As the death knell sounds on the private sector final salary pension schemes and the number of employees saving for their old age plummets the government is urging companies to offer ‘Dutch style’ hybrid pensions.
There are currently two basic types of pension in the UK – ‘defined benefit’ and ‘defined contribution’.
The defined benefit (DB) or final salary schemes give the worker the peace of mind of knowing what they will receive in retirement but all the investment/interest rate/inflation uncertainties are deposited at the employer’s doorstep. Should the economic conditions at the time leave the employer having to fill a pension void it could drag the company and remaining workforce as well as ultimately the pension fund down with it, leaving any government/insurance based bail-out scheme to clear the mess up.
The defined contribution scheme sits at the other pole. The employer and employee contribute defined amounts and what the retiree gets is based on investment decisions, interest rates and inflation. So it’s the worker that bears the risk not the employer. But no-one knows what they will get until the point of retirement. In this case the retiring worker will be left with the hit in bad economic times, not the company.
With the closure of final salary schemes to new workers the pendulum is fast swinging from what was traditionally seen as an employers’ problem to a workers’ problem.
What Steve Webb, the LibDem MP for Thornbury and Yate and Minister of State to the Department for Work and Pensions, is pushing is for the adoption of a middle way alternative where there is a share of the risks between employer and employee.
This third way alternative is the ‘defined ambition’ pension used in the Netherlands, which could be backed by new UK legislation.
Here the worker would be given a guide or ‘ambition’ range of what the fund could pay out.
This would mean, said Steve Webb, companies saying to workers that they aim to make the pension pay out this sort of return but that there are no absolute guarantees. "I would rather know roughly what I was going to get than have no idea what I was going to get." Mr Webb added.
Emma Watkins, Director of Business Development at MetLife Assurance Limited commented “We welcome Steve Webb’s initiative to open the defined benefit (DB) versus defined contribution (DC) pension scheme debate through the proposal of a ‘defined ambition’ pension scheme. There is no doubt that workplace pensions need reinvigorating and this initiative represents a step in the right direction.
“Our research shows that employees value pensions. Over half (54%) ranked it in the top two of employment benefits alongside holiday entitlement. And yet over a third (38%) are concerned that they may not have enough pension income in retirement. There clearly is a need to provide individuals with a greater sense of what pension they will receive to assist in their retirement planning.
“Defined ambition pension schemes may be a way for an employer to provide something greater than a DC scheme without taking on all of the volatility and perceived risk of a DB scheme. The recent closure of the last remaining open DB pension scheme of the FTSE100 represents a milestone and acts as a timely reminder that more creative thinking is needed within the occupational pensions industry and by policymakers.
“There is clearly still a lot of detail to be determined. In addition to looking at models in other countries, we need to ask employees and employers what they want from their workplace pension and design a system that is financially sustainable yet sufficient to allow individuals to retire in dignity. Whether finance directors’ memories are sufficiently short to risk the possibility of an ‘ambition’ subsequently turning in to a ‘cast iron guarantee’ remains to be seen.”