Reshaping workplace pensions for future generations. Buck Consultants response to DWP Consultation

Transcription

1 Reshaping workplace pensions for future generations Buck Consultants response to DWP Consultation December 2013

2 2014 Xerox Corporation and Buck Consultants, LLC. All rights reserved. Xerox and Xerox and Design are trademarks of Xerox Corporation in the United States and/or other countries. Buck Consultants is a registered trademark of Buck Consultants, LLC in the United States and/or other countries. BRP2825. Other company trademarks are also acknowledged. Document Version: 1.0 (July 2014).

3 Introduction and executive summary The importance of defined ambition Buck is pleased to have this opportunity to respond to the latest stage of the DWP proposals on this very important issue. We continue to be supportive of the efforts of the government to create an environment through the defined ambition initiative where employers, with the assistance of the pensions industry, are encouraged and empowered to provide good quality workplace pension schemes for their employees. We strongly agree that this should if possible be achieved through the removal of unnecessary regulatory and other barriers, rather than by prescription as to particular designs, and we are pleased that the government continues to embrace this principle. However, we do have some concerns over aspects of the initiative and the wider regime into which it needs to fit. Concerns over level of understanding This consultation paper constitutes a useful next step in trying to refine the wide range of concepts discussed in the first paper to a smaller number of design options that might prove practical for employers. Although the pensions industry and others have been extensively involved in this process, there is still generally a low level of understanding and appreciation of exactly what defined ambition is, and what it might mean in practical terms. In particular, one of the common high-level descriptions in common parlance is that it involves the employer taking on more risk. Although this is a part of some of the design options, it is misleading as a generic description, and has the effect of discouraging many employers from any consideration at all (and many advisers from instigating a serious discussion on the subject with their clients). One possible reason for this is that whereas there is a general understanding of what the terms defined benefit and defined contribution broadly mean, there is currently no equivalent for defined ambition ; many people are expecting to see a specific scheme design. The proposal to create a unified and identifiable legislative framework specifically around defined ambition if this can be done without the outcome being prescription of scheme design by legislation should ultimately help in this respect, but we believe that stronger messaging around this point in any case would bear fruit in helping the promotion of the concept. If employers are to be encouraged to provide high quality provision, they need to be both encouraged to consider the benefits of so doing and reassured as to the extent of any liability that may apply to them as a result. Such messages will only be possible to get across if there is a thorough understanding. Buck Consultants response to DA consultation 2

4 Concerns over encouraging more than the minimum the raison d etre of DA We are becoming increasingly concerned that the considerable amount of focus and effort that is being put into promoting automatic enrolment, together with the proposed new legislative and regulatory restrictions, such as blanket caps on defined contribution charges, a bias against smaller schemes and relentless attacks on pensions tax reliefs, will undermine the efforts to increase the quality of workplace pensions that the defined ambition project seeks to achieve. Although automatic enrolment is an important initiative in itself, no one would argue that provision at the minimum levels set for that purpose will provide anything like high-quality pensions. Employers must be encouraged, for their own benefit as well as for their employees, to embrace more generous provision and the regulatory system must allow them the flexibility to do so in ways that fit with their circumstances. This requires a balance between protecting those who, through lack of knowledge or resources, are deemed to be at higher risk of entering into a poor deal, and allowing those who want to do better than the minimum to do so. Currently the policies and rhetoric around the former is taking precedence over the latter, and threaten to undermine the whole benefit of the defined ambition project. Concerns over decumulation the elephant in the room One crucial aspect of defined contribution provision is the conversion of members monies into an income stream in retirement. The principal method of achieving this is of course through the purchase of individual annuities, or in exceptional cases through one of the drawdown options permitted within rules administered by HMRC. In the latter case the rules are too restrictive to enable it to be a useful option with anything other than the largest of funds; in the former case there are many problems both with the system and the terms that are often available. Until these problems are sorted out, any workplace pension that is essentially DC based (including a DC-based DA, and most automatic enrolment minimum schemes) is likely to be providing less than its full potential. Despite that, this is an area that has not yet formed part of the DA project. We recommend that this needs to be considered as part of the DC-based design considerations, as they are now being refined. Consultation concerns Finally we make the point that although we recognise that DWP has conducted, and is still conducting, extensive consultation with the pensions industry and other relevant parties, we are disappointed that so little time has been allowed for responding to this consultation paper, which has been 12 months in the making. In our view the time constraints will have restricted the breadth and depth of the responses, which threatens to undermine the effectiveness of this most important consultation. 3 Buck Consultants response to DA consultation

