers to receive bonuses in the current climate, he is more deserving than most.

Digging deep

Why is it so hard to find a mining chairman who pleases investors? Shareholders were disgruntled when Rio Tinto fell out with its chairman designate, Jim Leng, and pushed out the incumbent, Paul Skinner, who had offered to stay on, to make way for Jan du Plessis. Anglo American had to have two goes to install Sir John Parker; he takes the chair at a time when the chief executive, Cynthia Carroll, is under heavy fire.

If BHP Billiton had hoped for a smoother ride when it appointed Jacques Nasser, who replaces veteran Don Argus, it was soon disillusioned. Nasser, a former head of Ford, is undeniably one of the big beasts of the corporate jungle but detractors say that during his tenure, the company went from the strongest of the Big Three US carmakers to the weakest. His alleged obsession with emulating the notoriously ruthless approach of "Neutron" Jack Welch of GE, earned him the nickname Jac the Knife. You just can't get the chairmen these days.

ruth.sunderland@observer.co.uk

• FTSE 100 firms' shortfall is double previous estimate
• 'Prognosis bleak' for final salary schemes

Britain's biggest company pension funds are facing their largest ever collective shortfall of £100bn as a result of the financial crisis, in a stark reminder of the difficulties of funding retirement for an ageing population.

The deficit is more than double the £41bn estimated for the FTSE 100 companies a year ago, according to a new report by actuaries Lane Clark & Peacock. Bob Scott, a partner at LCP, warned that the financial crisis may hasten the demise of the traditional defined benefit scheme, where retired workers receive a pension income based on their salary.

The report found that within the FTSE 100, only Cadbury, Diageo and Tesco still allow new members to join their defined benefit schemes. Oil group BP recently closed its final salary fund to new joiners and others, including Barclays, have taken more drastic action, announcing plans to stop existing members building up more benefits. LCP expects it to be only "a matter of time" before smaller employers emulate the actions taken by these blue-chip companies.

"The prognosis is bleak for defined benefit schemes and the recent turmoil may have tipped the balance for some," Scott said. "Unless there is a political will for change we will see very few defined benefit schemes left in the private sector." Scott added that in future, as a result of the £96bn deficit, fewer people would have the "luxury" of early retirement, and that individuals would have to shoulder more of the responsibility and risks of providing for their old age.

British Airways has one of the largest pension funds in the FTSE 100 relative to its size with pension liabilities at 503% of its market capitalisation.

State-controlled banks Lloyds TSB and HBOS – now merged as Lloyds Banking Group – and Royal Bank of Scotland are shouldering £50bn of pension commitments between them and are among the companies with the largest liabilities as a percentage of their market value. That enormous pensions overhang is likely to make the government's shares harder to sell, and puts the taxpayer on the hook for a far larger sum than the £37bn of support injected last autumn.

Scott said: "Taxpayers are standing behind these banks and ultimately they bear the risk." The three banks' combined pension fund deficit – the liabilities less the assets they hold – is more than £4.5bn. Northern Rock is not included in the survey but has a deficit of £60m.

There is little hope of pension funds being restored to health even if the economy performs well, according to LCP. If Britain follows a gloomy path, with a further serious economic downturn, it forecasts the deficit will remain at about £100bn. On a middle-of-the-road scenario, with unprecedented government bond issuance, higher taxes, inflationary pressures and competitive currency devaluations, it might shrink to £50bn. But even in the benign case of a return to normal next year, companies will still be shouldering a £20bn gap in pensions funding.

The fallout from the implosion of US investment bank Lehman Brothers last September hit pension schemes particularly hard, with companies that filed results in December 2008 reporting an estimated £42bn of scheme losses.

In the immediate aftermath of Lehman's collapse, pension liabilities actually shrank because the yield on corporate bonds rose sharply – for technical accounting reasons, a rise in bond yields results in reduced liabilities. Deficits have since ballooned as yields fell following the government's programme of quantitative easing. Pension funds have also been hit by falling prices in the assets in which they invest, as stockmarkets tumbled last year and commercial property prices fell 40%.

Companies have had to review how long their pensioners are expected to live in the light of increasing longevity. On average, FTSE 100 companies saw longevity of employees increase by 0.7 years, with a man currently 60 years of age now expected to live to just over 86.

The report also suggested that the impact of pension fund deficits on company profits would be much worse under planned new accounting standards, which would make companies recognise pension gains and losses immediately in their profit and loss statement. If the proposals had been adopted this year, they would have slashed the profits reported by the 48 FTSE 100 companies with December year-ends by more than 70%, from £46bn to £13bn.

Despite the enormous deficits, some companies are still paying insufficient attention to pension risks. While 46 FTSE companies identified pensions as a significant risk factor in their business, only 17 set out a policy for dealing with it. That contrasts with much fuller disclosures on other types of risk such as fuel prices or currency exchange rates.

LCP said companies were increasingly looking at alternatives to final salary pension schemes such as those based on career average earnings.

About one in 10 workers with a pension has cut the amount they pay in or has stopped contributing in the past five years, according to research published by insurer Prudential this week. And the number planning to rely mainly on the state pension when they retire is set to hit 27% within 10 years, from 22% now.

You can see why: stockmarket performance over the past couple of years has done little to encourage investment. But in the last few months confidence has returned and, after a wobble in June, the market is taking off. Share prices now offer great value and this is as good a time as any to dust off your pension and start investing for your retirement again, because for those who must rely on state provision the future looks grim.

More than two million pensioners live in poverty, according to the work and pensions select committee, while one million more live on less than half the average income. The means-tested benefits system has not worked for them.

