I’ve been thinking over the weekend about hybrid pension structures, pension schemes that provide a defined benefit for core earnings – say the first £40,000 you earn and a top up contribution against earnings above this amount, which provides a pot – which pensioners can use to buy what they like.

It’s a hybrid pension scheme – but it doesn’t provide hybrid pensions. There is no pension option from the DB pot – only pathways to personas solutions (drawdown, cash-out, etc). If a pension is required – it still has be an individual annuity.

From a member’s point of view, the top up provides flexibility. You can use the pot as you like, knowing that you probably have between the state pension and your core defined benefit, the basis for a comfortable retirement. But it’s a bit complicated, a little over-engineered. Why split salaries in what seems an arbitrary way? Why not stick to the old idea of paying a pension?

There are quite a few of these hybrid arrangements but the one that most people will think of – because it is by far the biggest – is USS.

I have gone on record, indeed I spoke to an audience at Cambridge University,  to say that I see the long term future of a hybrid scheme like USS as a CDC scheme where the risk of the financial targets of funding the pension promise are shared between the scheme and its sponsors (employers and university staff).

But as each year goes by, the case for turning the DC section of the hybrid gets stronger. That’s because the section has more members, more money and more capacity to do the things that CDC can do – pool mortality risk, invest in long term assets and provide value for money through economies of scale. Rather than splintering into individual retirement decisions, the collective pension scheme can provide bigger and more sustainable pensions that last as long as its members do.

The hybrid also lends itself to negotiation. The CDC solution (with an opt out for those who don’t want a collective pension) is expensive to move to. TPR charge a £78,000 application fee, there are legal and actuarial costs in designing and documenting the scheme, you don’t get a better pension without trade-offs. But in a hybrid arrangement , there is scope to trade off. There are features of the DB scheme that cost a lot to guarantee, such as certain aspects of the indexation of benefit. The scheme membership may consider that it can dispense with these luxuries in return to a better top-up.

Over time, the logic of two types of benefit may become less clear and – as older members with grandfathered benefits pass on, the remaining DB guarantees can be swapped for a CDC approach. This is , as I see it , a long term strategy that both UCU and UUK could get behind.

As Derek Benstead’s fine chart shows, the one calamity that could have befallen USS, has been averted (the red box showing the impact of closing to future accrual).  USS and other hybrids that stay open for future accrual (whether DB or CDC) have the open scheme sweet spot

“benefits paid from income with an infinite time horizon hat makes market values irrelevant”.

First Actuarial are advisers to the UCU and so long as they remain so, these ideas remain current. Aon advise UUK, they too have been active in promoting the ideas behind “risk-sharing”. The Trustees of USS are well aware of the need to keep both UCU and the member’s interests balanced with  UUK and the employer’s interests.

My question is “do hybrid pensions make sense” and the grammar is important. I think that both the current DB and DC  sections of USS could be better focussed on maximising pensions for members. The USS DC scheme already leverages the IMAs of the DB scheme to get DC members better value for their money, this is an ancillary benefits of not closing the scheme a few years ago, as some called for. If assets can be cross-subsidised, so can liabilities. The USS now finds itself in unexpected surplus and now is the time for both employer and members to redefine the pension promise,.

I hope the forthcoming discussions on the future of the scheme will include discussion on whether  the DC section could be converted to CDC and what the cost/benefit analysis of doing so – would be.