Scaling back final salary pension payouts to savers could be an option to help firms at risk of going bust, an influential industry body has suggested.
‘Flexibility’ over benefits – including reductions in extreme cases – merging smaller final salary schemes and overhauling the regulatory regime are among ideas floated to ease strains on employers and the economy by a taskforce launched by the Pensions and Lifetime Savings Association.
Its report was published as pensions consultant JLT Employee Benefits pushed a separate plan – letting retirees already drawing a guaranteed final salary pension transfer out and take advantage of pension freedoms – which it described as ‘a win-win’ for employers and the Government.
JLT said its idea would be a relatively simple move, which would ease the pension burden on employers while the Government benefited from an increase in taxes from members who exited final salary schemes.
But it was dismissed as ‘ludicrous’ by financial adviser David Smith of Best invest, who said: ‘One thing is for certain, it can’t be to the benefit of all and I know who I would bet on “carrying the can” – the member.’
And the Treasury slapped it down, saying: ‘Protecting consumers is a top priority for the government and these proposals would not deliver the best value for money for pensioners.
The PLSA’s taskforce is exploring ways to address problems facing final salary pensions, which provide a guaranteed income for life in retirement and are typically the most generous available to savers.
But pension fund deficits have soared following years of record low interest rates and rising life expectancy.
And the scandal over the collapse of retailer BHS has prompted MPs to investigate ways to strengthen regulation, especially when a business with big pension liabilities is sold, to prevent more ending up in the hands of lifeboat scheme the Pension Protection Fund.
The PLSA task force said it had identified ‘a number of long-term structural weaknesses’ in the make-up of the final salary pensions sector, including the diversity of size, scale and governance of schemes, the fragmented value chain – in layman’s terms, the lengthy list of middlemen involved in the industry – and the broader legislative and regulatory framework.
It expressed the hope that the ideas aired in its report, such as those outlined below, would prompt further debate.
Flexible benefits: Employers’ ‘best endeavours’ are now a hard-wired promise
On the future of benefits, the report said: ‘The UK has, compared to its OECD counterparts [Organisation for Economic Co-operation and Development, made up of 35 developed countries], chosen to adopt a regulatory approach to benefit design that is inflexible and rigid.
‘Therefore what started for many employers as a benefit offered on a “best endeavours” basis, has now become a hard-wired promise.
‘It has also added significantly to the cost of providing pensions. The introduction of statutory revaluation and indexation [increasing payouts in line with inflation] alone has increased scheme liabilities for a typical defined benefit scheme by around 25-30 per cent.
‘As a consequence, sponsors [employers] in the UK do not have open to them the ‘pressure valves’ available to sponsors of defined benefit schemes in other developed economies.
‘Greater regulatory and benefit flexibility – such as that available to the Pension Protection Fund itself, which unlike pension funds does have the flexibility to reduce compensation in the extreme – may help avoid or address problems and could mean that funding issues could be addressed before failure (of the scheme or sponsor) became inevitable.’
Pension costs: City watchdog is probing whether investment managers offer value for money
‘Investment management fees and costs in particular place a significant cost burden on pension funds,’ said the report.
It noted that City regulator the Financial Conduct Authority had decided the possibility of flawed competition and poor value in the asset manager market was strong enough to launch a market study, which is due to be published next year.
‘The FCA cited concerns regarding the extent to which asset managers were “not incentivised to search value for money” when commissioning outsourced providers of, for example, research or transfer services, because they are able to pass on the costs to investors (such as pension funds) who are unable to scrutinise the fees charged to them.
‘The Investment Association also noted the risk of conflicts of interest affecting investment consultants, including the fact that they can charge for conducting investment performance reviews; setting or reviewing mandates for asset managers; or managing tendering processes.’
The report went on: ‘This creates a potential incentive to encourage an overly short-term focus, with asset managers being changed and investment performance measured over too short a time period.’
It suggested that some schemes, particularly larger ones, could make savings by reducing their on reliance on industry intermediaries and leaning more on internal expertise and support.
Asked for comment, a spokesperson for the Investment Association, an industry body bankrolled by asset managers, said: ‘Investment managers are an important part of the delivery chain, helping pension schemes to achieve their objectives in a very challenging funding environment, both in terms of markets and greater longevity.’
Overhauling regulation: Some 850 new rules and laws affecting schemes introduced since 1995
‘The tone and the nature of successive governments to pension protection in the UK, while protecting scheme members well on the whole, is, however, largely driven by the imperfections in the current defined benefit system,’ said the report.
‘The UK has a highly fragmented pensions system: almost two-thirds of schemes have fewer than 1,000 members, and many do not have the governance capacity to operate defined benefit provision in today’s challenging environment, which rightly requires high standards of governance and a strong focus on member protection.
‘As a result, there has been a necessary tendency for government and regulators to regulate to the lowest common denominator. The resulting regulatory system is highly prescriptive, with Department for Work and Pensions, the Treasury and HMRC regulations “micro-managing” the actions of trustees, scheme managers and their advisers, often in a way that reflects sub-standard governance arrangements.
