The complacency with which the decline of DB has been met by authorities takes some explaining, argues Con Keating.

The recent consultation on the proposed extension of the Solvency II insurance regulatory directive to pensions has thrust the issue of the relative efficiencies of differing forms of pension provision design into the limelight. There are material differences in efficiency of pension production arising from the myriad of variants in coverage and structure that exist. Inexplicably, this proposed attempt to apply a common regime to insurance and occupational arrangements fails to consider this aspect, which should be the central concern of national and international policymakers.

If we consider a pension simply as an income for life in retirement and use as our measure of efficiency the simple (normalised) ratio of inputs to outputs, the differences in efficiency are stark. Under current circumstances, if it costs £1 in contribution to produce one unit of pension under an assured book-reserve defined benefit (DB) arrangement, then to produce one unit using the orthodox UK-funded arrangement costs £2, and this same pension unit under individual defined contribution (DC) costs £4.

These figures are perhaps surprising. The scale of some differences may be simply illustrated. For example, to remove the dependence of a funded DB scheme on the employer sponsor, the scheme needs to be funded to the 'buyout' value - currently around 150% of the best estimate of the present value of liabilities. Beyond this, DC has further impediments, which are costly - the absence of risk-pooling and risk sharing among members, and economies of scale and scope.

It is also notable that the prudential regulation of funded DB is remarkably costly. As currently practised and proposed, it even introduces an entirely spurious source of risk, interest rates. However, the principal source of expense is the focus upon scheme funding. This is misguided in that this risk is conditioned on sponsor insolvency and only strictly relevant after that event.

This distinction is also very relevant for the European Commission's consultation - for insurance companies, regulation operating on assets and imposing solvency capital requirements is operating on the insurer's likelihood of insolvency, while for pension schemes it operates on the consequence and increases the primary, unconditional risk of the employer sponsor's likelihood of insolvency. The relative inefficiency of the proposed approach will have costs for the shareholders of sponsor employers that are greater than for the shareholders of insurance companies.

As funded DB and DC enjoy the same tax concessions, their relative efficiency is important. If DC were ever to be offered at the scale necessary to replace the pensions payable under historical DB, the tax cost would be twice as much. With that in mind, the complacency with which the decline of DB has been met by the authorities takes some explaining.

Con Keating is head of research at Brighton Rock