The Department for Work and Pensions (DWP) has published its long-awaited defined ambition (DA) paper, setting out three proposals for new structures for schemes, including a 'flexible' defined benefit (DB) model which would see the removal of indexation requirements.
After a year of consultation with the industry, the DWP has proposed ‘flexible defined benefit' (DB), guaranteed defined contribution (DC), and collective DC options.
The DWP said the end of contracting out brought on by the introduction of the single tier state pension provided an opportunity to simplify DB administration.
In its flexible DB model, the DWP proposes to remove, for future accruals only, the statutory requirements for the indexation of pensions in payment.
"Indexation would no longer be compulsory, enabling employers to provide a slimmed-down, reformed DB scheme," the DWP said.
"This would enable a new form of risk sharing, with the employer continuing to bear the risks associated with providing the new, simplified DB pension promise, while in future the member would bear the risks arising from future inflation.
"This would create a more affordable, simplified statutory DB framework on which employers could then choose additional design features to meet their individual requirements so that their pension arrangements, while continuing to include a DB element, are tailored and flexible for their own circumstances."
The DWP proposed four models for guaranteed DC.
It proposed a money-back guarantee, which would ensure members' money, when transferred, never falls below the nominal value of their contributions, to be provided by the market or a government or arm's length body similar to the Pension Protection Fund (PPF).
The DWP also proposed a capital and investment return guarantee, which would be purchased by a fiduciary on behalf of multiple scheme members in order to reduce cost to the scheme. This would be market-based and would require industry standardisation.
The DWP proposed two forms of retirement income insurance, to kick in during the run-up to decumulation. In one model, a fiduciary would use a portion of members' funds every year from age 50 to buy income insurance products. At retirement, the saver draws their pension directly from their fund and only if their fund is reduced to zero does the income guarantee insurance kick-in.
In its second retirement income insurance proposal, the DWP suggested a model where contributions are used for two different purposes. A proportion is used to purchase a deferred nominal annuity, payable from the current pension age. For every year of contributions each individual has a pension made up of a series of these deferred annuities. Thus the individual can see their pension income increasing over time.
The residual proportion of contributions is invested into a collective pool of risk-seeking assets along with the residual proportions of other scheme members.
This could be done on a single collective basis or among smaller cohorts (although these do need to be large enough to allow for enough variation in investment experiences among members such that there is potential for smoothing). This pool is used to provide future indexation on a conditional basis, with rights adjusted by way of bonus allowances based on the financial status of the scheme.
The DWP also proposed collective DC products, based on various structures from the Netherlands. Rather than setting out a single, prescriptive structure, the DWP listed elements good collective DC products could involve including fixed employer contributions, pooled scheme assets, good use of scale, target pension incomes, and intergenerational risk sharing.
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