The government has set out legislation on collective pensions in the new Private Pensions Bill.
The purpose of the new legislation, which was confirmed in the Queen’s Speech on 4 June, is to enable employers to develop shared risk, or defined ambition, schemes that offer more certain outcomes for employees, while still keeping costs under control.
The legislation, which goes before Parliament on Thursday 26 June, will also allow the development of new collective pension arrangements based on risk-pooling models.
These have been run successfully in other countries, including the Netherlands, Sweden and Denmark.
The government has also published the responses to its consultation, Reshaping workplace pensions for future generations, which showed a broad consensus of backing for collective pensions from business, trades unions and individuals.
The response document also confirms that the government has decided not to pursue measures to allow reform of existing defined benefit schemes, after the consultation showed concern about the potential impact on current savers and pensioners, as well as a lack of interest from employers in such an option.
Steve Webb (pictured), pensions minister, said: “This Coalition government has already made fundamental reforms to the pensions landscape.
“These new proposals are all about encouraging a flourishing and diverse private pensions market by providing greater choice to employers and savers.
“These reforms meet the needs and concerns of business while, at the same time, standing up for the interests of workers who are doing the right thing and saving for their retirement.
“With the backing of consumers and industry, this bill will bring about new and realistic pension scheme options for employers that want to do right by their staff.”
This new legislation will enable employers to develop shared risk schemes for the first time. It’s interesting to see that despite the negative response by many regarding shared-risk schemes, the official response to the government’s consultation has shown that more than a quarter of employers may be interested in greater risk sharing, as well as a clear preference from individuals for greater certainty over their finances.
The legislation will also allow the development of new collective pension arrangements based on risk-pooling models, which can potentially offer more certainty and stability of pension outcomes than traditional defined contribution schemes.
We expect the outcome will be a range of risk-pooling models, varying from simple arrangements designed just to pool ongoing management costs and/or investment strategy, all the way up to more complex Dutch-style, target-benefit arrangements.
Some employers may decide that their existing defined contribution schemes are perfectly adequate for their needs and those of their employees, but this legislation will give those who feel that defined contribution is the “wrong tool for the job” the opportunity to put something more appropriate in place should the decide to do so.
The creation of a new risk-sharing structure is likely to start the creation of new and innovative pension arrangements. However, key to the development of new designs is an overhaul of the existing pension taxation structure, which is overly rigid and complex. For employers to seriously consider introducing such arrangements clarity around how the tax regime applies to risk-sharing schemes will need to be resolved quickly and not left until after the Bill has been passed.
The government is rightly focused on changes ‘that are likely to make a real difference’. The forthcoming defined ambition legislation is aimed at providing more certainty and stability of outcomes as individuals accumulate the savings from which they will fund their retirement. This is laudable. We remain concerned that at the extremes of poor investment performance and accelerated life expectancy there is a danger that the certainty defined ambition promises breaks down. We have seen this in Holland. Great care will therefore be needed as defined ambition schemes are designed and operated.
The timing couldn’t be worse. Large employers have already gone through auto-enrolment; they don’t want to go back now and redo the whole exercise as a defined ambition scheme. In addition, the Chancellor’s new pension freedoms announced in the budget are pulling pensions in precisely the opposite direction.
Without a large employer, industry trade body or union to embrace defined ambition and to provide the numbers of members and momentum they require, it is hard to see how they’re going to get off the ground for the foreseeable future. Whoever does first embrace this new type of scheme will have to bear all the set up costs while having to wait many years to reap any benefits.
For now all the momentum is away from defined ambition schemes, as the pendulum swings away from defined benefit towards defined contribution. The moment for defined ambition has been missed and it may be many years (if ever) before it swings back again.
As a Dutch-owned company, Aegon UK is in a unique position to understand what collective defined contribution (CDC) would mean for UK savers, and at first glance it looks like this is a case of two steps forward one step back for pension reform. Even in the Netherlands, where these schemes have been in place for some time, the government has recently launched a wide-ranging review of their pension system amid concerns about how well it is serving the population.
The 2014 Budget has given individuals more flexibility about how they take their pension – whether as an income or lump sum once they reach age 55. Under the Dutch CDC model there are no such flexibilities. People can only receive their pension at the time and in the format set out in the scheme rules leaving them little room for manoeuvre. Getting the UK ready for retirement requires simple, reassuring and digital solutions, not more complexity.
The scheme does have its merits. The collective buying power would offer benefits through economies of scale and could provide higher investment returns than personal pensions, but the move doesn’t reflect trends in UK society. The Aegon Global Retirement Readiness Report 2014 revealed that only one in three UK workers currently expect to have a fixed retirement date, so the constraints of a CDC scheme would severely damage the retirement plans of the remaining 71%.
The new legislation will allow employers and providers to set up CDCs from 2016, but it’s unlikely the industry will be so fleet of foot as they continue to focus on delivering choice and new ways for customers to engage in saving for retirement. Only the very largest employers, those that continue to run defined benefit schemes, are likely to be interested.
It is welcome that the government is actively encouraging pension innovation. However, with so much currently happening in pensions, we would strongly urge the DWP to ensure it has got the basics right before rushing into promoting new types of product.
We are at a pivotal point in the auto-enrolment project and we need to ensure that we are 100% focused on delivering that. Just adding more complexity on top of an already complicated system risks confusing employers and savers. So far the government has failed to deliver simplicity, transparency and comparability in charging. Without this, consumers risk getting a raw deal.
Any changes to the current system should not prohibit people in final salary schemes from accessing the 25% tax-free cash to which they are presently entitled.
In our experience, many people depend on these funds for a number of planned initiatives; up to 70% of our clients use it for debt consolidation, 20% on home renovations, and 10% on other activities like helping their children through higher education or tackling their mortgage.
We are genuinely concerned that, should the government decide to remove the ability to transfer out of a final salary pension, it will have a negative impact on the lives of millions of people who would have used their tax-free cash to set themselves up for a more stable retirement.
Many of the features of CDC plans that we have advocated are incorporated in the draft Bill. In particular, Steve Webb has made it crystal clear that an employer’s obligation will be limited to the contributions paid, so there is no danger of the plan morphing into a defined benefit scheme. This will give many employers the reassurance they need to consider these arrangements seriously when they grapple with the consequences of the Budget and the cessation of DB contracting out.