A timely report arrived yesterday from the Pension Corporation estimating that the cost of replacing a standard DB benefit structure using DC had risen to 55% of salary.
PIC’s business model is based on managing out DB plans on a collective basis providing greater security to members (they’ll keep you from the Pension Protection Fund) and value to their shareholders from their good efforts. So far so good, PIC has been a great success, as have the other insurers buying out benefits; It’s a competitive market, unsung but of great benefit.
I don’t take issue with their headline number. Right now, the cost of targeting a defined benefit using a defined contribution has never been higher. The projected returns on your invested assets are low and the cost of purchasing an annuity high. Thank inflated stock-markets in the 1990s, low economic growth, high levels of sovereign debt and artificially depressed gilt yields for that.
By comparison, DB plans can ride out some of these local issues. On the face of it, they are are in deficit because of lower growth and higher costs of matching liabilities (because of QE depressed gilt yields) but unlike DC plans, DB plans do not have to crystallise these deficits and can wait till the market turns in their favour- not for them compulsory annuity purchase.
PIC point out that the problems for Defined Contribution pensions in the UK are long-term. They suffer from systemic problems to do with inefficiency. They capture few of the economies of scale available to large DB plans, are expensive to administrate, require labour intensive member attention and do not benefit from discounted fund management fees as enjoyed by the multi-billion pound company pensions.
Put these systemic problems together with the local issues facing DC today and you get a system of pension provision (DC) that costs perhaps treble the cost of the DB equivalent.
It is this fundamental issue of inefficiency that Steve Webb should be addressing with his ambitious pensions.
In practice there is no difference between a defined contribution pension targeting a certain benefit and a defined benefit pension that has ambitions but no guarantees. Tom Mcphail tweeted yesterday that Steve Webb should be concentrating on improving DC rather than making life easier for DB plans. In practice he could be doing both at the same time. Ambitious DC pensions can aspire to the efficiencies of a DB equivalent while ambitious DB plans can aspire to the certainty of costs of a pure DC approach.
The biggest issue facing the minister is cultural. The unions have dug in their heels to preserve those guarantees still provided by employers (and in the public sector by the taxpayer), companies seem hell bent on de-risking their balance sheets to get rid of any toxic pension risks they can. To talk with some FDs you’d consider longevity risk the financial equivalent of asbestosis.
The polarisation of these positions can only be altered through Government intervention. Some form of political mediation is required that appeases the unions by ensuring that the costs of increased longevity ,low bond yields and equity returns are not crystallised at an individual’s retirement. Companies need to be assured that they can set up schemes that provide their staff with a degree of certainty without limiting their capacity to operate and grow.
Put another way, the Government should be looking to encourage a narrowing of the gap between the 20% of payroll needed to run a standard DB plan and the 55% of payroll needed to target an equivalent benefit through DC.
But it should not be doing so by dumbing down the DB promise.
As I wrote in a blog a few days ago, the Government has to intervene at a high level in the way UK pensions are provided in the UK. Currently too much of the tax-payer subsidy is targeted on providing guaranteed benefits for the public sector. Money needs to be taken from this subsidy either by taking away guarantees (as has happened in Jersey) or by reducing benefits, as has happened in the switch from RPI to CPI and to some extent in the move to career average. The Government has to move further in due course.
As it takes from the over-pensioned, so it must give to the under pensioned. It must remove the stealth tax on pensions introduced by Gordon Brown in 1997 and set about relieving corporate and private balance sheets of some of the longevity risks these balance sheets bear. This can be achieved through the issuance of longevity bonds available to target groups or through the opening of institutions such as the PPF as a source of scheme pensions (see many blogs on this).
Necessarily such measures will be bitterly opposed by those within the Treasury more concerned with bringing down national debt. However it must be argued forcibly that it is the business of Governments to recognise long-term liabilities such as the pensioner poverty that PIC point to unless we do something about the DC/DB imbalance and if that means transparently accounting for the cost both now and in years to come, then Government must be brave and bite the bullet.
We cannot persist in the current practice of pretending we have solved our pension problems through an increase in the Basic State Pension and through the introduction of auto-enrolment, we must set about, as Steve Webb is doing, reviving the effectiveness of corporate pension provision and do so with public funds and funds diverted from over provision of public sector pensions.
- Steve Webb’s good week (henrytapper.com)
- Steve Webb needs hard cash for his defined ambitions. (henrytapper.com)
- Aspirational pensions – popcorn pensions!! (henrytapper.com)
- Define your aspiration. (henrytapper.com)
- To get better pensions we need to share risk (henrytapper.com)
- Can we have a word Mr Webb? (henrytapper.com)
- Pension Equality? Don’t make me laugh. (henrytapper.com)
- For proper pensions, we need more than ambition (telegraph.co.uk)
- What have the Australians done for us – not much! (henrytapper.com)
- Workers to be offered guaranteed pensions under new plans (oyiabrown.wordpress.com)
“In practice there is no difference between a defined contribution pension targeting a certain benefit and a defined benefit pension that has ambitions but no guarantees.”
I agree – and both will end in tears and lawsuits if the member doesn’t get the amount they expect/want/need to keep up their subscription to the golf club at retirement.
As well as a legislative change – which is undoubtedly overdue – a cultural change is necessary. Pension scheme members need to accept the concept of a ‘guideline’ or ‘target’ income at retirement, and be prepared to take the risk that that income will not be met. Otherwise nobody is going to take the responsibility of giving those members any idea of the income they can expect in retirement, with the attendant risk of having to ‘top up’ the member’s account if those expectations are not met. It will be plain vanilla DC for all, every man and woman for themselves.
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Spot on Judith, people need to get real on their financial futures. I think the State has a part to play as wee, as Peter Tompkins wrote in a post on the Pension Play Pen, we need the State to involve itself in tilting the playing field so both employers and employees reckon its worth deferring consumption till later.
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