• Risk-sharing schemes are already possible under current legislation but the risk of Government tinkering deters companies from implementing them
• UK needs to ‘loosen the bonds’ of defined benefit pension provision, and keep them loose, for example, by ending regulatory prescription on benefit design
• Politicians need to accept that risk sharing involves risk, so there may be losers, as well as winners
Mercer has greeted comments by the Pensions Minister, Steve Webb, in which he expressed his support for establishing a reasonable balance of risk in private pension provision with half a cheer. According to the consultancy, under the current regulatory system, companies can already establish a wide range of risk-sharing schemes but are deterred by endless political rule-changing.
“Steve Webb has had his ‘back to the future’ moment. Fifty years ago UK private sector pension schemes were largely based on a defined ambition that was perhaps imperfectly communicated, and subsequently much maligned and misunderstood,” said Dr Deborah Cooper, Head of Mercer’s Regulatory group. “This developed into a nightmare of gold plating as successive governments bowed to political pressure to intervene in the pension contracts that companies had made with their workers. The result is a mutation of the original ideal and the creation of an unwieldy and often unaffordable mess.”
Mercer would support Steve Webb’s initiative, if it came with guarantees that future politicians could not subsequently tighten the bonds of pension provision. Companies interested in starting a risk-sharing scheme need to know that the element of a risk-sharing scheme for which they are responsible, is not going to be loaded with incremental costs when politicians find it politically expedient. If companies could have this reassurance, Mercer predicts that moves to set up risk-sharing schemes will gather pace.
“Although the current regulatory environment is a mess, in principle there is nothing that stops companies from setting up a variety of different types of risk-sharing schemes,” Deborah Cooper said. “What stops them is that they never know what the government is going to do next and what additional costs they will have to bear. For new defined ambition arrangements to take off, employers’ need reassurance that the contract made between employer and employee would be sheltered from the whims of politicians.”
“Regulatory risk has resulted in a flight to DC, where all the risk passes to the employee, since companies can control the cost. However, the UK needs to be adult about this: companies are also not in a position to shoulder all the risks of retirement provision. The Government must accept that some private sector outcomes will be more disappointing than others, without this necessarily being a failure, or that it needs to pass new legislation. Overall, our retirement system will be much better served by less interference rather than endless new initiatives.”
Many of today’s private sector final salary schemes were first introduced as a ‘defined ambition’ promising a fixed pension at retirement age in return for labour. If employees left the company before retirement, or the employer was no longer solvent, then often the pension was reduced or forfeited.
“As the population became more mobile,” pointed out Dr Cooper, “this caused an outcry and lead to changes in the legislation. The original ambition was no longer perceived as good enough.”
This was followed by legislation requiring occupational pension schemes to increase pensions in payment, and to revalue pensions in deferment, as high rates of inflation eroded the value of the benefits provided.
“Each change, although made with good intentions, was a knee jerk response to short term problems that are bound to affect any form of risk sharing arrangement,” said Deborah Cooper. “However, by shifting the risk from employees to the employers, they fundamentally altered the nature of the original ambition. There is undoubtedly a need for the Government to encourage employers to provide, and help employees to value, good occupational retirement provision. However, currently, defined benefit schemes place excessive commercial and regulatory risk on employers, so there is little incentive for them to provide anything more than a DC scheme,” argued Dr Cooper. “Companies and their shareholders need to see that there is value for them in protecting members from falls in fund values, or helping members achieve particular pension outcomes, otherwise there is no reason from them to accept the associated cost and risk.”
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