The UK has approximately 6,200 defined benefit schemes in operation, serving around 11 million people. Sally Turner hears from Lesley Titcomb, CEO of the Pensions Regulator, about how companies can implement a successful defined benefits scheme, whereby members receive a level of benefit determined by the length of service and salary.
The latest Golden Age Index estimates that at least 50% of children born in developed countries today will live to the age of 100. This would require people to work and save until they are 80 to achieve the equivalent levels of retirement income of those available today.
Given the current state pension is set at £155.59 a week for those paying the necessary national insurance contributions, an additional income at retirement is essential to meet rising living costs. Yet a major survey of the UK’s personal finances published last year by the Financial Conduct Authority revealed that 33% of men and 53% of women have no private pension plan and will have to rely solely on the state. When asked why they had made no provision, 32% believed they had left it too late to set up a plan, 26% said they could not afford to make contributions and 12% were relying on their partner’s pension.
This scenario is a challenging prospect for employers, who must improve employee engagement with retirement planning and reassess former pension models that were based on a clearly defined career path and a fixed retirement age of 60–65. How can a company thrive and grow, given the financial rigours of the market, while still delivering on its pension promises? Issues surrounding provisions – defined benefits schemes, defined contributions schemes, master trusts and, crucially, auto-enrolment – are now at the forefront of business strategy, across all sectors.
With such a dynamic shift happening in the industry, the Pensions Regulator has a lot to contend with in terms of balancing the needs of employers and employees. Unsurprisingly, it has a wide remit.
“We work to ensure trustees and employers meet their funding obligations to defined benefit schemes, but we also regulate defined contribution schemes in the workplace,” explains CEO Lesley Titcomb. “We authorise master trusts that more employers are taking up, ensure that public sector schemes are well run and make sure employers meet their obligations under the automatic enrolment requirement, to enrol their employees into a pension scheme.”
Risk and reward
A defined benefit plan is based on employer (and often employee) contributions and promises a set pay-out at retirement, regardless of investment performance, because the employer has to address any deficit. Whereas a defined contribution plan requires employees to make their own contributions; employees have to bear the investment risk and thus the level of benefits is not guaranteed.
Because defined benefit plans are costlier for employers, many have downsized their schemes or ditched them altogether. In recent years, declining interest rates have had a dramatic input on the investment return, and low tolerance of risk by the regulatory authorities has been another influencing factor.
“Plus, people are living longer, meaning the cost of providing a defined benefits pension has increased,” says Titcomb. “This is why so many employers have decided to close their defined benefit schemes to new members or not run one at all, because the cost of providing direct benefits was so huge.”
Regardless of the type of plan, funds are invested in the global markets and the final benefits for members of defined contribution schemes will depend on the fluctuations of the stock market. In 2014, the Pensions Regulator provided a revised code of conduct for defined benefit schemes that is an important practical tool to help trustees and employers comply with legislative funding requirements.
“The white paper that the government has just published looks further at defined benefits schemes, and it’s likely to involve us consulting further on changes to the code,” says Titcomb. “Companies still running defined benefits schemes must ensure they are properly funded moving forward and are likely to be able to meet the future standards and expectations of their board.”
The challenge of auto-enrolment
It has been six years since the government introduced its autoenrolment scheme to persuade more people to invest in their pension provisions. Initially aimed at major corporations, the scheme has now been rolled out to almost one million employers in the UK, from start-ups to big business, with approximately 9.3 million employees now paying into workplace pension schemes. In 2012, the minimum level of contribution by employees and employers was set at 2% each. This year, the rate has risen to 3% of salary from employees, with employers expected to contribute a further 2%. Next year, auto-enrolment contributions are set to rise again to a combined total of 8%.
But given rising debt, is Titcomb confident about convincing people to reach into their pay packets for increased retirement provision? “Pensions are a complex business, and it’s been particularly hard to get young people to save,” she admits. “But I recognise that automatic enrolment will be challenging for some; that’s why the public policy has recognised that people need to be able to opt out, if that is the right thing for them to do.”
She is firmly convinced, though, of the value of saving regularly, even in times of financial instability and restraint. “Just in terms of compound interest, if you start small early in life then that can stack up into a really healthy saving. We’ve tried to make the pensions journey as easy as possible for employers and I hope people will see that auto-enrolment is starting reasonably gently,” she says.
Titcomb is keen that the challenges of employee engagement are recognised. “You then need to engage with them about how their pension and savings are performing,” she says. “And the choices they are going to have to make in later life about whether, for example, they want to access their pension when they’re 55. Because we’re still in the early days of auto-enrolment, we’re still seeing some of the challenges to come in that regard.”
Optimising work-based pension schemes
Maintaining the viability of a pension scheme through changing times is crucial. With this goal in mind, one of the Pension Regulator’s key objectives is to improve governance and administration. “We encourage employers to get good pension advisers and to give trustees the time, resources and training they need to do the job properly,” says Titcomb. “In turn, we support the trustees, who are the first line of defence for members of the scheme, by offering our Trustee toolkits and a huge amount of guidance and support.”
CEOs can also ensure that they have a robust pension scheme in place by making sure investment risks are being appropriately managed and, for defined benefit schemes, working with the trustees at the required threeyear valuation point to address any deficit. As a pension is a hugely valuable part of an individual’s remuneration package, Titcomb also recommends that employers engage with employees at regular intervals on how the scheme is performing.
“The best support for a defined benefit scheme is a profitable employer, so we absolutely recognise that employers are going to have to strike a balance in the funding of their scheme against all the other demands on their money,” she explains. “If they want to remain profitable, they can’t completely stop paying dividends or investing in their business, but what we are keen to ensure is that the pension scheme is treated fairly, so if there is a deficit, then some of the available money goes towards addressing that deficit.”
Pensions administration can be a time-consuming and expensive business for employers, particularly smaller businesses, which is why many are now choosing to use master trusts, multiemployer occupational schemes where each business has its own division within the master arrangement.
A major challenge for employers in managing pension schemes is addressing the changing needs of employees of all ages. For companies still running occupational schemes, it is crucial to optimise draw-down options to provide freedom of choice in how and when a pension is accessed.
“In terms of the ageing workforce, the benefits may be constrained by how much they can put into their pension, so in some cases they’ll want to continue to work,” says Titcomb. “So you’re looking at imaginative solutions, like cash alternatives for people who have put in as much as they can. People aged 55-plus can get access to their pension in ways they couldn’t have before and are then able to make choices about how they invest in that pension.”
At the other end of the spectrum, engaging millennials with the subject is also a challenge. According to the Resolution Foundation, which offers analysis and action on living standards, it will take a millennial an average of 19 years to save a deposit to own their own home, compared with three years in the 1980s. So persuading them to contribute additional funds for future retirement is a big ask.
“If you think about the average millennial having 11 jobs in their lifetime, you want to get them saving as early as possible,” says Titcomb. “You see some fantastic work going on among employers in terms of communicating the benefits of saving for later life. It is important to enrol them anyway and only offer the opportunity to opt out if they really want to do so.”
Titcomb also points out that with this new generation of employees changing jobs more frequently, it may prove difficult to keep track of the number of pension pots they amass. Engaging the workforce about their finances and pension choices may indeed prove the toughest challenge yet for employers in terms of retirement reform. A 2014 S&P Global Financial Literacy Survey of more than 140 participating countries revealed that in 83% of cases, less than half of the adult population was found to be financially literate. Whatever pension reforms governments and employers choose to adopt, educating and empowering the workforce will be crucial to sustaining long-term success.