The Government's idea is to try to bridge the divide between defined benefit (DB) and defined contribution (DC) pension schemes, by encouraging the use of 'defined ambition' schemes where the risks are more evenly shared between employers and employees.
Some employers are now reluctant to provide any form of pension benefit other than pure DC, perhaps having had their fingers burnt by the low investment returns, rising life expectancies and repeated government intervention of the last two decades. Others are dealing with legacy DB schemes for a closed group of employees who might continue to build up benefits for years to come. Others still want to provide something other than pure DC for their new employees but without jeopardising their own balance sheets.
Critics of the Government's policy paper might say we've been here before and the paper offers little in the way of new concrete proposals, but we think it reminds employers of two important points.
First, it's a reminder that pensions don't have to be 'all or nothing'. The debate around pensions has become polarised in recent years as DB versus DC, but that's an unnecessarily narrow view of the options. There are many interesting ways of providing a pension benefit valued by employees where all the risks don't fall entirely on the employer. Employers struggling with the costs and risks of final salary schemes may find employees receptive to a defined ambition approach.
Employees sometimes expect alternatives to DB will automatically be DC; understandably this can make them very defensive towards any change in their final salary schemes. However, employees might welcome a defined ambition approach if the more balanced sharing of the risks means the scheme is sustainable over the long-term.
Secondly, while we encourage employers with an appetite for innovative benefits to engage with the Government on policy reform, there is no need to wait for Government action as scheme designs are already available offering the best of both the DB and DC worlds. Investments with more certain or less volatile outcomes, and targeted contribution rates are already available in the DC framework. In the DB framework, cash balance benefits, career-averaging with discretionary increases, longevity adjustment factors, and foundation DB accrual with DC top-up can be introduced.
As well as scheme redesign there's a lot more that can be done with existing DB schemes by introducing additional options for members that could increase employees' benefits whilst reducing risks on the corporate balance sheet. Members can be given additional options to 'reshape' their standard scheme benefits into another form, either within the scheme or via a transfer to an external pension plan or insurer. This idea is known as 'retirement flexibility' (which Mercer abbreviates as 'ReFlex') and it enables DB members to access the additional flexibility DC members are already used to. This usually leads to a higher tax-free cash sum. It also allows members to reshape their benefits for a higher initial pension and, for some, lets them take advantage of impaired life annuities or flexible drawdown.
Some things won't change, whatever the scheme designs of the future. Good communication and scheme governance will remain key, and the size of a pension will be most closely linked to how much money has been contributed to the scheme, however it is set up. If those challenges can be met there are wins for both employers and employees.
Glyn Bradley (pictured) associate in Mercer's Retirement, Risk and Finance business
