Page 12 - IrishPensions Spring Edition

Irish Pensions Magazine Spring 2013 12
This season’s fashion is all about black and white.
Just for a moment the worlds of fashion and
pensions may be aligned: more “black and white”
pensions legislation is anticipated; and, with low
corporate bond yield impacts on company balance
sheets, the contrast between defined benefit (DB) and
defined contribution (DC) pension schemes is starker
than ever for employers.
Employers are being driven to conclude that DB is a
pension solution they cannot afford or control. With
no clear alternative, DC is the default replacement.
Yet, as more employees use DC plans it is becoming
clearer that it is difficult to achieve meaningful DC
pension outcomes. This has led the Netherlands
and the UK to investigate alternatives to DC pension
savings.
Steve Webb, the UK’s longest serving pensions
minister has issued a consultation paper 1 highlighting
the problems with the DC system into which people
are being auto-enrolled. That paper examines the
need for improvement in DC outcomes and proposes
“defined ambition” (DA) alternatives.
Meanwhile, the Dutch are coming at DA from the
opposite direction. They are seeking more stable
employer contributions and member outcomes as their
current DB arrangements struggle with the current low
interest rate environment.
So what does a “defined ambition” scheme look like
and could it form part of a solution to the challenges
facing the Irish pensions industry?
What DC issues might DA address?
The UK paper acknowledges that auto-enrolment is
just the beginning of the future pensions challenge.
The Department of Work and Pensions (DWP) is
concerned that employees coming into DC pension
saving through auto-enrolment should be confident
that the saving is worthwhile. After analysis of DC
outcomes and the ideal conditions to increase
employee saving, the paper sets out six “principles”
for the development of DA systems. It suggests that a
DA scheme should be:
Consumer focused – i.e. meet the needs of members
and employers
Sustainable – i.e. affordable over the long term
Intergenerationally fair – i.e. not be biased to
pensioners
Risk-sharing - between stakeholders
Proportionately regulated – i.e. permissive
regulation to enable risk-sharing
Transparent – and have high governance standards
It is implicit in this list the UK government anticipates
that the current DC auto-enrolment vehicles do not
meet all these objectives. Its hope is that a range of
DA scheme designs can be developed which would:
• enable greater certainty for members about the
final pension outcome than is provided by a pure
DC scheme; and
• ensure less cost volatility for employers than a
pure DB scheme by sharing the longevity and
investment risks between employers, individuals,
insurance and investment businesses.
The premise is that increased certainty and lower risk
relative to DC would improve employee confidence
and result in increased contributions. At the same
time the reduced risk and cost volatility for employers
relative to DB would make the DA product attractive
to employers and result in a more stable occupational
pension system.
So what does DA look like?
There are two main approaches to DA design– by
transferring DB risk away from the employer; or by
transferring DC risk away from the employee. This
leads to a spectrum of designs some of which are
already familiar. The spectrum roughly runs:
DB(final salary) – DA(from DB) – Collective DC –
DA(from DC) – DC
The DA from existing DB models suggested by the
DWP paper are:
• Career Average Revalued Earnings (CARE)
schemes
• Cash balance schemes
• Risk-managed schemes (i.e. ordinary DB but with
buy-outs or buy-ins, swaps etc to remove risk)
• and ‘new’ ideas such as:
• Life expectancy schemes – i.e. where normal
pension age increases in light of increasing
longevity so that pensions commence at a later
date. This mitigates the increased life expectancy
risk/cost for the employer
• Core DB schemes – i.e. with ordinary DB core
benefit and a more lightly regulated “ambition
Are “Defined Ambition” schemes just another fashion?
by Philip Smith
Expert Opinion