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.
3. Ability to change scheme pension age
The third and final proposed design directly tackles longevity by extending existing ‘life expectancy adjustment factor’ provisions to allow employers to adjust a scheme’s normal pension age to limit the risk of increased costs related to longer life expectancy.
The paper states there will need to be requirements on schemes which choose to change their pension age “to limit the extent to which they can increase the NPA in one step”, in order to avoid schemes implementing rapid rises to “catch up” with demographic changes that would severely impact savers.
The fours models to provide defined contribution scheme guarantees are:
1. Money-back guarantee
This would ensure that the amount of accumulated savings at retirement or at the point of transferring out does not fall below the nominal value of contributions made.
The paper argues that while the probability of such a “low-level guarantee” being required to be exercised is small - “less than 10 per cent and close to zero for long periods of saving” - it could have real value for an individual.
It adds that this guarantee could be provided either as a “market-based” solution, or by the establishment of a ‘defined contribution protection fund’ akin to the Pension Protection Fund, for which models suggest premiums “could be very low”.
2. Capital and investment return guarantee
This option is intended to offer guarantees at the mid-point of the pension life cycle and would offer protection over not just the capital contributed but also over investment returns that have been accumulated.
The guarantee would be purchased by a fiduciary on behalf of the member to secure a guarantee against part of the capital and an investment return for a fixed period, the DWP explains.
The paper states that the biggest barriers to feasibility of such a model be “access to illiquid investments, governance and fiduciary element, and the interface between insurers or trustees and investment opportunities”.
3. Retirement income insurance
This model would address the “single event conversion risk” associated with buying an annuity and maximise the investment returns on a member’s fund through the purchase of an income insurance product on an annual basis from a set age, for example 50 years.