UK: on growth track
There is a discernible trend toward DC in the UK, although this may have been exaggerated.
The following reasons for this were given by respondents, representing over 40% of UK occupational pensions by value, to the survey conducted by InterSec: increased job mobility; desire for transferability of savings; demand from workforce, in certain industry sectors; erosion of state provision; government policy which may involve DC arrangements replacing pay-as-you-go provision, and a perception that DC arrangements are less costly.
Finally, a social shift in the UK may be engendering greater individual empowerment over one’s own affairs. This may translate into an individual allocation of funding into a separate account, the purest definition of DC.
A basic question must be posed - what is an occupational pension scheme for? A significant majority of respondents to the survey stated that a well-funded pension scheme was there to provide long-term financial security for the workforce in retirement. Pension funds are also regarded as valuable personnel tools with which to give incentives to employees and differentiate, often competitively, between employers. A clear view is expressed that DB plans are superior because the funding risk remains with the informed employer. Many employees are unable to make appropriate and informed decisions and would be unwilling to accept the open-ended liability that a DC plan entails.
The DC debate must appear to many pension providers as a blessing. Here at last may be the opportunity to break an unhealthy cartel. Little wonder then that there are now about 40 providers with distinct DC products with more to come. Some estimate, perhaps inspired by a self-fulfilling prophecy, that the DC market may represent 50% of the entire UK occupational market by 2005. Other more sober predictions suggest a market of approximately $80bn by then.
How big is the UK DC market? The UK is ill-served by central statistics but InterSec estimates that the group money purchase (GMP) and group personal pension (GPP) markets combined total less than $40bn. Strong cash flow into these younger schemes make growth rates more attractive than for mature DB plans. Nevertheless this is a small market. There will have to be almost precipitate change to nudge the DC share over 10% of UK occupational pensions by 2005.
Proponents of DC argue that these plans will be less costly than their final salary counterparts. Respondents to the InterSec survey were ambivalent, stating that cost was normally a neutral factor. Their prime concern is to provide pensions that suitably reflect the dynamics of their particular organisations. DB plans have faced increasing regulatory and legislative costs, it is true, but if there are pension holidays to enjoy these are easier to bear. DB plans are also typically less expensive to administer. The hidden costs” are critical in this debate because, as one respondent stated, “we have to balance risk and the what-if questions. DC can save us money because contribution rates may be up to 5% lower. But what if there are market corrections? Who will have to pay? With high inflation and low returns in the 1970s the companies paid for employee pensions and this may happen again. Certainly if pensions do not meet expectation the sponsoring company will be blamed.”
The US can provide useful examples for many things. The US DC “model” allows for considerable participant choice, accompanied by education and programmes. The consumerism entailed by an individual having an embarrassment of over 20 fund choices in some cases may mean inappropriate decisions are taken. In the UK four or five options, including the increasingly popular life-cycle fund, are typically offered to participants. Certainly the DC boom, whereby mutual fund providers have dominated the US market, is unlikely to be replicated in the UK.”