Government reveals ideas to reinvigorate workplace pensions

Despite significant reform of the UK pensions system, the Government is concerned that people are still not saving enough towards their retirement. It has therefore issued a strategy paper considering how to reinvigorate workplace pensions and rebuild trust and confidence in pensions. We examine its main proposals.


Next steps

Key points

  • Concerned about the dual effects of an ageing population and the reluctance of working-age people to save for retirement, the Department for Work and Pensions has published a strategy document examining the key issues that need to be tackled to reinvigorate workplace pensions.
  • The paper looks at the case for a new type of pension arrangement which it labels "defined ambition", which would create scope for greater sharing of risks under pension schemes.
  • Current defined-benefits and defined-controbutions (DC) scheme models are examined, with the outcomes under DC schemes being scrutinised in particular, and ideas proposed for improving their provisions for the benefit of both employers and employees.
  • A number of ways of increasing people's trust, confidence and engagement with pensions are suggested, including improving the quality of pension information.
  • The paper confirms that the Government is intending to progress the implementation of a single-tier state pension and examine ways of introducing a formal structure for regularly reviewing state pension age.

Although automatic enrolment has only recently started to be rolled out, the Government is still worried that whole generations will grow old without making adequate provision for retirement. Given the ageing population, this puts an increasing financial burden on those of working age. In a move that had been much trailed by pensions minister Steve Webb, the Department for Work and Pensions (DWP) has published a strategy paper (PDF format, 2MB) (external website) setting out in some detail its ideas for revitalising workplace pensions, including the minister's big idea of a new kind of pension arrangement called "defined ambition".

The paper, which draws on discussions with various parts of the pensions industry, sets out the DWP's views on the key elements that are needed for a private pension system that delivers a decent outcome for savers. It also considers ways in which trust and confidence in the pensions system can be rebuilt. The overarching revitalising objectives behind the DWP's deliberations are to:

  • increase the amount of pension savings;
  • increase the income individuals receive from their savings;
  • enable innovation in the pension industry;
  • increase transparency, and build trust and confidence so that people are encouraged to save for retirement; and
  • ensure the sustainability of the UK pension system.

Proposed new defined-ambition scheme

First there was defined-benefit (DB); then money-purchase morphed into defined-contribution (DC); now the Government is proposing a defined-ambition model of pension provision. The pensions minister has already set out some of his thoughts about defined-ambition pensions that would be intended to complement existing DB ad DC structures. The aim of defined-ambition pensions would be to create greater certainty for members about the final value of their pension than is provided by DC pensions, and to ensure less cost volatility for employers than pure DB schemes. It seems to be risk sharing by another name.

The DWP has already established a defined-ambition working group chaired by the Association of Consulting Actuaries, which has suggested a number of products and design options that would aid the introduction of the defined-ambition model.

Defined-benefit starting point

The paper notes that some DB models that share or mitigate risks are already available. These include career-average revalued-earnings (CARE) and cash-balance schemes. However, it suggests another way forward could be to have simplified or core DB schemes that provide a minimum level of guaranteed benefit with additional benefits being discretionary. These benefits could include conditional or optional indexation or spouse's and dependants' benefits.

Other ideas include: converting DB benefits into a DC amount of equivalent value at the point of leaving, retirement or death; pensions that fluctuate in accordance with the financial state of the scheme; and linking retirement age with changes to state pension age.

Defined-contribution starting point

The Government believes there is consumer demand for more certainty about pension outcomes than is offered by the current DC model. It notes that under existing legislation a number of improvements could be made, including: offering bonuses on top of a basic minimum investment growth; purchasing deferred annuities; and targeting or managing the amount available on an individual basis.

It also considers the idea of having capital guarantees as put forward recently by the Institute and Faculty of Actuaries. In addition to the concept of a guarantee based on contributions made, as suggested by the actuarial profession, the DWP highlights a type of guarantee recently analysed by the Organisation for Economic Cooperation and Development whereby schemes provide an ongoing capital guarantee that applies throughout the whole accumulation phase. However, it comments that the price of having guarantees is that retirement income is reduced. Therefore it identifies three other potential DC-type models for consideration, namely:

  • mutualised guarantees and risk-sharing in various forms, which would be funded by a levy on members' funds and would involve sharing the investment or longevity risk between providers and schemes or employers;
  • guarantees and risk-sharing provided by the insurance industry, such as a standardised income guarantee insurance; and
  • an employer-funded smoothing fund, where the employer would pay a percentage of core contribution into a central fund that could be used to provide a targeted amount at retirement through the use of bonuses.

