8 Risk-sharing and Defined Ambition
pension schemes
131. This chapter explores the Government's ideas
for introducing a new form of pension schemes which takes a different
approach to sharing risk, in what it terms "Defined Ambition"
schemes.
Risks associated with pension
saving
132. Government, pension providers, employees
and employers all share the market and longevity risks involved
in pension saving to some extent. However different types of schemes
share risks between employers and employees to varying degrees.
In DB schemes, employers bear the risk of low investment returns,
and of scheme members living for longer than expected. Conversely,
in most DC schemes, it is the scheme members who bear the risk
of poor investment returns, low annuity rates at the point of
retirement and longer than expected longevity, factors which could
potentially result in a lower income in retirement.
133. The proportion of people saving in DC rather
than DB pension schemes, in the private sector, has increased
over recent years as employers have found it prohibitively costly
to continue to offer final salary-related pension schemes. This
growth in DC scheme membership will be accelerated by the large
number of new savers who will be introduced to pension saving
as a result of auto-enrolment. This means that, in future, many
pension savers, especially in the private sector, could bear many
of the risks of pension savings themselves.
Sharing risks between employer and employee
134. The decline of DB pension schemes in the
private sector and the shifting of risk to employees has raised
the question of whether new ways can be found to share risk more
equally between employers and scheme members and has led to discussions
about whether the greater use of the type of risk-sharing schemes
which are more common in some other European countries is worth
exploring in the UK. Some risk-sharing schemes "have elements
of current DB schemes, but with greater sharing of risk; others
may start from a DC standpoint, but with increased certainty for
members."[146]
For example, a "hybrid scheme" is a type of risk-sharing
scheme in which employees accrue benefits in both a DC scheme
and a DB scheme at the same time.
135. Collective Defined Contribution (CDC) schemes
are a type of risk-sharing scheme which shares risks between members.
They are in widespread use in the Netherlands. CDC schemes are
Defined Contribution schemes in which:
- Members' contributions are pooled into a collective
investment fund, rather than each individual owning a personal
fund
- members pool their risk and diversify their investments
more widely
- members share risks with each other rather than
with the employer
- members subsidise each other in the case of poor
investment returns or increases in longevity
- in-built annuities can operate, which pay benefits
to members from the fund or can give members lump sums at retirement
with which to purchase an annuity.
136. Saving in CDC schemes can result in higher
incomes in retirement than saving in individual DC pension funds:
[...] by enabling riskier investment strategies,
self-annuitisation and cost efficiencies, collective DC schemes
can deliver outcomes for individuals 37% above pure DC pensions
(the government's own evaluation in 2009 estimated the average
benefit would be 39% higher).[147]
This is illustrated in the chart below.
Chart 2: Defined Contribution vs. Collective Defined
Contribution[148]
Example of the potential difference in Mr Smith
and Miss Snow's weekly annuity income at point of retirement after
contributing the same amount to a pension for 40 years
137. Some witnesses supported the idea of CDC
and there was general agreement that CDC could produce higher
retirement incomes for individuals and offer consumers greater
protection without pushing an unreasonable burden of risk on to
the employer.[149]
However, other witnesses expressed concerns around potential legal
barriers to introducing CDC schemes in the UK. It was suggested
that CDC might not work in the UK unless membership was compulsory.
The general view expressed was to question whether there was sufficient
social appetite for the cross- and inter-generational risk-sharing
and subsidisation underlying CDC schemes.[150]
Defined Ambition
138. In November 2012 the Government published
a strategy paper, "Reinvigorating Workplace Pensions".
Amongst its proposals, it outlined ideas for risk-sharing under
the banner of "Defined Ambition" pensions. The paper
discussed the potential benefits and limitations of the various
current forms of risk-sharing pension schemes including CDC schemes.
The Government stated that its objective was to "Enable industry
innovation and development of new products including those which
will give people more certainty about their pensions and encourage
more risk-sharing." The Government concluded by promising
to:
[...]work closely with industry and consumer bodies
to develop possible models and designs for DA pensions. [...].
