A blueprint for DC pensions

Low DC pots, inefficient individual annuities and short-sighted buying patterns meant that 86% of annuities purchase last year were purchased without indexation. We are storing up problems for our society for generations to come.

While we cannot increase the DC pots of those buying pensions today, we can offer those converting from accumulation to decumulation, a better pension by buying their pot back into a collective pension fund. The Pension Protection Fund was set up by Government to salvage occupational schemes that had become so underfunded that without its help, would have led to members receiving dramatically diminished pensions.

In this article I am arguing that the Pension Protection Fund can be used to provide pensions today for those ill-served by the individual annuity process, namely those whose pots are above the level of commutation (£17.000) but below the levels where income drawdown becomes viable (£200,000).

Inevitably, such a structural change to the pension conversion process requires consultation and detailed investigation into its impacts

Concerns will be voiced on a number of fronts

  1. Will the longevity risk transfer from private insurers to another generation of taxpayers be politically acceptable?
  2. Will the transfer of pension liabilities from the private to the public sector materially damage the UK life insurer’s business models
  3. Will such a transfer contravene wider EU legislation
  4. What would be the impact of a reduction in the purchase of gilts to a more balanced funding approach using corporate bonds, equities and other real assets.
  5. Can the tax-payer be protected from the risk of occupational pension schemes off-loading longevity risk through such an arrangement
  6. What will be the impact of financial advice and will such an arrangement damage the burgeoning income drawdown products

Set against such considerations are the obvious attractions of such a reform

  1. The operational costs of paying a scheme pension through the PPF- especially for smaller pots, should be considerably cheaper than through individual policies
  2. The infrastructure for a state run pension payment system already exists
  3. The covenant offered by a state pension, especially to those unfamiliar with pensions is likely to be considered better than that of an insurer
  4. The ability of the PPF to maintain the assets backing such pensions in real assets offers scope for more appropriate investment strategies
  5. The capacity of the PPF to operate unconstrained by the restrictions placed on insurers by EU Solvency II provides it with further advantage.
  6. The scale of the existing PPF fund allows it to provide scheme pensions immediately – effectively providing a seeding service for NEST which may be able to take on this role once it has established sufficient funds to take on the role independently (in line with the proposed review of NEST’s scope in 2017)
  7. The 2008 Pensions Act offers scope for an occupational fund to absorb transfers-in from a variety of sources including protected rights, GMPs and self employed DC arrangements
  8. While no market currently exists to provide CPI linked annuities, it is possible for the PPF to escalate pensions in line with CPI as a default indexation rate
  9. The Government Actuary has the capacity to set commutation rates and monitor the solvency of the collective arrangement
  10. Similarly GAD can build in a solvency margin for the fund to ensure it is ring-fenced from the PPF and does not risk negatively impacting on occupational scheme levies.

Historically we have seen a gradual transfer of risk from the public to private sector, initially through contracting out. The Initial system of GMPs has been superceded by “protected rights”. This risk-transfer has been predicated by the assumption of an efficient annuity system. This system does not currently exist and the option to buy-back money purchase benefits into occupational defined benefit arrangements has all but disappeared as DB solvency rates have plummeted.

The reversal of the long-term trend towards individual annuitisation and towards collective provision has been argued for by a number of parties – implicitly by GAD who have published relative annuitisation factors for individual annuities and scheme pensions with a 20% improvement in rates for scheme pensions. A recent paper by the Royal Society of the Arts suggest that a proper system of collective DC decumulation could enhance current individual annuity rates by as much as 50%.

The need to test these assertions, explore the issues outlined at the outset of this article and analyse the regulatory options available to protect the various stakeholders involved is very urgent. It cannot be achieved without the support of these stakeholders.

If you wish to add your support to a campaign to initiate this analysis , please contact me at henry.h.tapper@gmail.com or leave a message on this blog.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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