| Defining
the future of DC
Pensions Age
DC roundtable
The combined
effects of falling stockmarkets, growing deficits and increased
life expectancy have thrown the future of the defined benefit market
into question, allowing the defined contribution set-up to come
to the fore.
But any pension arrangement is only as good as the legislative framework
in which it resides and, unless the government can address the shortfalls
in the current pensions system, the future of all occupational pensions
may be under threat.
It is with this in mind that Pensions Age brought together four
experts in the field of DC to contemplate the future of the DC market,
highlight some of the holes in the current legislation, and shed
some light on the shape of things to come.
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The
cast:
Chairman: Roger
Cobley, having recently been re-elected as
President of the Pensions Management Institute (PMI), boasts extensive
experience in the pensions sector. He is currently a director of
Stamford Associates Limited, the investment consultancy firm, chairman
of several pension funds, a fellow of the Institute of Actuaries,
an associate of the Society of Actuaries as well as a Freeman of
the City of London, to name but a few of his achievements
 Nick
Wheeler is sales director at Paymaster, where
he has worked since January 1999. Nick boasts more than 25 years
experience in the financial services sector, concentrating largely
on pensions, and is also a fellow of the Chartered Insurance Institute.
Jeremy
Ward is head of pensions marketing at Friends
Provident, where he has worked since 1994. Previous roles at Friends
Provident include head of product management and head of strategic
marketing.
Richard
Parkin is head of DC product development at
Fidelity Investments, having joined in September 2002. He has also
been an associate of the Pensions Management Institute since 1992.
Andrew
Cheseldine is a senior consultant in Watson
Wyatt's Benefits Practice. His principal area of expertise is in
advising on and implementing employee benefit programmes, particularly
DC pension arrangements in replacement of existing DB pension arrangements.
The debate:
Chairman:
We have now had the proposals from the Inland Revenue regarding
simplification, and the announcement that the new tax regime is
not going to start until 2006; in view of that simplification, how
is it going to change the DC landscape?
Do we think that there will be trust-based schemes in the future
or will employers opt for the alternatives that are out there?
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Parkin: I think that trust-based schemes
will continue for a number of reasons. First, there are some advantages
to running a DC scheme alongside a DB scheme within the same trust.
Some have, of course, disappeared along with surpluses, but there
are advantages there.
What I do think, though, is what simplification has done is take
away some of both the real and perceived advantages of occupational
schemes, for example, putting in place one tax regime for all pensions
is going to take away some of the funding flexibility.
In addition, there are a number of things coming out of the wider
pension reform that are likely to make occupational schemes less
attractive or at least put them on an equal footing to personal
pensions, for example immediate vesting or near-immediate vesting.
I also think that, with some of the product flexibility that is
afforded under the new regulations, some trustees are going to balk
at putting them into their plans if they have got to do it themselves.
Chairman: But, if you move away from a
trust-based scheme, is it not the case that the employer becomes
less of a provider and more of a facilitator of pensions which,
in turn, breaks with tradition and weakens the partnership between
employer and employee?
Ward: Some employers would see this as
a good thing. With a contract-based approach, costs are lower and
there are fewer burdens. As a result, I think we are already seeing
most new schemes being set up as contract-based, and the trust-based
DC schemes today are only being set up where there is already a
DB scheme in place.
Wheeler: I think it all depends on how
paternalistic the employer is as many employers would actually welcome
becoming more disconnected from the pension scheme because of the
responsibilities attached.
This means that more is being thrown back onto the individual again
with employers of DC schemes increasingly seeing themselves as making
available a facility to their employees, rather than making available
a pension to them.
On the other hand, you do have the more paternalistic employers,
for example large employers with DB schemes, who will set up trust
based DC schemes to run alongside their existing DB schemes, and
these are the ones that want to still have some say in what's going
on.
Chairman: Because it becomes contract-based
rather than trust-based, when you do the marketing are you selling
to the employer to sell on to the employee, or are you using the
employer as the conduit for marketing the pension to a group of
individuals?
Cheseldine: I think it depends on who
you are. From the consultant point of view, I think you are nearly
always selling to the employer in the first instance; if you are
a provider, you just want contributions and you don’t care
what distribution channel you use to get them.
But, following on from this, I think there is a strong argument
for saying that many employees shouldn’t put money into a
pension unless they are getting a matching contribution from an
employer.
The reason I say this is because a pension, per se, is not inherently
a very good tax effective investment – all you are doing is
deferring tax, not saving it, therefore, for a large proportion
of the population (lower earners particularly) investing in a pension
is not a financially astute thing to do.
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Employer
contributions
Chairman: Picking up on this point of
employer contribution, why would they contribute; what do they get
out of it?
Cheseldine: In short, the employer will
only contribute if there is a commercial advantage in doing so.
For example, I know of three FTSE100 organisations that have moved
from DC to a form of DB in the last year and I think we have reached
the point at which employers do see the commercial advantage of
saying to new prospective employees, “we offer a DB scheme”.
True, we have had three years of falling stockmarkets, but, the
reality is that mortality rates are not deteriorating and organisations
may find that offering a DB pension scheme of some variety helps
get people through the door.
Chairman: So why doesn’t the employer
just offer a pay rise and let the employees do what they want with
the money? Isn’t that easier?
Ward: The trouble with that is, a pay
rise will help the motivation problem for several months or so but
eventually the impact will wear off and the company down the road
which offers a pension scheme is going to look more attractive.
