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DC pension funds present 'considerable' risks for staff

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  • DC pension funds present 'considerable' risks for staff

UK - Defined contribution (DC) schemes present "considerable" risks for staff and leave UK employees with a 10% chance of receiving a pension that is only a third of their final salary, according to new research.

Employees in France, Italy and Spain, however, risk ending up with even lower pensions than their UK counterparts, the study from academics at the University of Bath revealed.

Professor Ian Tonks from the university's school of management said: "When a pension scheme invests in stock market investments, it is tempting to believe the risks of the scheme depend on equity market risks.

"We show that it is also important to allow for correlations between equity returns, bond yields and wage growth."
 
The study by Tonks and Dr Edmund Cannon from the University of Bristol assesses the financial risks faced by individuals in DC schemes where contributions are invested in stock market securities.

It simulated the size of an individual's typical pension pot and pension payout based on a four-year study of evidence on equity and bond returns and wage growth, in 16 countries over a 107-year period.

The authors calculated that the average replacement ratio of likely pension income to final salary was 0.79.

This means that, based on historical evidence, an individual could expect to receive a typical pension of about 80% of their final salary, they said.

While a UK pensioner contributing 10% of salary over his working life could expect an average pension that matched his final salary, there is also a 10% chance that the pension would only amount to a third of final salary, the authors said.

"Although the likely replacement ratio based on historical data is high, these simulations demonstrate that the risks in defined contribution pension schemes are considerable," said Tonks.

However, given historical returns, pensioners in France, Italy and Spain had a 10% probability of ending up with a pension of only a quarter or even less of their final salary, the study found.

Cannon said the financial crisis had emphasised the need for policymakers and individuals to be aware of the risks of financial savings schemes.

"Defined contribution pension schemes shift pension risks away from the state and the employer towards the individual, and it is important that individuals recognise the implications of this transfer of risk," he said.

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