Pensions cart before the horse
It may come a surprise that the UK, Europe’s leading pension market by assets, has been one of the least innovative in terms of benefit design – something the present government is keen to rectify. The latest Queen’s Speech, which outlines the government’s legislative plans for the forthcoming session of Parliament, mentions plans to introduce risk-sharing pension, or collective defined contribution pension funds. The minister for pensions, Steve Webb, has previously spoken admiringly of ‘defined ambition’ pensions, which have developed in very different forms in Denmark and the Netherlands, while cash balance plans exist elsewhere in Europe, for instance in Switzerland.
Why has Britain been so slow to adopt hybrid pensions which, after all, are nothing new? The UK certainly has a small number of hybrid schemes – cash balance pension funds, for instance. But a highly rigid legislative framework has straightjacketed sponsors looking for alternative forms of benefit design to defined benefit. So those feeling pressure from accounting standards – in other words, pretty much all large corporate pension sponsors over the past 10 years – have been left with little alternative to defined contribution pension schemes.
Many DC schemes have come about with scant regard to design, governance or investment options. With increasing assets has come increasing scrutiny of DC pension design, however, and a focus on fees.
The auto-enrolment system, and well-governed providers like the state-sponsored NEST, have helped set a benchmark. There is increasing recognition of the importance of default funds, and that target date funds of some kind will probably become standard. The planned charging cap for auto-enrolment might be imperfect and may result in sub-optimal investment strategies for some. But it has, at least, focused debate on fees and kick-started a debate on the right (and wrong) level of fees.
What also emerges from this debate is that large-scale collective pension schemes are better able to negotiate favourable fee terms for their members. Without the collective labour agreements of continental Europe that have facilitated the emergence of large pension funds and providers in countries like Denmark, the Netherlands or Sweden, and with union-sponsored funds unlikely, it is unclear how collective pension funds would emerge in the UK. The regulator seems too squeamish to push for scale in the way its Dutch counterpart has done indirectly by imposing high requirements for governance and expertise that smaller funds feel ill-equipped to meet.
Scale is, of course, an entirely separate matter to hybrid pension design and the government’s announcement of its plans to push collective DC also lack clarity, as a clear legislative outline is lacking. Now that most large and small sponsors of DB schemes have closed, at least to new members, if not to future accrual, corporate appetite for hybrid pension schemes seems limited, to say the least.
There is also a lack of clarity about how the government’s stated desire for risk-sharing will dovetail with the announcement in the Budget earlier this year that compulsory annuity purchase is to be abolished. Here, pension funds themselves should play a role and they should be understood as more than a collective savings scheme that hands accumulated assets back to members at retirement to do with as they wish. If the role of a pension institution is to help members secure a lifelong retirement income, there is certainly a greater role for trustees to play here. There is no reason why large-scale pension institutions should not offer collective drawdown for retirement income.
The onus is clearly now on the government to frame its proposals with legislation that assists the UK industry to improve outcomes for members. Then it will be up to the industry to do more for current and future members.