UK – The end of contracting out could offer an opportunity to end mandatory indexation, the UK's pensions minister has indicated.

Addressing a gathering of trade union representatives at a conference organised by union umbrella group TUC, Steve Webb asked the audience to share their views on some of the defined ambition approaches outlined in the Department for Work & Pensions 'Reinvigorating workplace pensions' paper.

The Liberal Democrat also indicated that the reform of the state pension system, which will see the creation of a single-tier first pillar and thereby end firms' existing contracting out of the state second pension, would potentially allow for a re-assessment of index-linked pension benefits.

"For as long as you've got contracting out and you are providing a pension instead of what the state provides – and the state equivalent is index-linked – then you can see why you would require firms to provide an index-linked pension," he said.

"Once what the firm provides is additional to state provision and is only mandatory up to a fairly low level of auto-enrolment, do we want to be as prescriptive as we have in the past?"

He said it was easy to view indexation protection as a positive, but he insisted that, if all occupational funds offering a salary-related benefit absorbed the impact of inflation, companies would no longer offer defined benefit and shift to defined contribution, which individual members more often than not converted into a annuity without protection.

"So while I feel rather smug because I have required firms to provide inflation protection, unfortunately, nobody was listening, and they shut all the inflation-protected schemes, they opened un-indexed schemes, [and] I have achieved nothing," he said.

He said his goal was not make the best the enemy of the good.

"I appreciate this is not quite Les Misérables, this is not quite 'Mount the barricades'," he said. "This is compromise, this is somewhere in the middle, this is not quite as good as it used to be, but better than it might be – but that's the world we are in."

He said a core defined benefit (DB) fund would be one way of allowing this – as proposed in the paper, removing spousal benefits and indexation – but nonetheless guaranteeing a percentage of salary upon retirement.

He said a "less dramatic" alternative would be an allowance for conditional indexation, or a core benefit with additional allowances based around fund returns.

"This is all tough stuff, this is not comfortable, not easy, not what we are used to," he said. "But it is better than the firms just saying 'I've had enough of this, I'm going to stick 10% in defined contribution'."

Webb questioned whether there might be better ways to use the capital when companies are willing to spend a certain amount of capital on pensions.

He added that employees would reconsider their involvement in DB if a few firms led the way by once again moving toward a middle-ground provision with guarantees.

Topics