Associated British Ports has proposed to change the accrual rate for its defined benefit pension scheme, in a bid to cut costs and focus on fairness while keeping the scheme open to accrual.
Pension scheme closures to future accrual, driven largely by the volatile liabilities of DB pensions and increasing cost, have become more common over recent years.
The reason for change is fairness amongst employees for pension provision due to the increasing cost of DB future accrual
Company spokesperson, Associated British Ports
Examples of large pension funds closing to future benefit accrual include Smith & Nephew in 2016 and ITV in 2017. More recently, Royal Mail and GKN have also announced scheme closures.
Scheme to stay open, but accrual rate may change
A company spokesperson, however, said that ABP has “indicated willingness to keep future accrual open, subject to triennial valuation review”.
Rather than closing the DB scheme, the company has proposed to move to a 1/75 accrual rate, from 1/60 starting in July 2018. This includes an option for DB members to move to DC on an enhanced company contribution rate while DB benefits are deferred.
The spokesperson said: “The reason for change is fairness amongst employees for pension provision due to the increasing cost of DB future accrual.”
A consultation started at the end of November 2017 and finished in mid-February 2018, with the outcome due later this month.
Members were given access to an independent financial education specialist regarding the proposal.
A summary Q&A document on the consultation showed the company’s cost of accrual was estimated to be around 40 per cent of DB contributory pay, “which the company considers would be hard to justify”.
The accrual change would almost half this; the spokesperson said that if the proposed change is implemented, “it would reduce the cost of the company accrual down to circa 23 per cent”.
A change with a choice
Alistair Russell-Smith, partner at consultancy Hymans Robertson, said this sort of change is “a way to both give members choice and also reduce DB cost and risk for the company a bit”.
While it is a more common thing to do if closing the scheme is deemed “over the top”, Russell-Smith said a lot of companies tend to move straight to closure.
Companies might move ahead with a full closure if they consider the cost and risk to be unaffordable, or want to harmonise benefits among the workforce. If affordability is not a huge issue but the company wants to cut costs, then changes to the accrual rate might be an option.
“Arguably, giving members the option to switch into [defined contribution] is helpful… it’s at least giving them the flexibility and enabling them to understand the options they’ve got,” Russell-Smith noted.
For example, if a member has built up a significant DB pension over their working life, they might also want to build up a bit of a DC pot for the last few years, which they can use more flexibly, he said.
When it comes to communication, asking members to make a decision differs from a proposal to close the scheme to future accrual and move to DC.
“There’s a whole series of choices and decisions that members have to make, so engagement with members and communicating the changes is really important – arguably more so than with a change where there isn’t actually a decision to be made,” he said.
A suite of options
Alex Hutton-Mills, managing director at covenant specialists Lincoln Pensions, said this kind of change is about “restructuring the benefits to make sure they are affordable” as “they’re looking to basically reduce the strain… on the covenant”.
Restructuring the benefits is “typically part of a broader suite of options”, he said. Schemes could also look at transfer value exercises, or pension increase exchange options to try and manage the liabilities, for example.
Changes depend, however, on the pension fund. “It’s part of a strategy to try and manage the covenant strain, but its impact will ultimately depend on other features like the maturity of the scheme and the member profile,” Hutton-Mills said.
Companies take baby steps towards the big switch
Charles Cowling, director at consultancy JLT Employee Benefits, said most companies are moving to DC, “but it’s typically the case that it’s done in more than one step”.
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To jump straight from a 1/60 final salary scheme to a DC scheme “is such a massive change in value of remuneration packages”.
In the past years, there have been a number of employers putting in place career average revalued earnings schemes, for example. “Reductions in accrual rates are less common, but have happened,” said Cowling.
Once schemes have closed to new entrants – typically five to 10 years later – there might be more members in the DC scheme than in the DB scheme.
“That changes the dynamic, in terms of being fair to your employees, and that’s typically when employers bite the bullet and switch the whole lot to DC,” Cowling said.
