The perception in the UK that a defined contribution pension (DC) plan is a ‘second best’ occupational pension has grown chiefly because of the low level of employer contributions.
Employers contribute significantly less to DC schemes than to defined benefit (DB) schemes. The National Association of Pension Funds (NAPF) annual survey of 37 DC schemes found that the long term average employer contribution cost for DB schemes was 15.45% compared with 6.4% for DC schemes.
Employer contributions may even be falling. A survey this year of over 450 employer-sponsored schemes by Mercer Human Resources found that contributions averaged 6% of salary, down from 6.3% in a previous survey two years ago.
This average conceals some wide variations in contribution levels. Employers in the banking and finance sector pay the highest contributions to DC plans, with an average of 8.1%. This compares with the food and drink, transport and publishing industries which contribute 4.4%, 4.6% and 4.9% respectively.
Employer contributions to stakeholder pension plans are even lower. The Association of British Insurers (ABI) collected information about 108,977 schemes, a third of the schemes designated in the period April 2001 to the end of June 2002, and found that only 9% of employers were making any contributions to stakeholder pension schemes on behalf of their employees.
Where contributions are made, they are likely to be small. The latest available figures from the Inland Revenue show that employers paid £20m (E31m) to 210,000 members of employer-sponsored schemes in the period between April 2001 and October 2001 This represents an average of £95 for each member over six months or £16 a month. With national average earnings of £23,500 this represents less than 1% of salary.
However, employer contribution levels to DC may be tell the whole story. A report by the Manufacturing Services and Finance (MSF) union ‘The crisis in occupational pensions’ warns that broad statistics about contribution levels are deceptive. Many new DC schemes that provide age-related contribution scales have a relatively young membership. So contributions are likely to be initially low. On the other hand, employer contribution rates to DB schemes may vary depending on whether schemes are in surplus or deficit.
MSF says survey figures may exaggerate the gap between contributions to the two types of plan. Employers with DC plans may be paying separately for life insurance benefits. They may also be paying into the State Earnings Related Pension Supplement (SERPS), which supplements the basic state pension. Only 6% of new DC schemes are contracted out of SERPS so the employer will be paying towards their employees’ overall pension through a higher National Insurance contribution.
However, although there is doubt about the size of the gap between DC and DB plans, there no doubt that it is widening, chiefly because of the fall in investment returns. The Association of Consulting Actuaries (ACA) Pensions Trends Survey 2002, a survey of 336 firms employing 1.8m people, shows that while employers with DB schemes increased their contributions by 14% to offset the effect of deteriorating investment returns, employers with DC schemes have done nothing.
The effect of this is to further devalue DC plans in the eyes of employees. A report on occupational pensions by the Trades Union Congress (TUC) published earlier this year it, commented: “Our primary concern is not the nature of DC plans as such but rather that many schemes are simply not good enough to provide a decent pension for employees – principally because contributions are too low.
“Given the much lower investments returns being achieved, together with the improvements in mortality, it is worrying – in terms of pension benefits emerging – that contributions into the range of money purchase DC arrangements generally are not rising to reflect these changed circumstances .
The TUC concludes that “the emerging pensions offered by money purchase arrangements at these average levels of contributions are likely to disappoint members”.
One solution may be to compel employers to pay more. This has some support from employers themselves. Two out of every three of the companies covered by the ACA survey said they would support the introduction over a number of years of minimum employers contributions – for example, 5% of earnings – into employer-sponsored schemes covering all employees.
Whether or not the government would support such an idea is uncertain. However, the introduction of Statutory Money Purchase Illustrations (SMPI) next April could raise awareness of the impact of low contributions on the pension pot. SMPI will enable people to see approximately how much their pension might buy after they retire, in terms of today’s prices.
Stewart Ritchie, chairman of the Faculty and Institute of Actuaries SMPI working party says: “For many people this will be new information and if it shows there is unlikely to be enough to retire on, it will act as a wake-up call to save more. We hope it will lead to people taking more interest in their pension.”
The net effect may be to raise levels of contribution by both employer and employee into DC pension plans.