The government has today (7 November) published its highly anticipated paper on so-called ‘defined ambition’ pension schemes that it believes can rescue the ‘defined benefit’ model by sharing risk between employers and savers, and offering greater flexibility.
In May, Steve Webb, pensions minister said the industry only has 12 months to save the defined benefit model during an industry event at which he outlined a vision for a “slimmed down” version of salary-related pensions, which are under threat as employers drastically scale back their offering due to high costs and spiralling liabilities.
According to figures published by the Department for Works and Pensions alongside the paper, defined benefit schemes have declined rapidly in recent years: the percentage of open schemes has more than halved since 2007 to 14 per cent, equating to just 841 schemes in total.
But what would a new ‘defined ambition’ framework look like?
In the press release accompanying the paper the DWP talks about “greater risk sharing between parties” and offering a “high level of certainty, but with much greater flexibility over the nature of benefits provided”.
In practice, an industry working group put together by the government has proposed three new ‘designs’ for more flexible defined benefit pensions, alongside four models that could be introduced to offer ‘guarantees’ to workers in money purchase, or defined contribution, pensions.
The three designs for flexible salary-related pensions are:
1. Removing indexation on future accruals
Under this design, for future accruals only the statutory requirements for the indexation of pensions in payment would be removed. This effectively means that while the employer would continue to bear the longevity risks of offering a defined benefit, savers would bear the risk that inflation would erode the value of any guarantee.
The paper states employers could choose to provide greater flexbility in benefits - for example providing specific additional benefits when the funding position allowed or adding indexation on a fluctuating basis - but would not be legislatively required to offer a particular inflation link.
It said this approach would require changing the legislation on requirements such as “preservation, revaluation, scheme funding, employer debt and the Pension Protection Fund levy” so that they would only apply to benefits required to be paid and not to those offered on a discretionary basis.
2. Automatic conversion to DC when member leaves employment
This second option would see the employer offering a traditional defined benefit model to members during their period of employment, but if they were to leave their company before retirement their accrued savings would be crystallised and the cash value transferred to a nominated defined contribution scheme.
The paper states that while the employment continues the employer bears the investment risk associated with providing a defined benefit, but that they will be able to reduce liabilities related to workers that are no longer employed with them.
It adds that there is likely to be a need for regulatory protection to “address risks of avoidance activity”, for example by setting out a timeframe for employers to calculate and transfer benefits when a member leaves employment.