On 22 November the DWP published "Reinvigorating Workplace Pensions", which sets out the Government's strategy to resolve the long-term challenges of an ageing population and getting people to save more for their retirement.
Stating that each of the Government, employers and the pensions industry has a role to play in making pensions easier to understand, the paper draws on extensive discussions with pensions professionals to do the following:
- outline several issues faced by the pensions industry including governance and risk-sharing;
- examine key factors that affect outcomes for savers in defined contribution (DC) schemes; and
set out five reinvigoration objectives:
- to increase the amount people are saving in pensions;
- to increase the amount people receive for their savings;
- to enable industry innovation and development of new products including those that will give people more certainty about their pensions and encourage more risk-sharing;
- to increase transparency and build trust, confidence and engagement in pension saving as the norm; and
- to ensure the sustainability and stability of the UK pension system.
The DWP admits that confidence in pensions is low and states that auto-enrolment is the first step towards a fundamental shift in culture and attitude towards savings and pensions.
Whilst the Government's paper covers a range of issues affecting pension provision in the UK, one of the most interesting proposals relates to what the Government refers to as "Defined Ambition" or "DA".
Is Defined Ambition the answer?
Steve Webb sees DA as a way of bridging the gap between DB and DC pensions. A DA pension would seek to give members greater certainty about the final value of their pension with less cost volatility for employers than a DB pension. The DWP believes this could be achieved by sharing longevity and investment risks between several parties, including employers, scheme members, insurers and investment businesses.
From DB to DA
The Industry Working Group has identified four potential new models to make some provision of DB sustainable:
Simplified / core DB schemes:
- Providing a core level of DB and discretionary additional benefits. For example optional, or conditional, indexation and no spouse's pension.
Conversion of benefits:
- Providing DB during the accumulation phase, which is then converted to a DC amount of equivalent value when the scheme member leaves, dies or retires.
- This model would remove longevity risk from the employer.
- As an example, a scheme could provide a core non-increasing pension each year, with a discretionary supplement, dependent on investment performance and the strength of the scheme.
Linking scheme retirement age to changes in State Pension Age:
- Enabling DB schemes to adjust their scheme retirement age for both accrued and future service.
From DC to DA
The paper identifies several models which look like DC but offer something more, recognising there are ways this could be achieved within the current legislative framework:
- ■DC with bonuses on top of a basic minimum.
- Buying an annuity before retirement date is reached, to lock in certainty about that portion of retirement income. This is possible within the current legislative framework.
■Targeted / managed DC:
- Building on currently available products which target an income in retirement, on an individual basis.
- This requires regular review of both contribution levels and investment performance to stay on track.
- Providing a capital guarantee seems attractive, because it removes the fear that a member would lose the money paid into his pension.
- However, guarantees come at a price with reduced income in retirement. Therefore the decision should rest with the individual member.
New models build on the idea of mutualised guarantors, which could include a centralised mutual fund supported by a levy on members' funds:
Mutualised guarantees and risk-sharing, which could be either:
- a contribution back guarantee; or
- a guarantee of retirement income in later years with the mutual fund guaranteeing the pension beyond a certain age.
- Mutualised guarantees and risk-sharing, which could be either:
Guarantees and risk-sharing provided by the insurance industry:
- A guaranteed fixed-period return purchased on a member's behalf. The provider takes on the downside risk with the upside being shared by the provider and the member.
- Standardised income guarantee insurance – for example from age 50 part of an individual's pension savings could be used to secure a guaranteed income in retirement. This income could go up in line with investment performance but would not fall.
Employer-funded smoothing fund:
- The employer pays a percentage of core contributions into a central fund to provide a targeted outcome at retirement, via annual bonuses or a final terminal bonus.
- This removes longevity risk from the employer but does mean more cost volatility than in standard DC provision.
The DWP acknowledges that all the DB and DC based options require further work, covering government policy, legal and financial issues.
Finally, the DWP paper examines whether Collective DC schemes could offer a more effective structure for DA schemes. This requires further work from the Industry Working Group and a review of the legal framework.
There are significant challenges facing the pensions industry now, the most pressing of which is a lack of adequate pension saving among many working age people. Few employers want to carry on with DB provision, because it is an open-ended cheque book, but, equally, is it fair to ask employees to carry all the risks associated with DC.
DA may be the way forward but we see this as being DC with add-ons, rather than a form of "DB lite". Employers have been too traumatised by DB provision to consider re-entering this arena, even in a watered-down version. Those who have already exited DB are more likely, at most, to consider enhanced DC as a possibility. Those who cannot exit DB provision may be attracted by the opportunities for risk-sharing for the future subject to being able to amend existing schemes. One of the important areas that the paper does not address is the manner in which the new ideas would inter-face with existing DB provision. It is unlikely that new legislation would permit retroactive impact.
We applaud the desire to increase confidence in pension saving and member engagement. However, this needs to be supported by a clear strategy on pensions legislation and tax relief. Continual change is unsettling and counter-productive to ensuring stability and sustainability.
Some of the risk-sharing ideas are novel and worthy of further consideration.