31 January 2018
In the wake of Carillion’s collapse we have seen renewed calls for tougher sanctions against company directors who deliberately underfund their pension schemes whilst paying dividends to shareholders and large bonuses to themselves. There are calls, too, for the Pensions Regulator to have more powers.
But is that the right focus? Fining former directors of Carillion – or of other companies that have failed – is unlikely to do anything to improve the benefits that their former employees will now receive. Instead of being suddenly wise after the event, perhaps politicians should commission detailed research that seeks to explain why, despite widespread closures of defined benefit schemes and hundreds of billions of pounds in contributions over the past decade, the UK’s defined benefit schemes still have a sizeable overall deficit.
Members of Carillion’s defined benefit pension schemes will have their benefits protected via the Pension Protection Fund. In fact, the vast majority will, as a result, receive payments that are significantly greater than they might have received had they instead been in a defined contribution pension scheme with a modest contribution rate (eg 8% of earnings).
So what should the pensions minister be thinking about as he puts the finishing touches to the DB White Paper, due to be published in the Spring as he looks ahead to the consultation on long-term care later this year; and starts to map out the future direction of auto-enrolment for the 2019 review?
Levelling the playing field - RPI/CPI
For starters, the White Paper should make the government’s position clear on indexation. At present, the playing field is not level with some schemes gaining a windfall in 2010 when the government changed the statutory index to CPI. However, others continue to be required to provide RPI indexation - or in some cases even higher levels - because of the wording of their rules, whether that was the deliberate intention or not. The issue has generated lots of heat and noise as well as some high-profile court cases, and proved a boon for City law firms in terms of legal fees.
Facing up to the reality that some schemes will never manage to pay benefits in full
I think the White Paper should actually go further, as suggested by the Pensions Institute in their 2015 report (“Greatest Good for the Greatest Number”). More specifically, a facility should be introduced whereby schemes which were demonstrably unaffordable could, subject to safeguards, compromise benefits but at a level above PPF compensation.
On the whole, pensions are too complex. A plain vanilla defined benefit scheme established in the 1970s which has only ever provided statutory revaluation and indexation will have more than 10 different tranches of benefit to administer. And the typical scheme will have even more. The government should introduce a facility whereby schemes could simplify their legacy benefit designs into a single standard structure.
That would not only enable more cost-effective and efficient administration of schemes but it would make it easier for members of schemes to understand their benefits.
Build on Auto Enrolment progress
In the 2017 review of auto-enrolment, the government made a useful start by lowering the age at which contributions commence. But why not go further and lower the starting age to 16 to be in line with national insurance? The principle should be that people are enrolled automatically in pensions from the day they start work, so they are easily introduced to the concept and as a consequence are naturally invested and aware.
The Australian system has shown the way in getting people to save. From modest beginnings in the 1980’s when the government introduced compulsory contributions at 3% of earnings, Australia now boasts the 3rd largest pension system in the world for a country of 24 million people according to a recent bulletin from the Institute and Faculty of Actuaries.
I’d urge the government to tackle these issues in a joined-up way.
- easing pressure on employers who struggle to fund their defined benefit schemes could help make room for additional contributions to their defined contribution scheme (to which their younger employees belong)
- If the tax system were less convoluted and complex, people could more clearly see the benefits of saving
- simpler benefits are more easily displayed (and understood) on a dashboard – another key project that the government needs to make a success.
Addressing these issues in a measured way would help lay the groundwork for a pensions system that produced better outcomes for both current and future pensioners.
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