Chairman: There is also an argument for
saying that if Adair Turner, following his review of the industry,
says that compulsion is necessary, then the employer who has been
paying more salary rather than contributing to a pension scheme
is going to be saddled with that pay rise plus the contributions.
In addition to this, though, is it not true that if contributions
aren’t increased, some sort of compulsion is inevitable?
Ward: While that may be a very big picture
approach, I don’t think employers will contribute in order
to avoid compulsion – the main reason they may do so is to
secure a well motivated, loyal workforce.
Wheeler: The nature of the workforce in
question is also relevant – the more blue collar, the less
pressure there seems to be to have a decent pension scheme whereas
with white collar companies, the pension scheme becomes much more
of an issue when it comes to recruitment.
Cheseldine: The salaries of the employees
are also significant – if you have 20,000 employees, 19,000
of which are on £12,000 or less, then providing a pension
scheme is almost irrelevant as they are not going to be able to
afford to contribute.
Wheeler: That’s where you get the
problem of compulsion as, if you don’t earn very much, then
compulsory contributions are not going to produce a very large pension.
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The
effect of means testing
Parkin: I think this is one of the problems
with some of the current government policies – they have an
obsession with trying to make people with not much money save more.
Trouble is, if they do save, then they risk losing their state benefits.
Chairman: True. Approximately 5m people
are being means tested today. The government’s argument is
that it has limited resources available so it only wants to target
those that really need it and, therefore, some sort of means testing
is necessary; but this should not involve half the pensioner population.
So, I think the basic state pension should be increased.
Parkin: It is interesting to see consensus
growing around this point from all angles. The Pensions Policy Institute,
for example, is certainly more focussed on the social issues than
some of the other groups but it is in agreement on this issue; while
the Adam Smith Institute, with Alan Pickering on board, is coming
at it from the other end of the spectrum, but is proposing the same
thing.
Even David Willetts of the Conservative party agrees. Trouble is,
we are in danger of coming to a consensus on this with the only
people not in agreement being the DWP and the Treasury.
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Contracting
Out
Parkin: I would even argue that we should
get rid of any interaction between state pension and private pensions
and, following on from this, contracting out should be abolished.
I understand that there are swathes of the provider industry that
rely on contracting out rebates for a good deal of their income
but, otherwise, it is frankly a distraction for a lot of corporate
pension providers.
Wheeler: I agree. Removing contracting
out would help enormously with things like combined forecasts.
Chairman: I remember when contracting
out was first introduced in the mid 70s and I argued against it.
I was condemned at the time for being a heretic but I always maintained
that if the state wants to do something, it should do it, and if
an employer wants to something, then it should do it, and never
the twain should meet.
Today, presumably, those with large DB schemes that are still contracted
out are so because of a state of inertia?
Cheseldine: It isn’t quite that
simple. We have done a lot with schemes looking at contracting back
in and they always tend to stay contracted out as the costs of changing
the scheme are too high, and communicating the changes to their
members is also too difficult.
Cheseldine: There is a link between contracting
out and the Pension Protection Fund (PPF). I, personally, have a
bee in my bonnet that the PPF has a hidden agenda. At the moment,
if a DB scheme goes bust then the members are protected to the extent
that their GMP benefits/protected rights benefits are guaranteed
by the government under deemed buy back.
So, broadly, about 25 per cent of typical scheme benefits are guaranteed.
Under the PPF, however, this will be reduced to zero as the government
will guarantee nothing, it will all be provided by the employer
instead.
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Moving
from DB to DC
Chairman: Going back to the employer and
the difference between DB and DC, it always struck me that one advantage
of a DB plan was to use it in times of employment restructuring,
which went on quite considerably in the late 80s/early 90s, when
surpluses were common.
So, we should not lose sight of the fact that it was possible to
ease people into early retirement very humanely at that time; and
in the headlong rush to provide DC, people have lost sight of what
was, I think, an advantage for the employer.
Ward: But that is an advantage that probably
isn’t there today as there aren’t many surpluses about.
One other issue not to lose sight of is when employers at the lower
end of the scale move from DB to DC, there may well be significant
cost savings.
Cheseldine: This may be true with the
smaller employer but at the larger employer end of the market this
is not a key driver. I have helped transition four FTSE100 companies
and approximately 15 other large organisations in the last five
years and on only one occasion did the employer say they were looking
for significant cost savings. What they were all looking for were
savings in cost volatility.
Wheeler: I think, though, if you come
down the scale I have seen cases where the pension costs have come
down from as much as 14 per cent to three per cent contributions;
added to this, because of the low take-up, they are making very
substantial savings.
Chairman: So, going back to the point
of getting contributions up, how can the pensions industry achieve
this?
Parkin: There are some great lessons to
be learnt from other countries. For example, in the US they have
something called “compliance testing”, which will only
offer basic tax breaks for higher paid individuals if there is adequate
pension coverage of lower paid individuals in the company. It has
some drawbacks but it does manage to get some coverage of the lower
paid.
Cheseldine: Another design we have seen
in the US goes under the name of “Pay More Tomorrow”,
and it effectively relies on inertia. i.e. pension contributions
go up automatically each time the individual gets a pay rise and
there is evidence that it works.
Wheeler: But, you still need to educate
individuals more about what their income is going to be upon retirement
and, while I think some of these US models are very good for the
younger people, it is those further up the ladder that are going
to suffer from the DC shift. A point that, perhaps, should be picked
up next time.
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