Pension Schemes Bill

Written evidence submitted by the TUC (PS 02)

   The Trades Union Congress is the voice of Britain at work. We have 54 affiliated unions and work with them to support the six million trades union members in the public and private sectors to increase pension saving.

 

Background

1. This briefing covers the Pensions Scheme Bill, focusing on Part 3 containing the clauses relating to collective defined contribution (CDC) pensions.

 

2. The TUC is a strong supporter of the introduction of CDC pensions. We believe that the proposals would provide a welcome opportunity to improve the prospects for working people in retirement by delivering higher incomes in retirement.

 

3. Under CDC, employee members pool their assets and share investment and mortality risks, unlike traditional defined contribution arrangements where everyone invests their own money in their own individual pot. The pooling process means that these benefits are more stable than individual schemes, and can smooth out the ups and downs of investment markets. It also removes the responsibility for taking complex investment decisions from the hands of individuals and delivers economies of scale. But, as with individual defined contribution schemes, employers would not be required to guarantee an employee’s income in retirement.

 

4. We are, however, concerned that some of the specific provisions in the Bill may restrict the widespread take-up of the new CDC models the legislation aims to support. We also believe that the Bill gives insufficient attention to the need for robust governance at CDC schemes.

 

Collective benefits

5. One of the advantages of defined contribution schemes is that they can respond to market conditions by increasing or reducing the speed at which benefits are accrued. This includes in some circumstances, albeit extremely rare ones, reducing the level of accrued benefits and pensions in payment. The ability to take such action means that CDC schemes do not amass the sorts of significant deficits that have been faced by some defined benefit pension schemes. However, it is critical that this process is undertaken in a way that does not create intergenerational unfairness.

 

6. Taken together, Clauses 20, 26 & 28 produce the risk that unfairness could occur. In 20 (2) (c) the Bill requires schemes to set initial targets so that they meet or exceed a level of probability specified in regulations to be drawn up at a later date. The Department for Work and Pensions has indicated that it would prefer to see these probabilities set at a high level, for instance around the 97.5% mark required at some Canadian schemes at least for core benefits. Set at this level, scheme members would have the advantage of knowing there would be a very high chance they would receive the targeted income.

 

7. However, it would likely see schemes amass large buffers as they are run with this demanding level of probability in mind. This has the potential to penalise older generations as younger generations benefit from the eventual distribution of excess assets. It would also mean that the targeted income levels would be set low making them less attractive to potential scheme members. Returns might also be muted as schemes invested in lower risk assets to improve their chances of reaching the desired target. Clause 28 (3) & (4) allow scope for regulations to proscribe how schemes deal with the "deficit" or "surplus" over the target probability that is amassed. Depending on how this is implemented, this too could restrict how schemes operate. For instance, some schemes may wish to keep funding levels in a window of 90 per cent to 110 per cent of probability of delivering target pensions. They may make frequent changes to increases in the target pension or even cut target pensions, including those in payment. Others schemes may deem it more appropriate to operate with wider 80 per cent to 120 per cent funding with less frequent benefit changes.

 

8. The overall impact could be to restrict the diversity of CDC models that could operate in the UK. We believe it would be desirable for the DWP to set a relatively low minimum level of probability, ideally around the 50% mark but certainly no higher than 65%, and then allow schemes, if they wished, to operate to higher levels of probability..

 

Governance

9. The Pension Schemes Bill makes no provision about governance of CDC pension schemes. It refers to "trustees or managers" throughout, indicating that it would be permitted for schemes to be set up under contract-based or trust-based governance. We believe that this is a mistake and the robust nature of trust-based governance would be by far the most preferable.

 

10. Pension provision is notoriously open to conflicts of interest. Individuals often have little knowledge of what their pension provider is doing and little influence over their actions. In CDC there are important decisions to be made to ensure the sharing of risk between members that requires beneficiaries to have a high degree of trust in the way a scheme is run.

 

11. The business model of insurance companies that provide contract-based pensions requires them to extract profit from the saver. This makes them badly placed to take decisions that involve balancing the interests of investors and savers and different groups of savers. In trust-based governance trustees have a single duty - to look after the interests of all scheme members both active and deferred. They also have the ability to draw on the perspectives of employer and employee representatives.

 

12. It would be best if CDC pensions, like defined benefit pensions, were only to be introduced under trustee management run on a not-for-profit basis. The primary duty of the trustees should be to represent the interest of the members. The trustee boards should have members with adequate expertise to manage the investment and benefit issues they will confront. By establishing CDC pensions as trusts it would ensure they were run entirely in the interests of beneficiaries. This would avoid the potential conflicts of interests that previously hindered with-profits investment products.

 

13. In particular, robust governance will help mitigate concerns about intergenerational unfairness. Fears have been expressed that younger savers could end up subsidising the pensions of older pensioners if investment returns are muted. It should be noted that the current system of pure defined contribution schemes is unfair in intergenerational terms because people saving the same amounts can end up with very different retirement incomes based on the health of the financial and annuities market when they retire. Under CDC, pensions in payment, as well as those still being accumulated, can be reduced to reflect changing conditions. This is usually small and temporary. What is important is that the decision-making process is overseen by trustees with no loyalty to anyone other than scheme members.

 

October 2014