I hope that the DWP and its new Minister for Pensions will focus on increasing fairness between those who have a DB and those who have a DC promise when it sets out its new package of DC reforms on Monday. Right now – if you are in DB you are fine, if you are in DC you are not – that’s not fair and the Government need to do something about it now!
So far- it is the employer who has been key to pension promises
The promises are of course quite different, one is for a pension , the other is for a pot, one guarantees an income for life, the other a contribution so long as the worker remains in employment. It’s not hard to work out which is the easier for an employer to make and which is the harder to keep.
We don’t generally have a problem with employers keeping their DC promises – because they are easy to keep but we have in the past had a problem with employers walking away from pension promises which is why the Government set up the Financial Assistance Scheme and then the PPF and why there have been ever more rigorous funding regulations designed to ensure that members are certain of at least PPF+ through buy-out and have a reasonable expectation of having their expected benefits paid in full.
There is a cost to this and it has been paid through deficit reduction programs that ensured that employers whose pension liabilities had been deemed to be in excess of funds in hand, needed to pay large amounts into their DB funds so that if the proverbial hit the fan, the fund would be close to self-sufficient of its employer and the PPF protected. We now have a PPF that is so well funded that it is looking for ways to turn off the levy it embarrassingly gets from the schemes (and employers) it protects. We have corporately funded pension funds mostly invested in gilts (effectively nationalised) and we have employers starved of funds to invest into growth (and DC pensions).
But the employer is less and less relevant to the DC saver
This might make some kind of sense if we were winding up employment in the UK but we are not. When we decided to close our DB schemes first to new entrants then to future accrual for existing members , employers didn’t stop employing. They just changed the basis of employment so that the promise became a contribution into an investment pot that could be exchanged for a pension, not a pension.
And of course, the “exchanged for a pension” bit was taken away in 2014 when the Chancellor announced that nobody would ever have to buy an annuity again.
So while we have wrapped our DB scheme in swaddling clothes and put them in incubators ready for adulthood as annuities paid by insurers (strange to say), the new promises are that a new generation will get exactly the opposite, no guarantee, no insurance annuity but a lot of fun from an investment in the markets. That fun is tempered by the odd year like 2022 when prices go up by 10% and funds go down by 10% and those with DC pensions wake up to the kind of pension deficit which – were they their own DB scheme – would see them marched off to the PPF for assessment.
The Government’s problem
For all kinds of political reasons, we are where we are with DB promises (despite the £400-500bn crash in value in 2022) still very well funded and DC promises looking kind of weedy.
I understand the Government sees this as a bit of a problem, it’s the kind of social inequality that you don’t want to be presiding over as a progressive Minister for Pensions so I imagine Laura Trott is troubling herself as to what she can do about it.
The Government’s options
It seems to me there are certain options that the DWP could do to ease this structural problem that has been created by over-funding DB, underfunding (comparatively) DC and not having a third way; here are the options, I conclude my blog with what I think they should actually do!
- Have a third way – but this would be dependent on employers realistically funding some kind of non-guaranteed pension and trusting Government not to change the rules as it has in the past. The DWP may feel that employers who have got rid of DB as a problem may want to adopt Royal Mail style CDC for all staff but where is their evidence?
- Take the DB schemes out of incubation. The DWP could abandon its DB funding regulations and TPR its corresponding funding code and we could start requiring pension schemes to start taking some risk again, investing for growth, not for gilt yields. If that is part of the measures the DWP are proposing for DC to level up – I’d be delighted (but surprised)
- The Government could simply focus on making DC better, which is what I expect them to do (while doffing a cap to CDC). Actually CDC could be adapted to make DC better without us having to set up new Royal Mail structures – but let that be. What the Government can do in the immediate term is improve DC schemes by getting them to invest better and give better value for their members by way of outcomes.
- The Government could reset the purpose of DC pensions which is currently dialled “off”. We can’t have the purpose of DC pensions being “to never buy an annuity again” for ever, at some point we will, as Australia has, adopt a common purpose for DB and DC which is to provide dignity in retirement from a lifetime income.
- The Government could look to fix the broken bit of DC – the bit at retirement so that people can swap pots for pensions with a degree of certainty that is currently unavailable. So people can look forward to a wage in retirement that isn’t dependent on the vagaries of this week’s long dated gilt yield or the state of the pound and of global equities (or whatever it is that is determining today’s value of your pot.
