Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference
Add the QFINANCE search widget to your website

Home > Blogs > Anthony Harrington > UK leads search for a pensions plan that works: Part 2

UK leads search for a pensions plan that works: Part 2

UK leads search for a pensions plan that works: Part 2 Anthony Harrington

Facebook LinkedIn Twitter


In November 2013 the UK government issued a consultancy paper entitled: Reinvigorating Workplace Pensions. As I noted in Part 1, the aim was to seek responses to the government's attempts to formulate a "halfway house" between defined benefit (DB) schemes and defined contribution (DC) schemes. Both DB and DC schemes are recognized as having fatal flaws. DB puts all the responsibility for the solvency of the scheme on the employer, DC shifts it all to the employee. What the government is looking at are various ways of sharing the risk between the two, and it is calling this new approach "defined ambition" (DA) to differentiate it from DC and DB schemes.

The policy aim, as the consultation paper notes, is to increase the amount that people are saving in pensions; provide them with a better return for their savings; and stimulate innovation in the pensions sector so that more "risk sharing" products will appear on the market. To achieve this policy aim, what any DA scheme needs to be able to do is to create a lot more certainty for employees about the value of their pension pot on retirement, and it needs to achieve this without generating huge burdens for the employer and leaving the employer subject to all the risks that a company runs in sponsoring a DB scheme.

Now the first thing to be said about this is that any halfway house cannot but tippy-toe into exactly the same murky waters in which DB schemes are currently drowning. When an employer offers any kind of a promise, such as "we will pay you 10x salary after you have completed 40 years with the company, and pro rata for a lesser term of service", it commits itself to a financial obligation - and there is always the chance that, multiplied up by the number of employees in the organization, that promise will turn out to be impossible for the employer to meet. However, one of the nice things about starting with a clean sheet of paper is that the government can do away with a large part of the bureaucratic web of legislation that has strangled DB schemes. So, there may be ways of building some flexibility into that promise so that the halfway house concept would not turn out to be the tail that wags the dog, as was the case with DB schemes.

The government has written this into the proposal via its talk of "proportionate regulation", and has said it wants a "permissive" framework "that will enable innovation in risk-sharing, while still protecting member interests". There is a slight worry here, since it was the government's concern to "protect member interests" that generated the huge legislative burden that has all but killed off DB schemes. If you are sharing risk, you can't be protected from risk at the same time. That's the point of risk sharing. What the legislation has to do is to protect the employee from malpractice, bad administration and unfair practices - but the government also seems to want to guarantee that the investment outcome will be sufficiently significant. That is a tough thing to do unless you get the employer to guarantee a set minimum sum. This route runs the risk of dragging the "halfway house" idea all the way over to the DB side of things, where the employer shoulders all the risk.

This is where we come on to the Dutch and the Danish models. The Dutch group collective DC scheme idea promises a certain level of benefit to members, but that benefit is conditional on the investment performing to the expected level. If the investment returns are less than expected, the scheme is free to reduce member benefits accordingly. In 2013, this is exactly what happened to many Dutch collective group DC schemes. According to an article in the Financial Times, a combination of under-funding and poor investment performance has created a 30 billion euro shortfall in the funding of Dutch pensions. In April 2013, under orders from the Dutch Central Bank, 66 of the country's 415 pension funds started cutting monthly payouts to members, some of the smaller funds cutting by 7% or more. Many observers regard this approach as lacking "honesty", in that the rhetoric suggests that people will get a pension of "y" value, when in reality they wind up with "y-x", with "x" being the discount levied for poor performance.

By way of contrast, the Danish system - which looks to hold the bulk of pension fund assets in "safe" investments and to spice up returns with a small proportion held in higher yielding and riskier assets, while keeping charges extremely low - was found by a recent report by the European Federation of Financial Services Users (EuroFinUse) to be the only European system to provide consistently positive investment returns for savers. Key features of the Danish ATP DC collective system is its extremely low cost and heavy regulation by a government appointed board of trustees, offering very little by way of choice. Because it does not have to split its buying power across numerous "options", ATP brings tremendous buying power and bargaining power to any investment; it is always able to leverage its size when investing.

Quite which way the UK is finally going to go on DA remains to be seen. With an election due in 2015, there has to be some doubt that the government will bring forward legislation to enact DA this side of the election unless it can get cross party support. What is significant, however, is the fact that this whole exercise by the UK government amounts to an official declaration that the current pension system for citizens is bust.


Facebook LinkedIn Twitter


Further reading on pensions




Tags: defined benefit , defined contribution , Dutch model , private sector pensions , proportionate regulation
  • Bookmark and Share
  • Mail to a friend

Comments

or register to post your comments.

Back to QFINANCE Blogs

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • RSS
  • Bookmark and Share

Blog Contributors