The government estimates those eligible for pension credit are failing to claim up to £3bn a year. Add unclaimed housing and council tax benefits, and the total is closer to £5.5bn. If there were 100% uptake, 700,000 pensioners would be lifted out of poverty.

According to Age Concern, while some fail to apply for benefits because they are unaware they would qualify, or that the benefits exist, others are deterred by the complexity of the forms or sheer pride.

The select committee has called on the government to work harder at getting pensioners to claim. But pension credit has been around since 2003 and even if you do claim, the benefit won't necessarily pull you out of poverty: pension credit lifts your income to £130 a week, but the National Pensioners Convention (NPC) calculated the poverty level is £165.

A means-tested benefits system means some people are right not to save; pension credit is tapered according to the level of savings or income. Independent financial adviser Hargreaves Lansdown says a 65-year-old man needs a pension fund of about £40,000 to raise his income above guaranteed pension credit. Instead of relying on the benefits system, the government should concentrate on getting the basic state pension back in shape, even if it means taking more in tax. As the NPC points out, the state pension is the only reliable income for older people, the only bit not subject to volatility in shares or interest rate moves.

Labour and Conservative are committed to re-establishing the link between the state pension and earnings inflation, but not before 2012, and possibly as late as 2015. I'm sure the two million living in poverty will agree that is much too late.

About one in 10 workers with a pension has cut the amount they pay in or has stopped contributing in the past five years, according to research published by insurer Prudential this week. And the number planning to rely mainly on the state pension when they retire is set to hit 27% within 10 years, from 22% now.

You can see why: stockmarket performance over the past couple of years has done little to encourage investment. But in the last few months confidence has returned and, after a wobble in June, the market is taking off. Share prices now offer great value and this is as good a time as any to dust off your pension and start investing for your retirement again, because for those who must rely on state provision the future looks grim.

More than two million pensioners live in poverty, according to the work and pensions select committee, while one million more live on less than half the average income. The means-tested benefits system has not worked for them.

The government estimates those eligible for pension credit are failing to claim up to £3bn a year. Add unclaimed housing and council tax benefits, and the total is closer to £5.5bn. If there were 100% uptake, 700,000 pensioners would be lifted out of poverty.

According to Age Concern, while some fail to apply for benefits because they are unaware they would qualify, or that the benefits exist, others are deterred by the complexity of the forms or sheer pride.

The select committee has called on the government to work harder at getting pensioners to claim. But pension credit has been around since 2003 and even if you do claim, the benefit won't necessarily pull you out of poverty: pension credit lifts your income to £130 a week, but the National Pensioners Convention (NPC) calculated the poverty level is £165.

A means-tested benefits system means some people are right not to save; pension credit is tapered according to the level of savings or income. Independent financial adviser Hargreaves Lansdown says a 65-year-old man needs a pension fund of about £40,000 to raise his income above guaranteed pension credit. Instead of relying on the benefits system, the government should concentrate on getting the basic state pension back in shape, even if it means taking more in tax. As the NPC points out, the state pension is the only reliable income for older people, the only bit not subject to volatility in shares or interest rate moves.

Labour and Conservative are committed to re-establishing the link between the state pension and earnings inflation, but not before 2012, and possibly as late as 2015. I'm sure the two million living in poverty will agree that is much too late.

Workers with generous final salary pensions must give up at least 10% of their benefits if Britain is to avoid sleepwalking into a two-tier pension scheme with growing numbers of people living in poverty in old age, the president of the institute of actuaries said yesterday.

According to Ronnie Bowie, one of the pension industry's most senior experts, there needs to be a shift in thinking about pensions, away from short-term cost savings to a broader review of the support offered by employers to all staff.

At the moment, employers are devoting most of their time and effort to protecting the benefits built up by workers in final-salary schemes. Britain's biggest employers have pumped billions into the schemes. Bowie said that despite these efforts, schemes continued to run huge deficits, which were expected to get worse over the next 20 years.

The effect of propping up final-salary schemes in the private and public sectors, generally paying two-thirds of a worker's last pay cheque as a retirement income, was to deny younger workers and people outside such schemes a decent pension. "If we could wind back the clock, it would be better if all these schemes could be based on career average earnings and not final salary. Career average schemes have little effect on the incomes of the low paid and offer a fairer reward. They would also be more affordable for employers to run. But that didn't happen."

Tory shadow pensions spokeswoman Theresa May has signalled that an incoming Conservative government would encourage hybrid schemes that share the costs of increases in life expectancy or falls in investment returns between employers and staff. The government refused to allow reforms to occupational schemes, giving them greater flexibility, to be included in last year's pension act.

Bowie said that while reforms affecting future pension contributions would be helpful, the crunch for occupational schemes would arrive in 2030 when all of the baby-boomer generation was in retirement. "If companies could share inflation-proofing on benefits, that would allow around 30% of costs to be shared," he said. "That would reduce the risk costs would soar, but it is not the same as reducing costs to more manageable levels."

While a spate of scheme closures means that fewer than 2.5m workers currently pay into final-salary schemes, more than 18m workers rely on at least some guaranteed pension to form part of their retirement income.

Employees' accrued rights are protected under UK law, dating back to a 1993 pensions act, according to pension lawyer Robin Ellison.

He said the government would need to overturn that act, but even then rights would most likely be protected under human rights legislation.

Bowie said: "I think there is a degree of inevitability about this because I'm not sure there is anything the government can do now. It is unlikely people with these benefits will give them up, but without it companies will need to put more and more vital funds into these schemes and workers outside the schemes will suffer."