On 22 November 2012, the Government unveiled its strategy for "Reinvigorating workplace pensions"
. The proposals build on the Coalition Agreement commitment to put in place "arrangements that result in the provision of high quality pension schemes people can trust and take confidence in".1
The DWP paper outlines a number of so-called "Defined Ambition" arrangements, much promoted in recent months by Pensions Minister, Steve Webb, as a means of ensuring greater sharing of risk between employers and members.
In this Alert:
- As well as putting forward DA arrangements as alternatives to traditional DB and DC models, the paper also suggests possible improvements to existing arrangements.
- The proposals consider the role of the pensions industry, both in developing new products and in strengthening existing ones.
- Acknowledging the continuing importance of DC, good governance is also high on the Government's agenda, as is the need to engage individuals during their pension savings journey.
Reasons for reform
The paper's twin drivers are an increasingly ageing population and the fact that people are simply not saving enough for their retirement.2
Despite the recent introduction of auto-enrolment, the acceleration of Government plans to increase SPA, and its intention to create a single tier state pension (with a White Paper due "shortly"), the Government believes that these measures only go so far towards addressing the nation's pensions problems.
The new DA way?
Much hyped, the Government has finally put pen to paper on proposals for a new breed of pension scheme. Unlike the polar opposites of DB (where the employer bears all the risk) and DC (where the risk falls on the individual pre-retirement and on the annuity provider post), DA arrangements promise greater sharing of longevity and investment risks between a number of parties.3
While some options can be achieved within the current legislative framework, others will require certain adaptations to the present system.
The DWP's overarching aims are that any DA arrangement should:
- address the needs of both members and employers;
- be affordable to employers, pension providers and members over the long-term;
- take on board the needs of future pensioners and not be biased towards current ones;
- incorporate genuine risk sharing between stakeholders;
- have a regulatory structure that enables innovation, while protecting member interests; and
- be transparent, with high governance standards.
The DB starting point
The paper recognises that employers can already share or mitigate risk to a degree, for example by using CARE and cash balance schemes, or by adopting other options for managing risk (including buy-out, buy-in and longevity swaps).
A key alternative put forward is a "simplified" or "core" DB scheme, which would guarantee a core level of benefit, with additional benefits above that minimum being discretionary (the "ambition" element). The ambition elements (which could be subject to lighter touch regulation) that the Government is keen to explore further include conditional or optional indexation (largely based on the popular Dutch model) and removing spouses' benefits.
Other DB based alternatives on the table for consideration include:
- allowing benefits to be converted into an equivalent DC value at the point a member leaves the scheme, retires or dies;
- pensions that fluctuate in payment, depending on the financial health of the scheme; and
- linking scheme retirement age to changes in SPA, allowing employers to mitigate some of the increased costs of unexpected longevity.
The DC starting point
As with DB, a number of DC risk sharing arrangements are already possible, such as targeted or managed DC.4
Like the Labour Government's 2008 consultation
on risk sharing options,5
the paper considers whether there is a role for Dutch-style collective DC schemes in the UK. Noting that "distinct cultural and institutional differences" (including acceptance of compulsion) make such arrangements unfeasible, the Government nonetheless intends to explore whether elements of collective DC arrangements could help "inform the development of [DA] pensions".
Other new options under consideration include:
- Mutualised guarantees – such as a money back guarantee funded by a levy on members' funds (sharing the investment risk between the member and the mutualised fund) or a guarantee to cover retirement income in later years funded by a levy on members' funds (sharing the longevity risk);
- Guarantees provided by the insurance industry – for example, a guaranteed minimum level of growth, with the provider taking the risk that the investment does not reach that level; and
- Standardised income guarantee insurance – under which an insurance product is bought on the individual's behalf, which would go up with future investment returns but would not fall.
The fall and rise of DB & DC
The steady decline of the traditional DB scheme and the surging popularity of DC have led the Government to investigate ways in which current arrangements can be improved. (It is particularly keen to encourage pension saving beyond the 8% minimum required by auto-enrolment.)
Possible DB changes
Whilst recognising that one of the reasons for their decline is due to increasing regulatory cost, the paper concludes that "there is likely only to be a limited amount that can be done to revive DB schemes, at least in their pure, final salary form". However, the disclosure regulations are once again identified as having "significant scope for simplification", as well as a "few other discrete areas where regulation could be slimmed down".
Possible DC changes
Taking account of TPR's six principles
for good DC provision,6
the paper looks at a number of ways to enhance existing DC arrangements, including:
- Contribution levels – unsurprisingly, the most significant factor affecting DC retirement income is contribution levels.7 Popular in the United States, one of the options under consideration is the use of "automatic escalation" schemes, under which members are encouraged to commit to increasing contributions at a future date, often in line with wage increases.
- Charges – although charges have fallen in recent years, the DWP notes that small differences in rates can make big differences to members' benefits over time. With transparency critical, the Government supports the NAPF's initiative to develop a code of conduct on the disclosure of information on charges to members, as well as the ABI's action plan to provide clearer information on charges to consumers.
- Investment strategies and returns – the Government wants to ensure that employers and members making active choices have clear information on investment decisions and that default fund options are appropriate. It therefore backs the IGG's principles of best practice, among others.
- Increases in scale – the paper canvasses whether a pensions market with a smaller number of larger-scale multi-employer pension schemes might provide better value for money for employers and employees.
- Decumulation – historically low annuity rates are leading the Government to examine alternatives to traditional annuities, such as income drawdown or fixed-term annuities, both of which offer increased flexibility as pensioners do not lock in to a particular level of income for the rest of their life.
Currently at an "exploratory" stage, the Government intends to continue to work closely with employers, the pensions industry and consumer bodies to further flesh out its ideas. As yet, there is no timetable for reform, but we expect a more formal consultation to follow in due course.
Given that it has been more than ten years since the Pickering Report 8
suggested stripping away the "bells and whistles" in pension arrangements, and more than four since the Labour Government's risk sharing consultation, perhaps it's finally time for a little less talk and a lot more action.
"Written Ministerial Statement" (22 November 2012)2
According to DWP research, 40% of people between 22 and SPA are not saving enough to achieve their expected levels of income in retirement: "Estimates of the number of people facing inadequate retirement incomes"
(DWP, July 2012)3
Employers, individuals, insurance companies and investment businesses4
Under which an income in retirement is targeted, and asset allocation and contributions are reviewed regularly and varied in line with the desired target5
See our Alert:"Risk sharing - the Government consults"
(11 June 2008)6
See our News: "TPR's recipe for good DC provision"
(October 2012)7 "Closing the gap: the choices and factors that can affect private pension income"
(PPI, February 2012)8 "A simpler way to better pensions – An independent report by Alan Pickering"