Our planning assumption at this stage is that an early outcome
of this work is likely to be a publication outlining a framework
for DA pensions, possibly jointly with industry. Any proposals
for legislative or regulatory change will be subject to a formal
impact assessment and consultation. [151]
Employer appetite for risk-sharing
139. There was some support from witnesses for
the Government's plans for risk-sharing and a recognition that
risk-sharing schemes could be more beneficial to members than
pure DC schemes.[152]
However, some witnesses cautioned that employer appetite for offering
these schemes may be low because of the greater risks involved
in running DA schemes, rather than offering access to pure DC.
There was a feeling expressed by some witnesses that the Government
did not support employers enough in keeping their DB schemes open,
and were in some ways instrumental in forcing their closure.[153]
Towers Watson explained:
If the Government wishes to encourage employers to
sponsor risk-sharing pension arrangements, it will first need
to convince them that aspirations and best endeavours will remain
just that. Employers have had their fingers badly burned with
defined benefit pension provision. This has proven far more costly
than they anticipated, due in large part to UK Governments, over
a period of many years, turning soft goals into legislative commitments.[154]
140. However, the Association of Consulting Actuaries
(ACA) claims that they and others have conducted attitude surveys
which they believe "show that there is indeed demand from
employers for the freedom to offer new risk sharing pension options".
But they warn that the Government is not doing enough to enable
employers to introduce risk-sharing schemes and could do more
in terms of making the legal and regulatory environment more open
for risk-sharing schemes.[155]
This may become particularly relevant in 2016 when the Single-tier
State Pension is likely to be introduced and people will no longer
be able to contract-out of the State Second Pension, reducing
scheme income. DA schemes may offer an alternative to employers
who are considering moving away from DB, as a result of the ending
of contracting-out.[156]
Response from stakeholders to
the DA proposals
141. EEF suggested that the Government should
encourage greater use of risk-sharing through non-legislative
means such as providing forums for sharing examples and strategies
and stimulating the commercial sector to develop new products.[157]
Age UK, while welcoming the Government's plan to investigate DA
further, made the point that this should not distract the Government
from ensuring that DC schemes are held to high standards:
Whilst we look forward to seeing these deliberations
we are keen that this debate does not detract from what we see
as the immediate priority—ensuring that DC schemes, be they
contract or trust based, offer good value for money for consumers.
[...] DC schemes are still likely to predominate pension provision
for the foreseeable future, so the focus should be on ensuring
that competition in the DC market acts in the interests of consumers
in delivering better quality products.[158]
The TUC also emphasised the need to focus on DC scheme
delivery and believed the Government should "consider how
a greater degree of certainty in retirement outcomes can be achieved
within a pure DC model given the numbers of people that will be
automatically enrolled into pure DC schemes over the next few
years."[159]
142. Risk-sharing schemes can
give their members greater certainty over retirement benefits
and can help rebalance risk between the employee and the employer.
We welcome the Government's intention to develop plans for Defined
Ambition (DA) risk-sharing schemes. The Government should continue
to explore ways to encourage employer appetite for DA schemes
and to take the necessary steps to remove legislative and regulatory
barriers to DA schemes by the time the Single-tier State Pension
is introduced and contracting-out ends in 2016. This may provide
employers with an attractive alternative to DC that could potentially
offer employees better outcomes in retirement.
143. However, we also recognise
that many millions of people will be auto-enrolled into DC schemes
in the future and that joining a DA scheme may be an option for
only a small minority of employees. We therefore recommend that,
while it investigates options for DA, the Government remains focussed
on ensuring that people are being enrolled into DC schemes which
offer high standards of governance and reasonable and justifiable
charge levels.
146 Department for Work and Pensions, Reinvigorating
Workplace Pensions, November 2012, p 4. Back
147
Ev 238 Back
148
Data supplied by David Pitt-Watson, assumes 40 years of contributions
(at any level). Back
149
Q 29, Q 60 [PPI], Q 227 [Aon Hewitt], Ev 129 Back
150
Q 124 [Fidelity]. Back
151
Department for Work and Pensions, Reinvigorating Workplace
Pensions, November 2012, p 30 Back
152
See for example Q 193 [EEF], Q 226 (Aon Hewitt, ACA, Mercer] Back
153
Ev w84, Q 226 Back
154
Ev 226 Back
155
Ev 128 Back
156
See Fifth Report, The Single-tier State Pension: Part 1 of
the draft Pensions Bill, HC 1000, paras 90-98. Back
157
Ev 149 Back
158
Ev 106 Back
159
Ev 237 Back
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