Webb and Rubenstein: our solution for DA

If we do nothing, traditional salary-related pensions will disappear altogether. While the investment, longevity and inflation risks in a DB pension rest entirely with the employer, all the risk in defined contribution schemes – the main alternative – sits with the individual.

Some employers will still close their DB schemes due to the cost and volatility, but we know many will want to continue to offer their staff quality pensions.

That is why the government is consulting on proposals to reshape workplace pensions and create a legal framework to enable employers to take advantage of more flexible DB schemes, or offer staff more certain DC pensions.

We believe one model being proposed could provide employees with greater stability in their pension outcomes without the employer taking on any pension risk themselves.

These schemes are already running successfully in Denmark and the Netherlands – two countries whose pension systems are ranked among the best in the world.

Our middle way

One approach that has been tried and tested in both countries is what the Department for Work and Pensions has featured in its ongoing defined ambition consultation as the 'pension income builder'.

With its fixed contributions, this looks like a DC pension from the employer’s perspective; for the individual, it provides them with a degree of certainty in retirement income well before the individual actually comes to retire.

This is achieved by using part of the member’s contributions to buy a pension income in the member’s name. Each year an additional bit of income is purchased so that the member’s income builds up year-on-year.

The individual can see the value of their pension saving increasing every year, which makes it understandable from the consumer’s perspective – this also has strong behavioural benefits as individuals can see clearly the value of saving more into their pension each year.

The remainder of the members’ contributions then go into a collective pool of funds which are invested more aggressively in order to provide some protection against inflation in retirement – since the fund is collective and members therefore share the risks, such as longevity, outcomes can be smoothed.

So for members the outcome is a degree of certainty over the pension actually received, with the possibility of additional upside.

How it shapes up

Modelling carried out by the Pension Protection Fund and others to inform the proposals showed that on average, based on the same level of contributions, outcomes on retirement are similar to DC but with greater protection on the downside.

So when markets are volatile and returns poor, the pension income builder provides greater protection than DC, which is precisely when it is most valuable.

For sponsoring employers this looks like a DC scheme – contributions are fixed and the liability is limited to the contributions.

With proactive investment risk management and high-quality governance in place to ensure these schemes remain financially sustainable and protect their members, people can have a high degree of confidence and security in the running of their pension plan.

This high-quality, proactive approach to governance and risk is precisely how they operate in the Netherlands and Denmark. 

There is real interest in this approach from within the pensions industry and among employers who want to offer more than individual DC.

The DWP is working closely with stakeholders and meeting key pensions figures in those countries that already offer this scheme design, to learn from their experience.

There is real merit in this model since it provides greater certainty for the member at no additional cost to the employer.

To allow these schemes to run in the UK, much rests on the DWP’s consultation, which is open until December 19. We urge you to respond.

Steve Webb is the UK pensions minister and Alan Rubenstein is chief executive of the Pension Protection Fund