When the AIB banking group introduced its DC scheme for new entrants to the group’s pension plan, it pitched the contribution rate at 15% of salaries. The group’s pensions manager Colum McDonald explains: “We felt this was going to produce at least as good a benefit as our well established DB scheme over the longer term.” He adds: “Indeed, as the DC scheme is not integrated with the state benefits as is the DB plan, it is possible that if the DC scheme ultimately provides two thirds final salary, then with the state pension it would be providing better benefits than the DB.”
He is pleased with the change. “From the employer’s point of view, it gives you certainty over costs, while from the members’ perspective it gives them more control over their finances.” Graduate recruits in particular are more financially aware and definite that they want to control their own arrangements, he says.
The main downside is trying to recruit people who are in DB plans, as they find it hard to leave the safety net. “But one of the beauties of the DC approach is that when we recruit someone it does not matter how old they are.” He agrees that older joiners might have to put extra resources of their own into the plan to fund towards final salary, but under the DB basis, such later career moves were virtually ruled out because of the pensions costs. So DC brings back some of the mobility that may have been impossible before, he says.
At the same time, McDonald has no illusions about the resistance from existing staff if the bank tried to move its existing scheme from DB to DC, something it has no intention of doing. “But there have been some requests from individuals to switch from the DB to the DC plans, surprisingly enough, presumably because of their individual circumstances.”
Another plus point for DC in his view is the issue of flexible benefits, which is something AIB wants to introduce. “DC is the only practical way to do this for pension benefits; it is just too difficult on the DB side.”
The investment returns of recent years has helped the introduction of the DC plan, as each year since the plan was introduced in 1996 returns have been positive, for example, around 20% per annum for the managed fund. “The younger members we try to guide towards the 100% equity fund, which has also done well,” he says. “The good returns have gone a long way to overcoming any resistance on the part of staff.”
The DC plan offers a range of just four fund choices, a cash and a higher income fund which is a mix of 50/50 bonds and equities, as well as the managed and the long term growth fund, all in equities. About 75% of the Ir£3m new contribution flow goes into the managed fund. Altogether the DC plan has some Ir£30m invested compared with over Ir£2bn in the DB fund.
“Our aim is to keep the range of fund choices relatively simple. We feel we cover the volatility spectrum and cater for all requirements and tastes with these four choices,” says McDonald. All these funds are run by the bank’s in-house investment house, AIB Investment Managers. “We seldom have a trustee meeting where the issue of fund and manager choice is not on the agenda: do we have a wide enough range and how do the funds we have stack up against the competitors?” The trustees have had presentations from other managers and strategies, but so far they feel comfortable about the group managers, he says.
The bank pays the investment management fees, which is not something that happens in most DC plans. “This overcomes one of the drawbacks of the funds’ value being whittled away by investment management charges.” The scheme also uses an actuary on the DC side, who provides investment advice but only in very generic terms.
But the main information source for members is the scheme booklets and educational sessions, which McDonald says are vitally important in the success of any DC scheme.
“It looks certain that we will buy DC annuities in marketplace,” says McDonald. “This is even though we would not obtain as good a rate as if we used the DB scheme’s actuarial assumptions. It would not make any sense to turn the DC scheme into a new DB one at the point of retirement, guaranteeing an annuity.”
He is watching the arrival of the approved retirement funds (ARFs), which allow certain investors to draw down or otherwise invest their accumulated pension assets and not buy an annuity, provided there is always sufficient safety net of funds remaining to provide a guaranteed income of Ir£10,000 pa. “ARFs have provided an extra element of flexibility, with annuity rates falling,” he comments. “We have seen people in the DB scheme with additional voluntary contribution plans putting these benefits into ARFs, which gives great flexibility in terms of drawdowns.”
The DC scheme has had its death benefit increased substantially, by upping the cover to eight times annual salary. Even though only four times is allowed under revenue rules to be paid as lump sum, the rest can be provided as a pension for the family. “We used to give four times, but we decided this was not going to provide a decent income.”
McDonald comments: “I think every scheme has a date with DC some time in the future, we were wise to do it when we did.”