A Midway in pensions

The midway in pensions must be affordable, risk efficient, fair and practical.  Companies are unwilling to shoulder high levels of risk and at the same time individuals are being forced to bear large retirement risks, which many struggle to understand and find themselves exposed.

The Midway Model reduces company risk whilst providing individuals with security in retirement.  It offers a minimum secure pension and a higher risk top-up pension.

Key features of the Midway Model are:

• Fixed cost, split between members and company
• The majority of the cost finances the minimum pension, with the cost varying by age of member
• The balance of the cost finances the top-up pension

Key features of the minimum pension are to provide:

• Minimum guaranteed pension accrual rate (say 100^th)
• Corresponding assets invested in low risk inflation linked securities of appropriate duration
• Retirement age is defined by reference to life expectancy, which is fixed approximately ten years prior to retirement for cohorts of members. Members have full flexibility to draw benefits earlier or later, subject to pre-defined adjustments
• Future benefits may be amended to maintain the stable cost

On top of the minimum pensions, additional contributions would be paid into a higher risk top-up pension:

• Contributions are invested in diversified growth assets
• At retirement, the fund is converted into additional benefits at prevailing rates
• The amount of additional pension is not known until retirement
• As an alternative, some or all of the fund can be "fixed" at any time, by converting the assets into a defined benefit

The balance of the two provides a reasonable level of retirement income with a safety net.  For example, total contributions of 24% (16% company and 8% member) would be expected to deliver a fully inflation-proofed benefit of 1/80^th accrual based on 7% equity returns from a pension age of 67.

Advantages

In addition to reducing risk for members and employers, this benefit structure has several advantages:

• It allows members to retire on a safety net income whilst also benefiting from favourable performance should they chose to take that risk.
• Employer costs are set at an affordable level whilst still providing a valuable benefit to members.
• Investment risk is reduced by using low risk inflation linked securities for the guaranteed part of the benefit and by focussing on affordability for the growth part of the benefit.
• Mortality risk is reduced through the pre-determined nature of the retirement age. This provides long term protection to company, but shorter term certainty for both member and company (to plan for retirement).
• The benefit is targeted to members, because there can be total flexibility around the form of benefits taken including the retirement age.
• It is a form of risk sharing, which increases the partnership and unified perspective between the company and employees.
• Awareness and understanding of key pensions issues for employees are promoted and the fundamental trade-off between risk and reward is clarified.

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