Why I’m optimistic on the future of defined ambition

[DC-plus] has a greater chance of finding favour with employers 

While defined contribution will always be the only sensible option for small employers, I am hopeful that with the right changes to the legislative framework we will in the future see a shift away from pure DC and towards greater risk-sharing from larger employers.

Most employers have understandably found that the risks associated with providing DB in its current form is unsustainable and the scars it has left mean that many will not consider anything other than DC in the foreseeable future.

However, there are employers that still offer DB to new employees and others that would consider something better than pure DC if the right legislative framework could be put in place and reassurances were provided that would not see mandatory bells and whistles added to the system over time.

At the moment the legislative framework is heavily geared to provision of the DB and DC extremes but very little in between.

The government’s defined ambition policy framework explores the possibilities from two different starting points.

It considers adjustments to the traditional DB model where some risks are shared with members, termed ‘DB-lite’, and enhancements to the traditional DC arrangements where risks are shared with the employer or other members, termed ‘DC-plus’.

The latter has a greater chance of finding favour with employers.

This consultation has certainly highlighted the variety of ways in which risks can be shared and the approaches already in existence around the world.

DB-lite

This allows employers to convert DB benefits to DC upon a member leaving active employment, or when they retire.

It simplifies DB benefit provision to a type that poses less risk, such as fixed-term benefits from the occupational scheme combined with a higher state pension commencing once the occupational benefit ceases.

It allows retrospective changes in benefits in certain circumstances, eg a retirement age linked to national life expectancy statistics or state pension age.

DC-plus 

This includes collective DC arrangements – where risks are shared between members rather than between an individual and an employer, thus limiting the retirement date lottery we have seen in recent years with fluctuating DC fund values and annuity rates.

It can offer a guaranteed return of contributions, a minimum investment return or other guarantees that could, in theory, be provided at relatively low cost.

It could include DB underpins set at a manageable level and targeted benefits allowing employers to vary contributions.

According to HSBC’s ‘Future of retirement’ report, one in five workers in Britain believe they will never be able to afford to retire.

This is a worrying statistic and may show that people are starting to appreciate the high costs associated with retirement. It also underlines the need for us to restore confidence in the UK pensions system and for employers to play their part in helping their employees save for their retirement.

For employees, the most efficient way of doing this must be via an arrangement that involves some form of risk-sharing.

However, this must also apply to employers who will be looking to manage their workforce into retirement with a pension that supports them adequately.

One of the problems with many of the defined ambition ideas being discussed is their complexity and how they will be communicated so that employees understand them, and the risks they still face.

Perhaps if the industry can settle on a small number of specific designs that ultimately employees could become familiar with and trust, this challenge could be overcome.

The window for implementing a new framework will be short with a general election looming, which may result in a new pensions minister, as well as the new wave of DB benefit design reviews taking place over the next couple years as a result of the ceasing of contracting out.

Many will cynically suggest that no employer will ever move away from DC. I remain more optimistic, encouraged by the feedback I get from certain employers.

If we can find a framework that limits the risk to employers and allows risks to be shared between members, then there is a future for defined ambition.

Nick Griggs is a partner at consultancy Barnett Waddingham