- For all this, the public sector continues to get an exclusive DB promise that is causing social unrest. There needs to be a new settlement based on risk-sharing in pensions if we are to resolve the fundamental issues on compensation that give rise to current employment disputes
We cannot have a lasting DC settlement without a progressive policy on DB
Of all the things that the Government could do to improve the lot of DC savers and level their pensions up towards those of DB pensioners, the easiest to accomplish is to relieve employers of the curse of DB funding. But the Government is making such a hash of that that we have had to go lose half a billion of assets to enjoy the dubious benefit of higher interest rates. It seems intent on compounding its strangulation of corporate profitability by persisting with its extravagantly interventionist DB funding regulations and that will prevent meaningful money flowing into non-guaranteed pension savings schemes for a while yet.
Amazingly, the alternative to buy-out that the DWP proposed and consulted on in 2018 , the pension superfunds , have been strangled at birth, the 2018 consultation has still to get a DWP response and all that has happened since has been an application process for superfunds that has resulted in not one pension scheme availing themselves of their advantages.
The DWP seems intent on handing the insurers the incubated body of DB schemes, possibly the greatest windfall , the insurance and funds industries will ever have. That windfall will include all the deficit contributions that deprived employers of free capital in the last 20 years (and of the means of properly funding DC). It will not include the £400-500bn lost in 2022, mainly through DB’s over exposure to “risk-free” assets.
Meanwhile, the great project that is the RM CDC plan, remains on the slips, awaiting launch and looking increasingly like the first and last of its kind.
This blog – like many of my blogs, is a wake up call. But unlike many of my blogs, it comes at a time when the DWP say it is going to make changes to the system. Those changes must address the massive unfairness between DB and DC saving.
There is one final point that I must make and it is this. We have public sector pensions which are now becoming a real problem. They are so generous they are stopping doctors wanting to work, they are too expensive for nurses to join and they are creating envy from the private sector who understand the idea of total compensation as the value of both salary and benefits. The current hiccough of inflation is creating social tension because of inequalities of pensions.
It is incumbent on the Department of Work and Pensions to address this issue and I hope they will start doing this on Monday. The Government should without delay;
- Revisit the DB funding regulations
- Return to the good idea of superfunds
- Create a proper VFM standard to improve DC outcomes
- Explore better ways to turn pots to pensions
- Ease RM over the line and then look again at risk-sharing
- Address the issue of public sector promises in the light of (5 above)
We must also consider the DB promises that are funded and unfunded. The latter, involving a £2,100bn accrued liability for our crucial public sector workers, are sadly unsustainable. The underlying actuarial assumption determining contributions, pension fractions, revaluation and retirement age relies on GDP growth of 2.4% – 3.5% pa over CPI. The equivalent private sector deficit reduction contribution for a one year recession would be around 6p on the basic rate of income tax. We have a smaller intergenerational transfer for every year since 2010, but arithmetically it is a Ponzi scheme.
Henry. We are not OK being in a underfunded DB scheme that ends up in the FAS. Many of us elderly, ‘older pensioners DB’ do not get their promised return on contributions paid before 1997. If the PPF/FAS has a surplus for DB why are us pre-1997 service pensioners not getting our 3% RPI inflation indexing that we paid for? There is clearly an an inequitable unfairness in the way that the the past century government promulgated the ‘rules of the FAS’ for service in company pre-1997. Why won’t the DWP answer letters from the PAG to meet and attempt to ‘address this problem’?
“Gold plated”. Maybe we should start the value for money with a proper analysis of what was promised and what was delivered by DB in the PPF
Peter – I entirely agree!
An 0.5% increase in my largely pre 1997 pension in a 10+% inflationary environment seems like an insult.
I am also a sufferer from Premature Buy-out as my pension was bought out as the Pension Scheme was over-funded for entry into the PPF. My pension would have been 4.2% greater if the employer could have held back for just two months.
I wonder how many other pensioners in future will find that the trustees of their scheme’s have elected to pay the inflated price for an insurance company buy-out compared to the real cost of running out on a self-sufficiency basis even allowing for administration costs. A surplus that could otherwise have been used to partly restore inflation savaged pensions..
I am also aware of a few employers who are contemplating re-opening their closed DB Schemes with benefits determined by the current DC contributions as a way of realising a trapped surplus and also allowing them to report the pension scheme as an asset on the Company’s balance sheet.
Peter. Lets hope that our new ‘Pensions Minister’ sees these messages, will acknowledge us and address this problem with a workable practical solution. We would welcome her response on this blog.
One key issue DWP appears not to have recognised is that the ‘pension freedoms’ introduced in 2015 were half-baked. A DC system built around ‘pot conversion’ only made sense when you had compulsory annuitisation. Now, an accumulated DC fund should be retained with an investment policy that evolves from ‘growth’ to the generation of a level of income that supports a sustainable pension (and removes the risk from events such as the 2022 ‘lifestyle’ fiasco!)