Historically, defined benefit (DB) rather than defined contribution (DC) has been the commonest type of occupational pension in the UK. It is still the dominant plan type. The latest benefit design survey by consultant Watson Wyatt found that 58% of the occupational schemes surveyed were DB while only 23% were DC schemes.
Yet the tide may be turning in favour of DC. The number of people in DB schemes has been declining slowly since a peak in the 1960s. The main reasons are the reduction in the size of public sector and the move away from DB by private sector employers.
Private sector pension funds have been hit by a combination of greater longevity and unfavourable tax changes. To this has now been added lower investment returns. Companies are now deciding that their DB schemes are too expensive and are looking to set up less costly and less risky schemes for their future employees.
Over half (56%) of the companies undertaking major reviews of their DB pension schemes in the past five years have opted to close their scheme to new entrants, according to the Watson Wyatt survey. The survey shows that by far the most popular type of plan (62%) introduced after a scheme review is an occupational DC plan.
Employers are becoming more receptive to the idea of changing to a DC scheme. In JP Morgan Fleming Asset Management’s 2001 annual survey of DC schemes, 75% of companies with DB schemes ruled out introducing a DC scheme within the next five years. In the 2002 survey, this proportion had fallen to 69%.
The most favoured strategy is to close an existing DB scheme to new employees and offer them access to a group DC plan instead. A number of FTSE 100 companies have taken this course, including British Airways, Marks & Spencer, British Telecom, ICI, Lloyds TSB and Abbey National. A few have gone further. Accountancy group Ernst & Young and the Big Food Group, notably, have closed their final salary scheme to new contributions from existing members.
The move from DB to DC has not been entirely one way. Eaton Aerospace, for example, changed its pension scheme for all employees from DC to DB in April. Nor has it been without pain. The switch from DB to DC has been opposed by leading trade unions. Industrial action by the Transport & General Workers Union (TGWU) persuaded steelmaker Caparo to reverse its decision to close its DB scheme. Amicus, the UK’s largest private sector union, has called for legislation requiring employers to give reasonable notice to employees and to consult with them before making any changes to their pension schemes.
Companies say they are moving to DC plans because their portability males them better suited to the needs of a mobile workforce. John Peachey, head of group pensions at Marks & Spencer, says the new scheme is “more appropriate” for today’s business environment and will allow employees to take ownership of their final pension.
However, the main reason for the change is to reduce costs, according to David Butcher, chief executive of Invesco Pensions. “The two big drivers that are causing companies to look at DC are the cost of DB and the volatility of the cost.”
Paradoxically, he says, low investment returns, which have encouraged employers to close their DB schemes, currently favour DC schemes. “The markets over the past two years have had a far greater negative impact on DB schemes than on DC schemes. This is chiefly because the vast majority of DC plans have been set up recently, so members are investing when markets are at low levels.”
Most employers are still choosing the traditional trust-based company-run money purchase scheme, Butcher says. “The majority of the schemes that have been set up have been of the occupational DC type. That has been an enormous trend this year and the current view of the market is that the momentum is not going to slow down.”
However, companies now have a choice of DC plans. Employer-sponsored stakeholder pensions, essentially a low cost alternative to the existing personal pension, were introduced by the government in April 2001. Under the legislation an estimated 350,000 employers with more than five employees and without an existing pension scheme are required to designate a stakeholder pension scheme.
Between April 2001 and June 2002 335,719 employers – 96% of the total – designated schemes. However, the Association of British Insurers (ABI), which has surveyed the take-up of stakeholder pension plans, says it is worried about what lies behind these headline figures. The ABI points out that “a staggering 90% of employer-designated schemes have no members – these schemes are simply empty boxes.”
It says there could be several reasons for this: either the employer has merely met its legal obligations by designating a scheme and will do nothing further to attract employees into membership; or employees are not interested in joining the scheme because they think they cannot afford to; or the employer is too small – and therefore too uneconomic – to attract the services of a pension provider to provide financial advice to employees.
Take-up is strongly related to employer contributions. Most of the employer-designated schemes (90%) that do have members also have an employer contribution. The ABI says that an employer contribution can make all the difference between employees joining a scheme or not. Its own research shows that if an employer does not contribute to a scheme, take-up stands at just 13%. But where the employer contributes, take-up increases to around 70%.
Although the take-up of employer-designated stakeholder plans has been slow, their introduction has prompted a significant shift in the type of DC plans that employers are offering. Research by Mercer Human Resource Consulting has identified a change in the basis on which new, DC plans are being established. It found that, since April 2001, nearly 70% of new plans have been set up on a contract basis as either a group personal pension (GPP) or a group stakeholder plan.
Tony Pugh, European partner at Mercer, says the introduction of stakeholder pensions in April 2001 has had a profound effect on the use of contract DC plans and ‘bundled’ services. “These plans are less likely to adopt active management of their plan, as they operate without trustees representing the interests of members and monitoring performance.”
Pugh says sales of GPPs have grown at the expense of stakeholder, largely because their sales are driven by independent financial advisers who can earn a commission form GPP sales which is not available from stakeholder sales.
Occupational DC schemes in the UK may therefore be moving away from the ‘paternalistic’ plans of the past, where investment choice and administration was largely a matter for the company, to plans where members themselves exert more control over their pension. Whether this is what they want remains to be seen.

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