Kevin Wesbroom thinks the time has come for a different approach to defined benefit schemes.
The MP Frank Field was once asked to think the unthinkable about welfare reform. When he did, his thoughts were felt to be unacceptable!
Frank is now in charge of a Commons Select Committee that may well come up with radical thoughts about the UK's defined benefit (DB) pensions system. I would urge him to continue his unthinkable thoughts, because I feel our current system is unsustainable and inequitable.
What lies behind this are sustained low interest rates, with their debilitating effect on DB schemes. For those lucky few in open schemes, the cost of annual accrual is now easily in the 30% of salary plus range. Deficits persist, despite all attempts to remove or reduce them by extra contributions or any number of innovative contingent assets.
So I feel the time has come for a fairer system. At the heart of my change would be the removal of the indexation and revaluation that we have baked into UK pensions
The Brexit decision does not cause any new problems - it just gives another downwards twist to interest rates and makes the 'lower for longer' mantra all the more compelling.
The cost of DB benefits leads to one of the obvious inequities of our pensions system. Defined contribution (DC) schemes will struggle to get a look in, both in terms of management and trustee time - and in terms of hard cash - from a finite pension savings pool. How much longer should we tolerate this blatant unfairness?
The continued high cost of providing DB pensions places a brake on UK competitiveness and in some cases will lead to the inevitable 'failure' with companies passing their liabilities to the Pension Protection Fund. (In fact, as The Pensions Regulator has pointed out, this is hardly failure since it was precisely what the PPF was set up to do). Benefits will be cut for those falling into the PPF, and there is little members can do about it.
So I feel the time has come for a fairer system. At the heart of my change would be the removal of the indexation and revaluation that we have baked into UK pensions (one of a very small number of countries globally to have mandatory indexation and revaluation for DB schemes).
Unwind this clock and make ALL increases conditional, based upon rates of increases that can be sustained longer term by the assets available. There would be no overnight cuts to any pensions in payment or deferment. Annual increases would still be granted but they would be at a level that could be sustained longer term. A system of Conditional Indexation offers a number of long term advantages:
- Costs for the employer would become fixed. Pension contributions for their (previous DB) schemes would be capable of more precise budgeting and could be built into business plans with certainty.
- Accounting would become simplified - cash accounting as for DC schemes.
- Freed from the requirement to match bond-based liabilities, pension fund investment could move towards longer-term return-seeking assets such as credit and infrastructure, rather than the current tyranny of effectively being forced buyers of government bonds.
- Members would, counter-intuitively, have more certainty in their retirement planning. True, the level of future inflation proofing would be less clear, but their basic income level could be built into their future plans with a higher degree of certainty.
- We might see some rebalancing between DB and DC members. Who knows -if the Conditional Indexation system was seen as a success for DB members, we might even see employers offering it for their DC members!
It seems to me that a change away from hard-coded DB benefits could offer advantages for all involved in the UK pensions system. Unthinkable? I think not!
Kevin Wesbroom is a senior partner at Aon Hewitt
The views expressed are personal views of the author and may not reflect the views of the author's employer
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