ACA and Royal London call for radical simplification of DB rights

The paper, published on Monday by the Association of Consulting Actuaries and Royal London, outlined the idea of converting complex historical benefits into a single simple structure with the creation of a ‘pension pound’ into which all the complexity of any individual’s current pension rights could be converted.

It is a missed opportunity if schemes don’t get the chance to simplify more fully

Stewart Hastie, KPMG

These pension pounds would then be converted back into a set of standardised DB pension rights common across all schemes.

But implementing these controversial proposals could see some individuals losing out in any restructuring of benefits, and the process could also rack up big fees for advisers, although there could be long-term savings.

Statutory power needed

There are ways in which benefits may be modified but, as the law stands, the processes by which that can be done are complex and trustees tread warily, with the result that the few limited simplification exercises that have taken place have been costly and time-consuming. That is why the paper calls for a new statutory power to make benefit simplification changes.

With such a provision, schemes could radically simplify their benefits at the same time as they equalise guaranteed minimum pensions.

Bob Scott, partner at consultancy LCP and past chair of the ACA, who was partly responsible for drafting the report, said: “40 years of well-meaning legislative changes have meant that even a 'plain vanilla' pension scheme is faced with a wide array of different historical revaluation and indexation terms, not to mention different retirement ages for different periods of service. And most schemes will have introduced changes of their own over that period too.”

He added that the average member has great difficulty in working out what their pension entitlement is or what it is worth. Furthermore, pension scheme administration is complex, which leads to errors, and running pension schemes has become more and more expensive, Scott noted.

Losers and winners

If millions of scheme members had their pension rights restructured, the ACA says the amount paid would be easier to understand, while it would cut the cost of running the pension scheme by up to 50 per cent.

Combining DB schemes into a ‘consolidator’ would be simpler, as all members would have standardised benefits.

The process of transferring out of a DB scheme would be less complex as the rights built up would be easier for schemes to value and advisers to provide advice. Ranking pension rights by their value in pension pounds would also help people compare their DB, DC and state pensions on a pension dashboard, for example.

Scott urged prompt action: “DB schemes are becoming a legacy issue. The individuals who operate these schemes – pensions managers and trustees – are retiring, and so a significant body of knowledge is disappearing.”

There would be losers and winners from a simplified system, even though the overall expected value of benefits would be protected. Hugh Nolan, senior trustee representative at Dalriada Trustees, said: “A member who moved from a pension that increases in payment to a flat pension would get paid more in the early years of retirement but less later on in life.”

Not everyone in the industry is a fan. Penny Cogher, partner at law firm Irwin Mitchell, said the proposals “are just too sophisticated and involve too much actuarial magic and sleights of hand”.

She continued: “Who can trust an actuarial assumption? There’s no real science behind them - they are approximates. This has more than a whiff of, ‘We know what’s best for you’.”

Cogher said that “you only have to look at the fight that has gone on at British Airways over the change of the index for benefit increases from [the retail price index to the consumer price index] to see that members don’t want and don’t willingly embrace pension change”.

She added that the government continually shies away from passing legislation to move from RPI to CPI for all pension funds, as they know it is not a vote winner.

Simplification could ease admin switches

By contrast, Nolan looked to the bigger picture, highlighting that a simpler benefit structure would ease switches between administrators and could increase pressure on fees as a result.

“It could even allow new entrants to the administration market, removing barriers to entry for high tech and cheaper solutions,” he said.

“A more straightforward benefit structure would also simplify investment strategy, allowing schemes to match liabilities better in a standard strategy rather than having to spend huge amounts on bespoke advice,” Nolan added.

Implementation could be costly but Stewart Hastie, partner at KPMG argued that “it is a missed opportunity if schemes don’t get the chance to simplify more fully”.