5 Responses to the consultation questions The demand for defined ambition the consumer perspective 1. Do you agree that a greater focus on providing members with more certainty about savings or preferably income in retirement may increase confidence in saving in a pension? We strongly agree that a greater focus on providing members with more certainty about savings may increase confidence in saving in a pension; we believe that a greater focus on income in retirement would be an even stronger influence, since it would put that saving into a context to which a member is better able to relate. One of the current difficulties with getting the pensions savings message across is a widespread inability to understand the annuitisation process and its importance to the amount of the retirement income which is one reason for the continued failure of many retiring employees to utilise the annuity open market option. Providing more certainty about outcomes includes countering negative publicity around the safety of savings, as well as the likely outcomes. 2. As an employer, do you have experience of, or can you envisage any issues with, employees being unable to retire due to DC pension income levels or certainty about income levels? As advisers we have heard from employers who have experienced such difficulties. However, the experience is not yet widespread because many people retiring now have some past DB benefit to cushion the disappointing DC benefit. We expect the problem to grow significantly as the numbers with meaningful past DB benefits declines. 3. Do you have any further evidence or research planned which might help inform the development of DA pensions? Not at the moment. Buck Consultants response to DA consultation 4

6 Flexible defined benefit - making it easier for employers to sponsor schemes where benefits accrue on a specified basis Design 1: Ability to pay fluctuating benefits 4. What are your views on the feasibility of this scheme design? This scheme design potentially provides an attractive balance of DB benefit for members, but at a cost that the employer feels comfortable with, yet allowing for additional benefit to be provided on a basis where any additional cost is controlled. It would be imperative for schemes and/or employers making such a promise to ensure that its precise nature is clearly communicated, but that is an issue for them and so this is not an area where it would be appropriate for any regulations to be imposed. Although we agree that the regulatory requirements on any such discretionary uplift should be kept to a minimum, once discretion has been exercised it should be accompanied by a specific payment into the scheme to fund it. In our view it would be acceptable in principle to express the benefit as being subject to there being sufficient funds at the member s retirement to pay it, but if it is to have a DB nature there should be a reasonable and verifiable attempt made to fund for it. 5. Are employers likely to be interested in providing benefits in addition to a simplified flat-rate DB pension on a discretionary basis or otherwise? We believe that some employers will be interested, although their numbers are likely to be few. In the past when final salary was the prevalent scheme design, it was not unusual for employers to use the scheme to provide additional benefits for selected individual or groups of members, as a workforce management tool. That potential still exists. Factors that may affect the decision today include the level of the basic DB promise and the headroom with a (falling?) lifetime allowance, the extent of the regulatory burden, and the extent to which the liability can be controlled. 5 Buck Consultants response to DA consultation

7 6. What role do you see for scheme trustees in relation to discretionary payments? For example: Should they be involved in deciding whether a discretionary payment is made at all? Should they be involved in setting out how these payments are apportioned to members or should this be down to the employer? We do not see that the scheme trustees should normally have any role other than to deliver the additional benefits promised by the employer, as long as the basis upon which the promise is made does not involve them in assuming responsibility for an additional liability over which they effectively have no control. 7. Do you agree that our starting point should be to keep regulatory requirements around discretionary benefits to a minimum? Yes, the starting point should be that regulatory requirements are kept to a minimum. 8. How do you see funding for the non-discretionary DB element being sufficiently protected while allowing for extra discretionary benefits? For example, is there a risk that paying discretionary benefits could threaten the funding for non-discretionary DB benefits for younger scheme members? If the extra discretionary benefits are not separately provided through a ringfenced fund, then the trustees will need to have control over them as part of their funding responsibilities, subject as usual to relevant oversight by the Pensions Regulator. They should make sure that the funding for the basic level benefits is not compromised by a later promise made by the employer to provide additional benefits, especially since such a promise is likely to relate only to some or all members who are active members at the time it is made. Design 2: Automatic conversion to DC when member leaves employment 9. What are your views on the feasibility of this scheme design? This is feasible and would certainly be attractive to employers with DB schemes seeking to manage their liabilities by focusing on employees actively contributing to the business. However, there is a potential issue for an employer/trustees in selecting the nominated DC scheme to which the transfer is made, in that they may acquire a Buck Consultants response to DA consultation 6

