The consultation paper “Reshaping workplace pensions for future generations” formally introduces the concept of ‘defined ambition’; a system of pension savings which promises to share risks (including inflation, investment and longevity) between employer and employee.
There are many different ways in which this can be done. For example, an employer could promise its members a minimum size of pension pot at retirement age; the member would not know how much retirement income that pot would provide; instead he would know the minimum that would be in the pot.
Never has the debate on workplace pensions in the UK, which has raged on for more than a decade, been so polarised. On the whole; employers, actuaries and trade bodies have backed the proposals stating that “there is much to welcome in this consultation paper” however, some industry professionals and members’ groups have been far more reticent in highlighting a “big risk that members don’t realise what they’re losing”.
Few would argue with Minister of State for Pensions, Steve Webb MP, when he states in his foreword that “traditional final salary defined benefit schemes” are in “terminal decline”, they have been for some time. Since 2007, the percentage of open schemes has more than halved – from 36% to 14% – leaving just 841 schemes remaining open today.
The DWP may argue that this type of wholesale reform is needed to stop the decline and allow employers to continue to deliver “high quality provision that will appeal to employees as well as employers”, however many will view it as simply a way to “kick the can further down the road” by making defined benefit schemes more affordable for employers and therefore, permitting expensive workplace pensions to “limp along in a reduced form”.
Counting the cost
There can be no doubt that one of the primary aims of the proposals are to improve the likelihood that schemes will be able to meet their obligations through reducing the cost to employers. The DWP feel that this can be done by “making it easier for schemes to change pension age in order to cap costs that stem from improved longevity; and allowing employers to cease to bear the financial costs and risks for people who leave their employment”. That is good news for employers but what does it mean for members?
The answer is relatively simple; if employers are making cost savings then ultimately they must be passed on in some form to the individual members.
This impact could manifest through; a limitation of investment strategy which restricts long term growth in favour of lower guaranteed returns or perhaps even more directly through increased fees charged by investment firms to pension savers, but these fees are already a hot topic.
The DWP themselves have worked so hard to highlight and tackle in recent months, the “hidden charges” applied to members of workplace pensions.
‘Members don’t realise what they’re losing’
Perhaps the biggest impact for members will be the benefits which up until now have been taken for granted but may be lost as a result of the proposals. Defined benefit schemes have, for the most part, sheltered members from falling annuity rates.
While private pension savers and defined contribution members have been at the mercy of the market over the last decade, DB scheme members have continued to enjoy employer backed pensions based on their service and salary. If these proposals are implemented then the risk of annuitisation would fall firmly back onto the members who were previously insulated from such concerns.
This increased risk will be of concern to members but there are other changes which could come about as a result of the proposals which are far more likely to grab the headlines.
As it currently stands the UK government requires employers in the private sector that offer final salary schemes to provide a spouses’ pension on death of the member, which amounts to at least half the member’s full pension income in retirement, in addition to inflation-linking to guard against the rising cost of living.
The DWP state in their consultation paper that while employers may “continue to offer schemes that include index-linked benefits and survivor rights” this will no longer be “a statutory requirement".
Research by UK broker Hargreaves Lansdown highlights the significant impact that loss of indexation could have on members. An annual pension of £10,000 adds up to £250,000 over 25 years without inflation increases whereas it would add up to £351,000 if it rose in line with the current rate of inflation, at 2.7% and so the loss of indexation could effectively almost half the level of benefits payable to the member.
To compound the problem further, employers would also be given the opportunity to move the age at which a worker is allowed to retire on a full pension.
The last waltz
Whichever side of the divide you are on, it is hard to shake the overwhelming sense that change is coming. The fact that for the first time, the UK government seems to be indicating that traditional defined benefit schemes will not be able or required to meet their obligations going forward is a significant indictment of the current system of pension savings.
As for the timeframe, well these proposals from the Department for Work and Pensions could come into force as early as April 2014, leaving members with very little time to shuffle their feet to adjust to the changes.
So, the DWP acting as band leader have announced that there is one last song to play in the UK workplace pension saga. After it is over, some will reflect on the good times that were had while it lasted and some will be left lamenting what could have been.
Mark Sanderson is director of operations at Brooklands Pensions
