UK – Pension fund consultants have broadly welcomed the UK government’s plan to remove inflation indexation from defined contribution schemes and said new US providers could enter the annuity market.
The change, by government amendment to the Pensions Bill, would be a simplification for schemes by removing complications caused by several different indexation regimes. It could add between 20% and 50% to a pensioner’s money, although with the risk that inflation could erode future gains.
Malcolm Wicks, Minister of State for Pensions, said: "Removing indexation from defined contribution schemes will help scheme members by giving them greater choice in the type of annuity they will be able to purchase with their pension rights.”
But increased choice put pressure on the industry to provide people with the information to be well-informed, he added. Baroness Hollis at the House of Lords second reading on the Bill said: “On indexation, it was clear the degree of inflation protection and hence the costs and liabilities this imposed on schemes was disproportionate. In effect, we were forcing everyone providing a pension to buy a high level of inflation insurance, which was becoming so expensive that some providers were choosing to pull out of pension provision altogether.” US insurers are seen as likely to enter the UK annuity market, with speculation regarding AIG, taking on the existing large players: Legal & General and Prudential.
The changes will remove all indexation from DC pensions coming into payment after the legislation comes into force, probably by April 2005. Currently, for DC schemes, indexation applies to contracted-out rights accrued 1988-1997 and to all rights accrued since 1997 and, for personal pensions, indexation applies to protected rights accrued since 1988.
Stephen Yeo, senior consultant at Watson Wyatt, said: “Hollis had previously refused to say if removing indexation would be backdated to 1988 so the news is even better than expected.”
Kevin Wesbroom, principal consultant at Hewitt Bacon & Woodrow, was also supportive. He said: “The change frees up members of a scheme and increases their ability to buy an annuity, which has been difficult as there are four or five different bits to it.”
He said the change to DC schemes was only a first step, however, as middle ground pension funds, which provide a guaranteed investment return similar to a defined benefit fund but with an accrued pot of money that is converted into an annuity, are excluded. DB schemes have had the indexation requirements reduced from 5% retail price inflation to 2.5%.
Kevin Painter, European partner at Mercer Human Resources Consulting, agreed: “The change for DC_schemes is good news but it would be logical if indexation was scrapped for DB schemes, although there is no indication the government is likely to do this, as it would be logical and one less reason to close DB schemes.”