One factor which could slow the flow from DB to traditional DC schemes is the growing interest in hybrid pension plans in the UK. Actuaries Lane Clark Peacock point out in their annual survey, ‘Accounting for Pensions’, that traditional final salary DB schemes and occupational DC schemes represent extremes of risk distribution. “Although one of these extremes will be suited to many companies, there is also a range of ‘middle ground’ alternatives, the so-called ‘hybrid’ schemes.”
Colin Singer, a partner at consultants Watson Wyatt, says chief executives have a number of risk reduction options. These include changing investment policy, reducing benefit levels or passing some of the risk to the state by contracting into SERPS. “In future, risk sharing approaches may begin to be seen as a good way forward,” he says.
A ‘cash balance’ scheme, where the benefit is a specified percentage of salary at retirement in lump sum form, is one way of sharing risk. The company bears the investment risk during an employee’s working career. At retirement, however, the risk passes to the employee. For example, the risk that the employee will live longer than expected is transferred from the company to the insurer who is providing the annuity.
Another possibility is ‘career average’, where each year’s benefit is based on the salary earned in that year rather than on salary at retirement. Food retailers Tesco and Safeway have both replaced their final salary DB plans with ‘career average’ schemes.
Their rival retailer Sainsbury has chosen to transfer some of the risk to employees with a stakeholder plan for new staff. “We’ve moved new people into stakeholder because of the relative risk of the company,” says Geof Pearson, Sainsbury group pensions manager. “Our final salary scheme is bigger than those of Tesco, Safeway and Asda put together so we’ve got a greater degree of risk. Reduction of risk was important from the company’s point of view.”
The stakeholder plan is managed externally by the UK insurer Legal & General. Management charges are considerably below the 1% cap, and are tiered from 0.6% to 0.35%. “Basically Sainsbury is a food retailer – it isn’t in their business of running pensions,” says Pearson “So effectively we have outsourced the investment risk and the administration.”
Sainsbury makes a matched contribution of 4%, with an option to pay 3% or 5% in the future. There is also free life cover of three times annual salary. Around 20,000 employees have signed up to the plan, making it one of the largest employer-sponsored stakeholder schemes in the UK.
Members can increase their state pension entitlement by choosing to remain in the Second State Pension (the replacement planned for SERPS) unlike in the DB scheme where Sainsbury decided to contract out.
Pearson rejects the argument that a DC scheme will always be a second best option. “Our intention is that the quality of the stakeholder compared to the quality of the final salary will be very much the same. It’s not our intention long term to have a scheme of inferior quality.”
One of stockholder’s main attractions, he says, is its portability: “We believed, although its not been borne out so far – that stakeholder would be the main currency in pensions. If the currency of stakeholder was higher than it is at present, then portability would greater. But although it’s got off to a slow start we still expect stakeholder will become the standard for pension schemes.”