8 liability if that DC fund provides an outcome that falls short of the member s expectations (even if those expectations were unrealistic, there may still be an attempted claim by the member). The trustees may therefore feel that they have an obligation to monitor the continued suitability of the selected DC fund, including for former members who have previously transferred out. We wonder whether this sits entirely comfortably as a policy alongside the government s policy in the DC environment of outlawing less preferable treatment for leavers than that given to employees. 10. If employers are able to use scheme designs 1 and 3, do you think it is still helpful for legislation to allow for this scheme design? Yes it gives another option, as long as the liability issue can be satisfactorily addressed. However the question appears to imply that the legislation will prescribe particular scheme designs as acceptable; as we observe elsewhere, such an approach would negate the benefits from having a DA system. 11. Do you think this scheme design could be extended to permit employers to automatically transfer members out of the scheme at retirement? No; if the scheme is promising a DB retirement benefit, that is what should be available to the member at retirement. 12. What would be the most suitable way for benefits to accrue under this model? And how might this best be communicated to ensure members understand the value of their pension benefits? This would probably work most easily with a CARE design, where the value of the accrued benefits will be most transparent. 13. Assuming a CETV would not represent fair value for the accrued rights when the member leaves or retires, how might it best be calculated? Should the basis for calculation be different when the transfer is initiated by the employer (for example on redundancy)? We would be happy with the basis proposed in the consultation document. We see no reason why the calculation basis should differ depending upon the circumstances of the members leaving employment; if the transfer value is considered to be fair for one situation it should also be so for others. 7 Buck Consultants response to DA consultation

9 14. For schemes providing a lump sum benefit, what are your views on how the cash value should be calculated for members who leave before retirement? Should the net present value of the lump sum be calculated on how many years away from pension age they are? That seems an appropriate method. 15. Could the accrual rate and pension value be along similar lines to existing cash balance arrangements? Yes. 16. What forms of regulatory requirements would be needed to: prevent avoidance activity? ensure the scheme has access to sufficient funds to enable a transfer when a member leaves? Employers should be under a statutory duty to inform the trustees of a leaver within a specified timescale. Trustees should be given a generous timescale within which to make the transfer, to help them to manage their cashflow. Design 3: Ability to change scheme pension age 17. What are your views on the feasibility of this scheme design? We consider this design may be of interest to some employers as a practical and effective method of keeping costs close to those envisaged when the scheme was designed. However, to be attractive its terms would need to be compatible with the employer s employment policy. 18. It could lead to more schemes having proportions of accrued pension payable at different pension ages. Would this further complexity outweigh the benefits? This is a valid concern, but it would be a decision for each individual employer to make. We do not consider that the additional complexity necessarily renders the design unattractive. Buck Consultants response to DA consultation 8

10 19. What role do you see the scheme trustees playing? Should they be involved in setting a new NPA, or should this be down to the employer and the employer s actuary? There is no need to involve the trustees if the change is made under the provisions of a statutory override permitting the change, following advice from the company s actuaries, but subject to the utilisation of the GAD index. 20. What are your thoughts on how future pension ages are set? For GAD to publish a standard index based on longevity assumptions? Or do you prefer schemes linking their NPA with the State Pension age, so that when the latter changes, the scheme s pension age automatically changes in line with this? The future pension ages should be reset by reference to a standard index published by GAD, although careful consideration will need to be given as to how to deal with differences between members derived from their jobs and domicile. For this reason, there should also be an option to use a measure that produces a more conservative figure than the omnibus GAD figure, but on a scheme basis. In this case it would require the input and agreement of the trustees. Although there are reasons for aligning the scheme s NPA and the SPA and in practice the two are frequently aligned, we consider that linking the NPA change to that of the SPA would be too restrictive in the future world of more flexible employment and would not necessarily be appropriate for schemes. 21. How might the decision to change the NPA work in multi-employer schemes? We see no reason why each employer cannot choose its own approach for its own employees if it is not satisfied with that selected by fellow employers. Indeed, separate approaches may be more appropriate if there are significant differences between workforces. 9 Buck Consultants response to DA consultation

