The Department for Work and Pensions (DWP) has published a consultation on its proposals for a new alternative model to the traditional defined benefit (DB) and defined contribution (DC) occupational pension scheme structures.  The "defined ambition" (DA) framework has been developed with input from the pensions industry, and the DWP is now seeking views on its work to date.

The consultation, entitled "Reshaping Workplace Pensions for Future Generations", outlines three broad categories of pension scheme models, namely flexible DB, collective DC and guaranteed DC arrangements.

Flexible DB
According to the DWP, the end of 'contracting-out' of pension schemes (following the creation of a single-tier state pension) presents an opportunity to simplify the complex legislative regime for DB pensions.  As such, the DWP is proposing to remove the statutory requirement to provide annual index-linked increases to pensions in payment.  This change would apply in relation to future accruals earned in respect of members of both new and existing DB schemes, and would consequently allow employers to remove an element of the risk which they currently bear.  They could, of course, continue to increase pensions at their discretion.

Building on this proposal, three different designs have been offered which are intended to increase a scheme's flexibility:

  • Employers could choose to pay certain additional benefits on a discretionary basis over and above the simplified DB level when the scheme's funding level allows.
  • Employers could continue to guarantee a DB pension and pay related benefits while a member is in employment and normal DB scheme rules would be applied in relation to the member's retirement or death in service.  Where the member leaves pensionable service before reaching their retirement date, however, the amount of pension benefit they have accrued in the scheme is crystallised and the cash value transferred to a nominated DC pension fund.
  • Employers could be granted the ability to change the scheme pension age in line with actuarial assumptions regarding longevity, meaning that they can ensure that members retiring at different times would be more likely to spend roughly the same amount of time in retirement.

Collective DC
Under collective DC arrangements, employers would pay fixed contributions into a collective scheme asset pool, which is used to pay out the members' pension benefits on retirement (rather than a member buying an annuity product to pay their pension). There is typically no guarantee being provided for the member regarding pension benefits - rather a target value which may often be complemented by conditional indexation payments - and the actual pension received will depend on the availability of scheme assets.

This may be a preferable option for employers in the sense that only fixed contributions are required and that no further funding obligations are to be borne by the employer or reported on the company's balance sheet.  By contrast, although the members would bear the inflation and investment risk under this arrangement, the risk would be shared amongst them as a collective.

Guaranteed DC
For employers who would like their employees to have a bit more certainty about their retirement benefits, but who would also wish to avoid taking on additional risk or forcing themselves to make expensive promises to members about the level of retirement income which will be due, the DWP proposes four models of types of guarantee, namely:

  • a way of guaranteeing that members would at least get the value of their contributions back if scheme investments underperform; 
  • providing a capital and investment return guarantee; 
  • using a portion of the member's fund to buy retirement income insurance; and 
  • adopting a Dutch-style "pension income builder", in which contributions are used for two separate purposes: part of them are used to buy a deferred nominal annuity, payable from the current pension age; and the remaining part is invested into a collective higher-risk asset pool alongside other members' residual contributions.  The return from the investment would then be used to fund indexation payments which would be made when the scheme funding position allows.

The DWP's intention with DA is to provide a type of pension scheme arrangement which acts as a middle ground between offering the benefit of greater certainty in what the member's final pension will be in a DB arrangement, and the lower capped cost for participating employers in providing a DC pension scheme. 

However, to borrow Antony's famous quote in Shakespeare's Julius Caesar, "Ambition should be made of sterner stuff"; questions have already been raised as to whether the proposals go far enough to address the wider challenges in the pensions market.

The consultation paper can be viewed here and is open to responses until 19 December 2013.