Accounting for Pensions Survey 2000 
Is final salary provision continuing?


Each year our surveys indicate an increasing move away from final salary, or defined benefit, provision towards defined contribution provision. This is the commonly perceived direction for pensions, and our survey this year might suggest that this is very much the case. Of the 94 companies who are UK based and account under UK GAAP, there are now ten that offer only defined contribution arrangements and another seven where new employees can only join a defined contribution arrangement. In fact, a third of UK based FTSE 100 companies now offer some form of defined contribution arrangement to UK employees. Does this mean that the march away from defined benefit schemes is on?

If one looks at the position in terms of employee numbers, the position is very different. The chart below shows the employee numbers in each of the companies analysed, where possible using the employee numbers in the UK only. Also shown are those where only defined contribution schemes are offered and those where new employees can join only defined contribution schemes.

Chart: Employee numbers in FSTE 100

It can be seen that the larger employers have very largely held to defined benefit pension provision. The numbers of employees covered by employers offering only defined contribution schemes is approximately 1½% of the total, with another 3½% in companies where new employees may join only a defined contribution arrangement. The largest of these is Barclays who introduced a defined contribution scheme for new staff in July 1997.

All ten companies where all employees are covered by only defined contribution schemes are in the "TMT" area - technology, media and telecommunications.
Sainsbury During their last reporting year Sainsbury introduced a defined contribution arrangement for new staff. However, this only applies for the first five years after which they are allowed to join the defined benefit arrangement, and all senior staff may join the defined benefit arrangement straight away.
Which is the better form of provision? It is often said that the right form of pension provision is a matter of "horses for courses". For example, the employment patterns in the new economy companies may be unsuited to defined benefit arrangements. Nevertheless, there are some general statements which can be made and, although not central to the point of this survey, we feel are very important and we take the opportunity to set them out below.
Cost Employers are generally worried about the cost of defined benefit arrangements. These are likely to rise in the long-term because of longer life expectancy and the effect of low inflation/lower investment returns.

It must be recognised that if employers take the opportunity to reduce cost by moving to defined contribution arrangements, the necessary effect is lower expected benefits for their staff.
Certainty of cost Employers naturally prefer certainty of cost to uncertainty, which means a preference for defined contribution arrangements.

The other side of this coin is that a move to defined contribution means uncertainty of benefit for the employees. We would ask, who is more able to bear the uncertainty - an employer who can spread cost over many years, and for whom pension cost is one among a number of uncertainties, or the employee who has to live perhaps 30 years in retirement drawing on his company pension?

Should an employer be so concerned about uncertainty of pension levels for employees? Opinions will vary, but in our view certainty about the final level of pension is important except for highly paid staff, who can bear risk more easily.
Ease of administration It is often thought that defined benefit schemes are more difficult to administer than defined contribution arrangements. The reverse is the case; every penny that is paid into a defined contribution arrangement must be properly accounted for on its due date and given appropriate investment credit, whereas the contributions for defined benefit schemes are relatively simple to administer.
Mobile staff It is sometimes argued that defined benefit schemes are unsuited to modern employment patterns because few people remain in one job for their whole career. In fact this was always the case, but it was and remains true that a high proportion of people spend their last fifteen or more years in one employment.
Responsibility for investment With defined benefit arrangements the trustees have to take responsibility for the investment process, and the employer has a strong interest in the outcome because he bears the balance of cost after any employee contributions.

With a defined contribution arrangement it is chiefly the employees who are concerned about the investment returns. Wherever members have choice they tend to take conservative options which leads to a reduction in what are perceived as "riskier" investments such as equities, but it is these that have historically produced the higher investment returns in the long run.

At retirement members of defined contribution schemes commonly have to use their pension assets to purchase an annuity. The price of annuities has risen dramatically in recent years, because of the reduction in interest rates available on bonds. Sometimes the increase is made up by increases in investment values, but by no means always. Between April and October 1998 the price of annuities rose by about 10%, and in the same period the UK stock market lost about 15% in value.
The future We expect that the trend to defined contribution will continue. Already this year ICI has announced its decision to close its defined benefit scheme to new entrants. However, this trend may reverse in the next few years, and we wonder if the move to defined contribution will be seen as a mistake in 10 or 20 years' time. Widespread use of defined contribution was seen as a mistake 25 years ago, and at that time many defined contribution schemes were changed to defined benefit.
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