11 22. As an alternative to opening a new scheme, do you agree it should be possible for an employer to modify the rules of an existing scheme so that it can be re-designed as a Flexible DB scheme in relation to new accruals, for example, it is possible to change the NPA and/or introduce automatic conversion to DC when a member leaves? We consider it imperative that there is an option to convert existing schemes; if it is necessary to start a new scheme in order to utilise this option, there will be further defections away from DB provision as some employers will take the opportunity of change to make a full move to DC. 23. Do you agree that employers should not have the power to transfer or modify accruals built up under previous arrangements into a new arrangement, beyond what is allowed under current legislation? Yes. 24. Should there be a requirement to provide independent financial advice in all cases where an employer offers to transfer a member s accrued rights from a traditional DB scheme to a new arrangement? Yes. It is already good practice embraced by many employers. Given the low levels of financial knowledge amongst the population in general, and in particular amongst those that have hitherto been in a DB scheme, it is unrealistic to expect them to feel confident enough to take difficult financial decisions without assistance. If the employer is responsible for making the change, it should also offer assistance. Buck Consultants response to DA consultation 10

12 Providing greater certainty for members in the defined contribution world 25. Do you think having more certainty than traditional DC would be welcomed by members, and help generate consumer confidence and persistency in saving? Generally yes, amongst those who understand that their traditional DC benefits are subject to considerable uncertainties (we recall having seen surveys showing that despite apparently understanding the nature of DC benefits, some members still thought that there was really a guarantee (probably provided by the employer) somewhere in the system). 26. As an employer, if these products mean there is no funding liability, only the requirement to contribute as for a traditional DC scheme, would you be interested in offering these products to employees? We would expect employers to be interested in the concept, but they would need to be reassured that there is no hidden additional liability or possibility of any future comeback on them. Support may also depend upon the amount of additional cost (if any) to them. 27. In relation to medium- and long-term guarantees outlined in model 2 (capital and investment return guarantee), and model 3 (retirement income insurance), would removal of the legislative barriers be sufficient to stimulate the development of market-based solutions? Potential providers would also need to be confident that a market for the products would exist and that it would generate a suitable return. 28. As insufficient scale has been identified as a barrier to providing affordable guarantees, is there a role for the Government in facilitating different types of pension vehicles that would create greater scale for this purpose? Facilitation would be helpful, as long as it did not extend to coercion. 11 Buck Consultants response to DA consultation

13 29. Are there any additional legislative barriers that stand in the way of innovation of products with guarantees? We cannot think of any at this time. 30. Do existing protection arrangements for DC products provide sufficient protection for members in the event of provider insolvency? Yes. 31. Would any protection mechanism need to apply in order to provide extra security for members and reassurance for the employer that it would not be liable in the event of any deficits arising? This is an issue for lawyers to address. 32. Are these models likely to be an attractive option for employers and members? We think they are likely to be attractive, over time, as aids to improving outcomes for members. However, the benefits of the options will still need to be promoted, particularly in the early days, before more widespread acceptance is achieved through demonstration by example that they work. 33. On model 4 pensions income builder what are your views on this model in which members are in effect deploying their own capital to guarantee their own entitlements? We think this model shows great promise in principle. It should address a number of the issues with DC. However, it will be relatively difficult to explain to members, which risks a lack of participation through mistrust. Having said that, given the low level of understanding of pensions generally, this additional complication may not in practice make any appreciable difference. Buck Consultants response to DA consultation 12

14 Collective defined contribution schemes 34. Do you agree that CDC schemes have the potential to provide more stable outcomes on average than traditional DC schemes? Yes. 35. Given there is no tradition of risk sharing between pension scheme members in the UK, are individuals going to be willing to share the benefits of protection from downturns in the market and increased certainty of outcome, with the potential disadvantages of intergenerational risk transfer? There is no way of knowing without trialling the design in practice in the UK; there will be an element of distrust to be overcome. One approach would be for an employer to offer membership of a CDC as its only offering under automatic enrolment; early experience with AE suggests that the inertia factor will result in large-scale participation by employees, whatever the details of the scheme on offer. 36. Is a CDC scheme designed to manage funding deficits by cutting benefits in payment going to be acceptable in the UK where traditionally maintaining the value of benefits in payment has been an overriding priority? It will be a difficult sell to members, and opens such schemes to negative, uninformed, publicity. The answer may depend upon how the scheme is described. However even if the terms, including the ability to reduce benefits in payment, are understood, human nature is such that people get used to receiving a particular income and will not take kindly to having it reduced. We understand that this has been the experience in the Netherlands. 37. What levels of funding do you consider would be appropriate to ensure that a CDC scheme has sufficient capital to meet the liabilities and minimise the risk of benefits in payment being cut? The appropriate funding levels will depend upon the relevant aspects of the particular scheme, such as how it is invested, the target benefits, the level of contributions and the available scope under the rules for coping with any underfunding. However, as a matter of principle, we suggest that the funding level should be maintained on a more conservative basis than the investment strategy would normally suggest is necessary 13 Buck Consultants response to DA consultation

