Many companies have no stomach for further Government pension changes, no matter how well intentioned, an expert has warned.
The Department for Work and Pensions is asking for views on whether the law should be amended to introduce new choices. But Stephen Hart, legal director in the pensions group at the Birmingham office of law firm DLA Piper, fears businesses have become so shell-shocked in recent years that they have had enough.
He cautioned: “The Government’s proposals aim to spread the risk more evenly between employers and members, but we have to ask whether employers now have the stomach to accept even this. Providing anything but a defined contribution (DC) pension seems unattractive nowadays.
“The new choices proposed are welcome, as the opportunity for different types of pension arrangement is surely worthwhile. Nonetheless, we do have to question whether a ‘top-down’ design of specific types of scheme is the right approach, and how keen employers will be to use these opportunities.”
Defined benefit (DB) schemes, including final salary ones, place the majority of the risk on the employer, and so have fallen out of favour with firms, many of which have either closed them to new members or closed them entirely, as costs rise and people live longer.
Companies still offer pensions, but more and more go for DC versions, which place the risk on members, leaving them more open to the vagaries of investment markets.
Mr Hart said the Government recognises there are a number of methods for sharing risk within existing law, including reducing accrual rates or introducing career average, hybrid and cash balance schemes. The DWP has now analysed pension provision in a number of other countries, including Denmark, Switzerland, Ireland, the US, and above all the Netherlands, and proposed two fresh approaches.
In the first, conditional indexation, revaluation of salaries and indexation of pensions in payment would depend on the financial health of the scheme. If it became underfunded, the following year’s indexation and revaluation could be withheld, unless the employer paid off the deficit. It would mean more supervision from the scheme actuary or the Pensions Regulator.
In the second approach, collective defined contribution, the employer would contribute on a DC basis, providing certainty on costs, but benefits would be targeted on DB lines – though without the guarantees of a traditional scheme. Contributions would be made to a collective fund rather than individual accounts. If the scheme became underfunded, revaluation and indexation could be withheld or, if funding levels dropped too low to allow payment at even basic levels, it could either increase normal pension age or reduce benefits.
Mr Hart said: “In both cases, one of the key issues identified is whether there is sufficient demand for these schemes, and the Minister, Mike O’Brien, has recently said he will not rush into allowing them. Some in the pensions industry are pressing for changes to the current bill before Parliament, but it is clear the Government will take its time.
“Of course, low demand should not prevent new types of scheme being permitted, but it must call into question how many would be set up.”
Mr Hart says that most of the causes of the difficulties for DB schemes are well known - equity and bond market conditions, rising life expectancy (especially among the 1930’s generation, so many of whom are the schemes’ pensioners), falling inflation, increased regulation, tax changes, and changes in accounting standards.
“But there is a more underlying issue. The entire employment culture which underpinned DB schemes being set up in the 1950s to 1970s has changed.
“In those days, many employers had a more paternalistic approach to their role, and recruited staff with a view to employing them for their whole career – or at least so they claimed. The employees in turn took on a job as though it was their life’s career, and in many cases it was.
“So employers were prepared to set up schemes based on final salary and length of service.”
Mr Hart said: “One suspects many of these employers did not appreciate what they were entering into.
“They were advised that the scheme they were setting up would cost them a certain percentage of pay, and were not fully aware how much that could alter. In fact, they were entering into a deal where the chance of cost reduction was much less than the risk of increases.
“Now, few employers or their staff expect a person’s career to be wholly with one company. The paternalistic relationship is a thing of the past.
“Employers are much more aware of the risk of running a DB scheme and, unsurprisingly, they do not wish to do it. Running the business they understand is a big enough risk – why add to it further?
“Even without all the problems of DB schemes, employers are unlikely to want to accept the risk in providing anything but DC pensions.”