With pension adequacy at the forefront of industry reforms, Railpen’s Jonathan Clark urges policymakers not to forget the vital role played by open defined benefit pension schemes for millions of people across the UK.
As policymakers grapple with the UK’s pensions adequacy challenge, it is time to recognise that funded open defined benefit (DB) – that is, schemes that have the assets required to pay all promised benefits now and in the future – is not part of the problem. It is an important part of the solution.
The strength of funded open DB lies in its collective architecture. The rail industry provides a particularly powerful example of that proposition in practice. The Railways Pension Scheme is one of the UK’s largest pension arrangements, serving more than 350,000 members with around £36bn in assets. It includes DB sections that remain open to future accrual and new members.
In the Railways Pension Scheme, members and employers contribute, meaning that both have a vested interest in keeping the scheme affordable and sustainable. Costs, benefits, governance risks and responsibilities are shared, rather than transferred to individuals or deferred to future employers.
The benefit for members is a predictable income in retirement without managing investment, sequencing and longevity risk. Meanwhile, employers gain a meaningful workforce benefit supported by pooled investment.
Far from being a niche arrangement, funded DB remains significant. In the private sector, 10.1 million people, plus another 8.7 million in the public sector, continue to rely on funded DB pensions, supported by almost £2trn of invested assets. These schemes represent some of the most successful examples of long-term financial planning ever developed in the UK and have been copied around the world.
Open DB is not simply closed DB at an earlier point in its journey. Openness changes the economics. Continuing accrual, ongoing contributions and a renewing membership support a different approach to cashflow, investment and risk.
It also means that this is not a relic of past generations – it is living pension provision that continually evolves across a complex and continually transforming industry.
Patient by design
An open DB scheme must consider how it will pay the pension for an 18-year-old apprentice joining the workforce today – even if that 18-year-old, somewhat understandably, hasn’t put a moment’s thought to it.
This means thinking long term, utilising continuing contributions and creating the governance to invest across market cycles. A beneficial side effect is that this can also provide much-needed patient capital to the UK economy.
The UK government is exploring how open DB schemes can support the UK economy through the British Business Bank and Office for Investment. By investing over long horizons, open DB schemes can back infrastructure, private markets and productive assets, as well as public market investments such as gilts, that generate long-term economic growth.
The Railways Pension Scheme demonstrates the point. Around 75 pence in every pound of pension paid by the scheme is generated by investment returns, helping to keep benefits affordable for employers and members. Meanwhile, the scheme has around £16bn invested in the UK.
In an era when policymakers are looking for ways to unlock investment and improve productivity, funded open DB schemes should be viewed as important contributors to the UK’s long-term economic policy and capacity, as well as successful pension arrangements.
Using the tools we have
If improving pension adequacy is genuinely the objective, policymakers should not simply focus on helping people save more into defined contribution pensions. They should also ensure that the remaining funded open DB schemes are able to continue delivering the strong member outcomes they already achieve.
This does not require radical reform. It means recognising the value of future service benefits. It means ensuring regulation reflects the operating reality of open schemes.
It also means giving appropriate weight to affordability, sustainability and member outcomes alongside the protection of accrued rights. Providing an explicit regulatory focus on future service benefits would be an important step in that direction.
The UK undoubtedly faces a pensions adequacy challenge. But in searching for solutions, we should be careful not to overlook one that is already in front of us. Funded open DB schemes continue to provide secure retirements, support economic stability and growth and demonstrate that collective pension provision can succeed in the modern world.
Rather than viewing them as survivors of a previous age, we should recognise them for what they are: one of the pension system’s greatest remaining strengths. If the UK wants better retirement outcomes for future generations, protecting and encouraging funded open DB should be one of the Pensions Commission’s clearest and most important conclusions.
Jonathan Clark is director of corporate and client affairs at Railpen.