15 on a realistic basis, in order to build a cushion to minimise the likelihood of missing benefit targets, and especially the need to cut back benefits in payment, even where that is an option allowed under the rules. 38. Given the need for scale and an ongoing in-flow of new members to ensure the sustainability of a CDC scheme, will it be possible to set up a scheme without some form of Government intervention? Yes. Although it appears that scale and an ongoing in-flow of members is necessary to make the CDC scheme work effectively, the DWP s own modelling indicates that the absence of these factors reduces the scheme s effectiveness, rather than rendering it unworkable. 39. As a mutual model, it has been suggested that CDC schemes might prove attractive to the trades unions and other social partners might this be an option worth exploring? Yes. Buck Consultants response to DA consultation 14

16 Enabling innovation legislative approach 40. Do you agree that creating a unified and identifiable legislative framework that brings together the legislation relating to DA schemes would be preferable to simply amending existing legislation? We are undecided. Provided that it proves possible to define DA definitively without resorting to prescription of scheme design, then it may be helpful. If this can be achieved (and currently we are by no means certain that it can), it should make regulation more straightforward and clearer for schemes to identify their responsibilities under the appropriate regulatory regime. 41. Do you have any comments on how to characterise the defining characteristics of DA pensions? This will be difficult. In view of the diversity of designs to be covered it may prove to be more straightforward to define DC and DB, and leave DA to be anything that does not fall under either of the other two, in order to avoid any unnecessary constraints. An example of the difficulties involved in allocating a scheme design to one particular definition would be Design 1 referred to above, where it is envisaged that the funding of the core benefit would be on the usual basis, but the discretionary benefit which would be provided under the same scheme would be subject to a lighter regulatory regime. To assist understanding it may be useful to recognise in the definition that there will still be elements of DB and/or DC in the DA design, but that there will also be other features which take it outside of those other definitions. A unified and identifiable legislative framework covering all DA exclusively must avoid effectively prescribing scheme designs, otherwise we will be back to the restrictive nature of regulation that was one of the original reasons behind the need for DA. 42. Do you agree that it makes sense to define DB schemes in their own right rather than simply by contrast to money purchase? See answer 41 above. 43. Do you agree that defining DA, DB and money purchase schemes should facilitate clear and proportionate regulation according to scheme type? See answer 40 above. 15 Buck Consultants response to DA consultation

17 44. Do you have any comments in relation to the suggested definitions of DA, DB and money purchase schemes? The principles appear logical, but the definitive test of whether the proposals work will be what the detailed legislation looks like 45. Are you aware of any schemes operating in the UK under the Regulatory Own Fund provisions? No. 46. Aside from Regulatory Own Funds vehicles, are there any other vehicles which might be appropriate for the provision of collective CDC which offers some form of guarantee or promise? We cannot think of any. 47. Do you think that setting up a CDC scheme should be subject to formal approval, for example licensing by a regulator? If they are subject to effective (but not unnecessarily onerous) regulation once established, there is no need for a specific licensing system. 48. Do you think that CDC schemes which do not provide a guarantee or promise should also be licensed? No. 49. Do you agree that such CDC schemes should also be subject to DA requirements on governance and member communications? Governance and member communication should be principles-based and not prescriptive. The principles should apply consistently across all scheme designs. Hence there would be no need to change the principles for any specific type of scheme. 50. Should there also be an option for schemes that currently offer DC to convert to CDC? It should be made possible for any existing scheme to switch to a DA design, to avoid having to shut one scheme and start another to take advantage of DA. This is an important principle to encourage a move to DA. Buck Consultants response to DA consultation 16

18 51. In the absence of both a guaranteed pension entitlement and an individually defined pool of assets, how should assets in a CDC scheme be apportioned such that pension accruals can be measured for tax purposes against the Annual Allowance and the Lifetime Allowance? We would like more time to consider this, but it seems likely that it would have to be done by reference to the target benefit. 52. What specific areas should we address in relation to governance and member communications for DA schemes? We would like more time in order to comment on this. 53. Do you have any comments on the assumptions in relation to scheme funding requirements? No. 17 Buck Consultants response to DA consultation

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