Recent reports and discussions highlight how greater uncertainty is driving debates about the future of pensions.
Covid has brought a renewed focus on pensions, with uncertainty about the future being the name of the game. Job losses, labour market turbulence, long term health issues and more have been accompanied by increasing inequality amid ongoing concerns about the impact of longevity on pensions.
An International Longevity Centre webinar last week highlighted how longevity has become the biggest pension fund risk in recent years, despite evidence from some quarters that our expanding lifespan has stalled. It heard a call for the issues around longevity to be given greater priority amid signs that some businesses are coming together to address issues such as health inequality.
Growing uncertainty is also driving a reliance on experts. This comes amid a crop of new reports on recent developments in the pensions area.
An analysis published last week by PwC shows that increased uncertainty has resulted in a drop in employer support for FTSE 350 defined benefit pension schemes to levels seen at the start of the pandemic. That means that some companies will find it harder to meet their pensions obligations.
In December 2019, PwC’s Pension Support Index stood at a high of 90, suggesting companies could comfortably support its pension obligations. The impact of the first lockdown saw the PSI fall steeply to 81 in March 2020, before a short-lived recovery following the easing of restrictions in June 2020 contributed to an increase to 87. But further restrictions over the winter saw it drop back down to 83 in March 2021. PwC says this is primarily due to significant reductions to profitability and cash generation experienced by many FTSE 350 companies as a result of the pandemic.
Performance varies significantly between companies, but a growing number have a score of 60 or below. While most will be able to meet their pension obligations as they fall due, PwC says there will be some schemes which have significant pension liabilities and will need to take action to protect their schemes.
Defined benefit pension schemes are established by individual employers and offer a set benefit each year after a person retires.
These and defined contribution (DC) pension schemes are particularly important for private sector workers who have fewer alternatives than those working in the public sector.
DC schemes are based on how much has been contributed to a pension pot and the growth of that money over time. It may be set up by an individual or an employer. One problem of a DC scheme in an era of greater longevity is that if everyone saves enough to last them until the upper end of the range of their possible lifespan, most people will save more than necessary, yet if everyone saves enough for an average lifespan, half of them will run out of money in old age when most vulnerable.
This potential drawback is, says experts, why the most effective pension systems allow individuals to share ‘longevity risk’ by buying an annuity when you retire. However, annuities can be expensive and in 2015 measures were introduced to allow DC pension savers to use their money in other ways.
Another way to share the longevity risk was through DB schemes. This used to be the backbone of occupational pension schemes. But greater longevity and changing economic circumstances made them unaffordable for most private sector employers and most are now closed or closing.
So what is the alternative? One suggestion, outlined in a recent report from the RSA, is the Collective Defined Contribution pension [CDC]. CDC offers a middle ground. The report argues that, “similar to early DB, it offers an income in retirement but with some flexibility in the pension paid” and like DC, the pension can only be paid from the money which has been subscribed.
The report warns that legislation needs to be clear that a CDC pension scheme cannot ask the employer for further funds beyond those which it has already committed.
It lists the potential benefits and drawbacks, saying CDC addresses the demand for a regular retirement income and “is likely to provide a much higher income in retirement than the alternative of individual saving and then buying an annuity”. Studies suggest that CDC will give at least a 30% higher retirement income than a conventional DC scheme with an annuity through sharing longevity risk and targeting higher asset returns than is possible for an annuity provider. While it provides a more predictable income, however, it warns this is not guaranteed and that employers cannot be asked to top it up if dramatic changes occur. Nevertheless, it says most changes do not have a significant impact, with Covid’s impact on CDC schemes being more limited than that on annuities.
On 7th January 2020, the Government introduced a Pension Schemes Bill to the House of Lords, part of which will enable the establishment of CDC pensions [or Collective Money Purchase – CMP – schemes]. Other parts deal with the pensions dashboard and DB pension protection. The RSA analysis, however, points to some challenges. For instance, the Bill doesn’t allow companies in the same sector to collaborate which could mean smaller companies are excluded from CDC schemes.
It highlights too that there is some concern over issues such as intergenerational unfairness, although it says the Bill could be altered to address these through better regulation. For the RSA, there is clearly latent demand for CDC schemes and some important opportunities, for instance, for the self employed who currently lack an effective pension scheme.
In 2018, the Royal Mail and the Communication Workers Union committed to delivering the UK’s first CDC scheme. If the Bill is passed they can become pioneers and open the way to greater discussions about the way forward.
*If you require independent free advice on pensions, go to Pension Wise.