The paper also suggests investigating collective DC as a basis for defined-ambition plans, which could be trust-based and would aim to provide a CARE-type benefit with a target level of pension calculated but not promised for each year of service towards which the employer would contribute a set percentage. All contributions could be pooled in a with-profits type of arrangement. Other features could include members' voluntary contributions and self-annuitisation.

Improving defined-benefit and defined-contribution schemes

The paper analyses current DB and DC provision, noting that a large number of factors including cost, regulation and tax charges have resulted in the swing from the former to the latter. However, the only idea it mentions for trying to halt the decline in DB provision is the "red tape challenge", and the sole area of pension regulation that the DWP has identified for action relates to the disclosure of information. Lawyers Eversheds may reflect the views of many in the industry when it comments that "those wrestling with the intricacies of the debt on the employer legislation, or s.67 scheme amendments may well disagree with the DWP's conclusion that 'the legislation is largely fit for purpose.'"

Hence much of the analysis focuses on improving outcomes and confidence in DC schemes as the Government seems to accept that this will be the dominant form of pension provision for the time being. Reference is made to the Pensions Regulator's six DC principles, which the paper reveals will be transformed into a code of practice and guidance, although for trust-based schemes only. Contract-based schemes are regulated by the Financial Services Authority and the DWP's only comment on this is that the two regulatory bodies and the DWP will "work together to ensure that this segment is achieving appropriate levels of protection".

The main reinvigorating objectives for DC schemes, according to the DWP, are:

  • to increase the amount people are saving in pensions - it accepts that the 8% minimum auto-enrolment contribution is inadequate, but it is not prepared to increase it because of the cost implications for individuals and businesses, so it seeks views on how to encourage automatic escalation options such as the US concept of Save More Tomorrow;
  • improving transparency around charges - the paper welcomes the pension industry's contribution in this area, but warns that it will monitor charges and will act if it believes that charges are excessive or structured inappropriately; and
  • increasing the amount people receive for their savings through investment - this is more difficult as investment decisions could be seen as a matter of individual choice, but the DWP refers to existing guidance intended to ensure that good governance exists, investment strategies are regularly reviewed, default options are appropriate and employers and individuals have clear information about their investment choices.

The paper also considers whether there is scope for obtaining economies of scale through collective occupational funds rather than employer-specific schemes.

Finally, under DC options, the DWP examines the problems around decumulation. Again it welcomes industry initiatives in this area, particularly the Association of British Insurers' code of conduct on retirement choices. However, it notes that buying a lifetime annuity is not the best option for everyone. At the moment the only other options are income drawdown and fixed-term annuities, which offer greater flexibility for some retirees but are not suitable for a lot of people.

It draws attention to the concept of a "retirement bridge" developed by Alliance-Bernstein, whereby on retirement the individual starts by using income drawdown while they consider the best annuity option for their circumstances. This gives people the time to examine all possibilities before finally committing to a method of receiving their decumulated funds.

Trust, confidence and engagement

The DWP recognises that there is a clear problem regarding lack of engagement with pensions. It believes that it is already moving in the right direction towards increasing trust and understanding of pensions with a number of initiatives that are outlined in the paper. These include automatic enrolment, the development of key information principles by the National Employment Savings Trust, the proposed introduction of the "pot follows member" principle in respect of small pension pots and the consolidation of the disclosure requirements on which the Government will consult early this year.

For the future, the paper suggests the DWP will be doing more of the same, mainly working with the industry to improve the clarity and consistency of communication, and also promoting guidance to employers on their duties in this respect. Otherwise it is seeking ideas on such things as using "rules of thumb" for pensions saving, although without giving any examples of what they may be, and putting in place mechanisms to allow simple comparison between schemes.

Next steps

The paper is not a consultation so there is no deadline for comments on its ideas. It reiterates that there will be a white paper on state pensions, setting out how the single-tier state pension will be introduced and seeking views on establishing a formal framework for regularly reviewing state pension age to ensure that it reflects improvements in longevity.

The only area where the paper indicates that options are being actively discussed is that of defined ambition: it says it is working with the industry to develop models and designs and also to see how legislation could be amended in order to promote more innovative pension structures. Otherwise there is no indication of possible timings.