‘As a result there is little room for the exercise of trustee, sponsor or adviser discretion. This might be described, therefore, as a “bottom up” approach to regulation. It has also resulted in a significant volume of regulation – 850 new pieces of regulation and legislation affecting DB schemes since 1995 alone. This has added significantly to the costs and complexity of operating schemes.’
The task force said its consultations had uncovered a strong view among those who responded that the increasing cost of pension regulation has been a factor in employer’ decisions to close schemes.’
The PLSA’s taskforce chaiman, Ashok Gupta, said: ‘The findings from our interim report show that, on the whole, defined benefit pension schemes are under severe pressure and without change the likely outcome will be hardship for members or sponsors [employers].
‘There is a clear economic imperative to address the issues identified, for the health of both individuals and the wider economy. It is becoming increasingly apparent that the opportunity to make a meaningful difference is diminishing as the sector matures and the cost of inaction is too significant to ignore.’
Nathan Long, senior pension analyst at Hargreaves Lansdown, said: ‘Defined benefit schemes are critical piece of the retirement jigsaw and must be preserved in their full format.
‘Allowing schemes to water down benefits risks doing irreparable damage to the pension brand, just as auto-enrolment is in the process of building it back up.
‘Consolidating small schemes would have the twin benefits of stripping out costs to the benefit of scheme solvency, whilst potentially freeing up funding for much needed infrastructure projects.
‘Given recent weeks have seen the Government’s cost of borrowing rise, this strategy could prove a useful source of alternative funding. Consolidation must be driven at Government level as few advisors are likely to champion a cause that sees a cut to their revenue.’
Pension Minister Richard Harrington said: ‘I welcome the work that the PLSA is doing to understand the challenges faced by some defined benefit schemes and will be working towards a green paper exploring these issues in the winter.
‘It’s important that people’s hard-earned savings are managed appropriately and I’m keen to work with industry to identify how best to support scheme members and employers.’
A spokesperson for The Pensions Regulator also welcomed the report, saying: ‘It highlights many points we have previously raised such as the advantages of consolidation and the importance of good governance.
‘The PLSA highlight that some schemes and employers find themselves in a difficult position. We believe this to be the minority and the majority of schemes are well positioned to pay members benefits in full. Therefore we would caution against proposals to reduce people’s pensions without a clear evidence base.
‘Going forward we welcome innovative ideas on how the pensions landscape can be improved and lead to better outcomes for scheme members, contributing employers and the Pension Protection Fund.’
Should retirees drawing final salary pensions be allowed to transfer out?
The Government should allow pensioners in final salary schemes to transfer out to relieve the pension burden on employers and raise additional funds for the public purse, according to pension consultant JLT Employee Benefits.
Head of corporate consulting Rob Dales, who was responding to the Government’s axing of plans to let pensioners sell annuities second hand, said: ‘The government’s decision to scrap plans that would allow pensioners to sell their annuities in return for a lump sum will no doubt be disappointing for thousands of pension holders.
‘However as an alternative, the government might look at instead allowing pensioner members in defined benefit pension schemes to transfer out and have access to the same freedoms permitted to other members of these schemes.
‘This would be a relatively simple move that would ease the pension burden on employers, and give them another option for de-risking their pensions schemes.
‘Not only that, but the government would also benefit from an increase in taxes from these members who exit to increase their current income or take a taxed lump sum – which makes this a win-win situation that I think the government would be wise to consider.’
At present, retirees who are already drawing a final salary pension cannot transfer out. However, people who have not yet retired can move savings to defined contribution schemes if they want, although getting financial advice is compulsory if their pot is worth £30,000-plus.
Advice on transfers typically costs £2,000 to £3,000 since it is a complex and specialist area, but experts say you could unwittingly pay a great deal more than that by blindly giving up valuable pension benefits.
There are nevertheless cases where people are in very bad health, are single and have no dependents, where it can be to their advantage to give up a final salary pension.
Tax changes on inheriting pension pots also mean some people now want to get their money out of final salary schemes in order to bequeath it to children.
Best invest director of financial planning David Smith, who advises savers considering such moves, says: ‘We are already seeing a sharp increase in demand from individuals who want to transfer out of defined benefit pension schemes. Our starting point for all such inquiries is that it is not in the individual’s best interests to do so.
‘We then delve deeply into their personal and financial affairs to see if there might be mitigating circumstances for certain individuals to seriously consider transferring out; for the vast majority, there aren’t.
‘To consider now opening this Pandora’s box of allowing members of defined benefit pension schemes with pensions in payment to transfer out – they can’t currently – is nothing short of ludicrous.
‘My main concern is for the members who decide to do this. After all, the allowance of such a facility should surely revolve around the pensioner getting a better deal, not the Government or the pension scheme itself? One thing is for certain, it can’t be to the benefit of all and I know who I would bet on “carrying the can” – the member.’
The Treasury said that JLT’s plan would not deliver the best value for money for pensioners.
Although people in final salary schemes are allowed to take advantage of pension freedoms before retirement if they wish, the Government has always made clear that it believes sticking with them is the best approach for the vast majority of members.