Government consults on reshaping workplace pensions

December 2013
Read Unite's response to this consultation.

November 2013

This consultation picks up on work carried out by the Defined Ambition Industry Working Group, which drew together pension providers and consultants.

Defined Ambition (DA)) is a term referring to innovations in pension design which aim to bridge the gap between defined benefit (DB) and defined contribution (DC) pensions.

DB schemes give a degree of certainty about benefit outcomes to employees (at least for past service) but leave employers bearing most of the risk, which is reflected in their costs. DC schemes give certainty about their cost to employers but leave employees bearing most of the risk, which is reflected in their uncertain benefits.
There are two main areas of DA which are looked at :

•    Flexible DB which looks to reduce the degree of certainty in DB schemes and allow employers to reduce costs and shift part of the risk to employees
•    New DC designs, which seek to reduce members’ uncertainty by seeking to limit  employee risks but without exposing employers to any cost variability

The consultation considers what changes in law and regulation might be made to facilitate DA ideas.

Flexible Defined Benefit
Changes are considered which are aimed at making it easier for employers to continue to offer DB benefits. These changes, which would apply only to future service benefits include……..

•    The requirement to provide spouse/dependant’s benefits  will be removed if contracting-out ends as planned (by the Pension Bill 2013)
•    It is proposed that the requirement to provide increases in pension once they come into payment should be removed
•    It is proposed that new flexibility to allow schemes’ normal pension age to be linked to changing life expectancy be introduced

These changes would not apply in any scheme unless the rules were changed to allow that.

The Consultation says that the Government is considering whether a statutory override might be provided to allow employers to by-pass restrictions on rule changes as might stand in the way of these flexibilities being taken advantage of by some employers/schemes.

A further flexibility that is raised in consultation is whether, where an employee leaves their employment before retirement, the scheme benefits may be compulsorily transferred to a nominated DC scheme or another scheme of the member’s choice.

New DC Designs
The Consultation reviews ideas about how guarantee elements might be introduced into DC schemes and considers what demands there might be for them. The guarantees, considered would be achieved through investment strategy or purchased out of contributions rather than being provided directly by employers.

Guarantee elements considered include :
•    The member’s fund would not be less than the value of contributions paid in
•    The member’s fund would not reduce year to year
•    A guaranteed amount of benefit would be provided at retirement, either by income insurance or purchase of deferred annuities

The general problem with guarantees is that securing them either places constraints on how contributions are invested or the cost of them reduces the amount of contributions invested. This means that guarantees are likely to reduce the level of benefits as might reasonably be expected, even if they reduce the possibility of the worst outcomes.

Another area considered is the scope for Collective DC Schemes (CDC) which seek to benefit members through pooling risks between scheme members in a way which would shield members from the impact of market fluctuations and deliver higher pensions by allowing members funds to remain invested  more in growth assets than in lower yielding asset chosen to reduce risks.

As members’ bitter recent experience has often show, there is already a great deal of scope for employers to change the future terms of DB schemes, but this has not stopped employers from moving to DC schemes.

Removal of guaranteed pension increases alone would reduce the value of a promised DB pension by around 40%. With DB schemes generally being in deficit the chances of receiving discretionary increases are not good.

The proposed use of an override power is especially objectionable as where restrictions on scheme rule changes are present allows employers to escape from obligations they have accepted to safeguard members’ future benefits.

Allowing DB benefits to be converted to DC if members leave before retirement will greatly reduce the attractions of DB for members, many of whom leave employment for reasons beyond their own control. Only a small minority of employees do not change jobs and this would reintroduce a big element of discrimination against early leavers.

The introduction of guarantees into DC schemes on the terms proposed has a potentially heavy price in reducing potential benefits. The best protection for members in DC schemes is a substantial employer contribution, which is the best assurance for members that they will get a good return on what they put in themselves.

Collective DC schemes, and more generally the development of large scale multi-employer schemes, would appear to offer a better way forward provided that member-representative trustees play a major role in their governance.

The consultation can be found here.