New pension system plan put forward
Proposals to inject new "exciting possibilities" into workplace pensions and give employees more certainty over the eventual size of their retirement pot have been put forward by the Government.
The Government has been investigating the scope for creating a new category of pensions called defined ambition (DA) schemes, which would widen choice by encouraging the growth of a "middle ground" between two very different types of pension which currently dominate the market.
Under the current system, people tend to belong either to a defined benefit (DB) scheme, where the employer bears the investment risks of a worker's pension, or a defined contribution (DC) pension, where the employee bears the risk burden.
"Gold-plated" DB schemes such as final-salary schemes are in long-term decline and have become increasingly expensive to run as people live longer. The percentage of DB schemes that are still open has more than halved since 2007 - from 36% to 14%.
DC schemes are the type of pension people are most likely to be placed in as the Government's reforms to place people into workplace pensions automatically are rolled out.
The Government has recently moved to tackle concerns that some of these schemes have "rip-off" charges and it is considering imposing a charge cap.
Up to nine million people will be newly saving into a pension or saving more over the next five years under auto-enrolment.
Under DA schemes, pension saving risks would be more evenly split between firms and employees.
Pensions Minister Steve Webb said: " Our proposals for defined ambition pensions are designed to reinvigorate workplace pensions, providing people with more certainty about what they will get in retirement."
Mr Webb said in the Government's consultation paper that the "time is ripe for innovation", adding that "these are exciting possibilities".
A range of suggestions has been put forward in a consultation paper to tackle the "market gap" between the two types of pension, which aim to give employees more certainty about their retirement outcome as well as removing some regulatory burdens for employers.
Suggested options include a "money-back guarantee", to ensure the amount of money someone gets out of a pension scheme at the point of retirement or transferring out is not less than what they paid in.
While the probability of having to put this guarantee into action would be "close to zero" for a long-term retirement saver, it could have "real value" when someone needs it, the consultation document said.
The document also looks at the possibility of c ollective defined contribution schemes (CDC), which pool members' assets.
When people using this type of scheme retire, they take their income from the asset pool rather than buying a retirement income with their pension pot as they would with a traditional DC scheme.
Such schemes are used in the Netherlands and their large scale can help to cut administration costs, the paper said.
The consultation paper said that discussions with employers showed that unless options to reduce cost burdens are introduced, more firms will be forced to consider closing their DB schemes.
The paper suggested that removing statutory requirements for the indexation of pensions in payment for future accruals only would encourage employers to continue providing DB schemes.
The move would ease some of the burden on employers by shifting the risk of the impact of future inflation on to the employee.
It said employers could continue to offer schemes with index-linked benefits if they choose, but it would no longer be a statutory requirement.
Andrew Vaughan, chairman of the DA industry working group and chairman of the Association of Consulting Actuaries, said the proposals provide "a way forward towards both reshaping and reinvigorating workplace pensions.
"They offer a range of new options that will be attractive to different employers and their employees."
The consultation will close on December 19 and the Government aims to consult on draft legislation in the new year.
Otto Thoresen, director general of the Association of British Insurers (ABI), said: " We have considerable expertise in risk management and will contribute fully to this consultation.
"Any new initiative must build on the existing pension reform framework and modern defined contribution solutions, so that those currently being auto-enrolled can also benefit.
"The ABI is keen to work with the Government to help to identify the most effective ways to increase pension saving."
Laith Khalaf, head of corporate research at Hargreaves Lansdown, said the proposals could result in some workers having the "rug pulled from under them".
He said: "Inflation-linking is an important part of final salary pensions, and workers probably don't understand the full value of it."
Mr Khalaf said that while a £10,000 annual pension adds up to £250,000 over 25 years without inflation increases, it would add up to £320,000 with inflation increases of 2% a year, assuming the Bank of England hits its inflation target, or £351,000 with increases of the current rate of CPI inflation of 2.7%.
Raj Mody, head of pensions at PwC, said the proposals are likely to be "too little, too late" to see a big swing back to companies using DB schemes.
He said: "For a noticeable shift in company provision back to anything with a DB element, you would need to remove more than just the compulsory inflation-linking promise but also give more flexibility around areas like reacting to dramatic improvements in longevity, for example."