Accounting for Pensions Survey 2001
The continued defined contribution trend


  In recent years our surveys have indicated an increasing move away from final salary, or defined benefit, provision towards defined contribution provision. Of the 94 FTSE 100 companies who are UK based and account under UK accounting standards, there are now 14 (10 last year) that disclose that they offer only defined contribution arrangements and another 11 (7 last year) where new employees can only join a defined contribution arrangement.

Over a third of UK based FTSE 100 companies now offer some form of defined contribution arrangement to at least some UK employees. With the Government's new Stakeholder Pension legislation coming into force in 2001, an increase in this proportion seems inevitable, albeit with relatively low, or nil, employer contributions.

Last year we showed how, although many companies have introduced defined contribution arrangements, the vast majority of UK employees are employed by companies that offer primarily defined benefit pensions.

This year's chart shows this is still the case, but there is a growing body of evidence in support of the trend to defined contribution.

The chart shows the employee numbers in each of the companies analysed, where possible using the employee numbers in the UK only. It highlights, based on the information disclosed in the accounts, where only defined contribution schemes are offered and where new employees can join only defined contribution schemes.

Employee numbers in FTSE 100

Three companies with over 50,000 employees offer defined contribution benefits for all new staff: Sainsbury, Lloyds TSB and Barclays. Furthermore, we understand there are others, including BT, who either did not mention this in their 2000 accounts or made the switch after their 2000 accounts were published.

Directors Whilst there is evidence that employees are increasingly being offered defined contribution pensions, there is less evidence of this at director level. Perhaps this is because the most effective way to deliver the maximum tax-approved benefit is to do so on a final salary defined benefit basis.

However, the effect of the Earnings Cap means that often the defined benefit promise can fall some way short of what a director may be expecting - since the pension is not based on the director's full salary. To accommodate this, it is increasingly common for unapproved benefits in excess of the Earnings Cap to be provided on a defined contribution basis.
Innovations The indications are that the move away from traditional final salary provision is continuing. But some companies have been quite imaginative with the replacement for their final salary scheme.

We understand that AstraZeneca has introduced a "cash balance" plan and that Tesco now have a "career average" plan. These are effectively hybrids between final salary and defined contribution arrangements. In the case of a career average plan, the pension is based on the employee's earnings in every year of membership rather than just the final years. The advantage of this to Tesco is that the cost of funding the arrangement should be less volatile than a traditional final salary plan.

Designs of this type allow employers to explore the middle ground between the extremes of pure final salary and pure defined contribution arrangements. In addition to improving flexibility for members, we believe that such plans can achieve a balance between risk and cost for employers and employees alike.

Sainsbury runs a defined contribution scheme for its new employees, who can join the traditional final salary arrangement at a later date. We understand that Boots are introducing a similar arrangement.

We welcome the innovations made by these and other companies. Final salary provision works well for people who stay with one employer for a long time; for a mobile workforce, defined contribution is seen by many as more attractive. However, it must be recognised that if employers take the opportunity to reduce cost by moving to defined contribution arrangements, the necessary effect is lower average benefits for their employees. Clearly defined contribution arrangements are currently being well marketed. But the popularity of defined contributions will not last if they fail to meet expectations and deliver inadequate pensions at retirement.

This is exacerbated by the fact that, under a defined contribution scheme, the employee generally takes the investment decision and bears the associated risk. Whilst this is seen as an advantage, all too frequently employees are overly cautious with their investment choice and end up with lower benefits as a result. Innovative scheme designs help to pool the investment risk, enabling a more appropriate investment strategy. Ultimately, this can deliver a greater employee benefit for the same employer spend.
Mobile staff Whilst the debate as to whether working patterns have changed continues, it is unclear whether employees are switching jobs more frequently. However, we can be sure that defined benefit schemes are protecting early leavers better than ever before.
"The last straw..." Compliance costs have been piled ever higher on defined benefit schemes in recent years. The cost of providing a pension seems to be ever-increasing; but there is more to come.

The Government's proposals to replace the Minimum Funding Requirement could be the last straw for beleaguered finance directors. Proposals could prevent companies from winding up defined benefit schemes unless they were prepared to buy out all the liabilities with an insurance company, which would be a far more expensive commitment than the much-criticised Minimum Funding Requirement.

In this and previous surveys, we have advocated better disclosure of pension costs and we have been delighted to see the substantial improvements made. That said, in the eight years that we have produced this survey, we have seen some stunningly confusing disclosures. The disclosure requirements of FRS17 are far more extensive and we cannot help but anticipate more confusion. Whether users of accounts will be able make head or tail of FRS17 disclosures remains to be seen. This will undoubtedly make interesting reading in future surveys!

Aside from disclosure, FRS17 has many features that may give finance directors a few sleepless nights. As an example, the way the volatile pension cost can hit the accounts (as described in section 3 of this report) could leave a profitable company unable to pay a dividend.

Let us not forget, also, that increased disclosure almost certainly means increased cost of disclosure.