The only solution to a second wave of final salary pension scheme closures is for the government to encourage the introduction of risk-sharing schemes, claims the Association of Consulting Actuaries.
Speaking at the National Association of Pension Funds’ (NAPF) annual conference, Ian Farr, chairman of ACA, says despite a continued reduction in scheme deficits, many employers are unwilling to continue with pension arrangements which could potentially damage the financial performance of their core business.
However, in a presentation alongside Richard Mulcahy of Hewitt, ACA says the solution to the closure of defined benefit (DB) schemes is not the wholesale adoption of defined contribution (DC) schemes, as many employers want to do more while employees want a greater level of security.
Instead the actuaries argue the government needs to introduce legislative changes as part of its pension reforms plans to encourage employers to adopt more shared risk schemes.
ACA says while many smaller employers are likely to only offer DC schemes in the future, it says research from its 2007 Pension Trends Survey ( due to be published next week) reveals 72% of the responding employers favour government pension policy. This promotes risk sharing schemes rather than policies which place 100% investment and longevity risk on to members through DC schemes.
Farr argues: “Risk sharing schemes can offer the ‘safety valve’ to provide the degree of cost and benefit predictability that employers need, while providing members with a more stable pension than DC.”
Both Farr and Mulcahy claim the Government’s Deregulatory Review provides an opportunity to implement the legal changes necessary to encourage these schemes. At the moment developments are restricted as most schemes have to be set up under the DB pension regime, which limits the flexibility needed, while the regime is increasingly only regulating closed schemes.
Mulcahy says risk sharing would allow employers to control contributions, better control their potential section 75 debt and could lead to lower Pension Protection Fund (PPF) levies and more flexible pension accounting rules.
Outlining how shared risk schemes might look in the future, the presenters revealed typical features could include the employer determining the accrual rate based on pay in the year. The expected cost of accrual would include a targeted rate of increase both pre and post-retirement and past service benefits of these new schemes could be cut back if life expectancy increases, although there would be protection for those close to retirement
Mulcahy says: “If we get the legal reforms needed, then I would expect shared risk schemes will be used for future service benefits by many employers, with many of those considering closure of their final salary scheme to future accrual going the shared risk way, rather than jumping – as at present – straight to DC.”
In addition, he suggests in the future some employers may decide to upgrade their existing DC schemes to shared risk as the weaknesses of the DC approach start to unfold.
Farr adds: “This isn’t ‘pie in the sky’ – shared risk type schemes are prospering in the Netherlands, where occupational DC schemes are much less common as a result. And what’s the alternative – the managed decline of a once excellent and growing private pension system?”
“Our generation will never be forgiven by today's and future generations if we simply fiddle around while Rome burns. There are clear challenges to address that require bold and innovative solutions.”
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