Proposals put forward in a consultation paper on the rolling deregulatory review of defined benefit pensions could see pensioners income fall by around 30% in the next 10 years, warns Standard Life.
The initial 47-page document published by former pensions manager at Unilever Chris Lewin and joint deputy general secretary of Amicus Ed Sweeney - the two external reviewers appointed to the review board in December - outlines “some options for possible changes in the DWP’s regulatory framework for occupational pensions”.
In the regulatory consultation which closes on 6 April 2007, Lewin and Sweeney outline proposals put forward by the industry in the initial consultation stage, the main idea being to adjust the regulatory framework to allow for the creation of more risk-sharing schemes.
However, Standard Life warns the three main proposals put forward by the consultation may save employers money, albeit at a cost to members as removing LPI and the revaluation of deferred pensions could reduce pensioner’s income by around 30% within 10 years.
LPI has been mandatory for all private sector DB rights built up since 6 April 1997, and between 1997 and 2005 LPI meant pensions in payment had to increase at the lesser of 5% and Retail Price Index (RPI), and since 6 April 2005, the lesser of 2.5% and the RPI.
Standard Life recognises removing this requirement would give substantial savings to schemes.
However, the consultation document itself points out a member retiring in 2020 on an average salary, after 30 years of pensionable service in a DB scheme with an accrual rate of 1/60ths, would receive just £31,410 annual income 20 years into retirement, if LPI is scrapped after 2008, compared to £37,740 under the current rules.
In addition, Standard Life argues if the review decided to implement the changes to the revaluation of deferred pensions, members would receive less protection against increases in inflation.
Andrew Tully, marketing technical manager at Standard Life, says if these changes go ahead, people are set to see pension benefits built up eaten away by inflation, as reducing the pre-retirement revaluation rate for these benefits to a maximum of 2.5% will see deferred benefits slashed in real terms, particularly if inflation continues at current levels or higher.
He suggests, for example, if someone left their company in their mid-40s, and inflation was 4% by the time they reach 65 their benefits will have reduced by 25% in today's money terms.
He adds: "Similarly, scrapping the need to increase pensions in payment will have a major impact, especially given increasing mortality. If inflation stays at its current level - around 4% - the purchasing power of pensions could fall 30% in the next 10 years. This is a big issue for those approaching retirement as many people can now live 30 years after they stop work."
The regulatory consultation suggests employers sponsoring defined benefit (DB) should be offered more flexibility over the management of future liabilities and the paper suggests three areas, in particular, where restrictions could be relaxed:
- Employers could be allowed to change the normal pension age;
- Limited price indexation (LPI) for pensions in payment could be scrapped from 2008, and
- Revaluation of deferred pensions could see increases limited to a maximum of 2.5%.
Although the paper suggests the changes could apply to future accruals of existing members as well as new entrants, the two reviewers confirm they do not necessarily agree with some ideas put forward to change the value of existing benefits which have accrued.
As it says this would be necessary to make the proposals attractive to employers, the reviewers point out “we are very reluctant to go so far, but include these suggestions for completeness and in the interest of full discussion of the issues”.
The consultation also suggests at least part of the regulatory framework should be shifted over time to a more light touch, principle-based approach, while it also proposes easing the requirements upon trustees, and analysing in more depth the affect of more technical issues such as the arrangements on surplus, employer debt and Financial reporting Standard 17 (FRS17).
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7034 2681 or email [email protected]IFAonline
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