Pension provision relies on cross subsidies from the working generation to pensioners. Normally this cross subsidy has seemed bearable, but during financial downturns the costs imposed become harder to justify. Since 2006, new deficits have emerged in defined benefit (DB) schemes, whilst the new funding regime has restricted employers' ability to balance the interests of employees and pension scheme members. The current market turmoil highlights the need to achieve a reasonable balance between the interests of the groups involved in their financing, to enable sustainable pension provision over the long term.
The strong regulatory protection afforded to DB pension schemes particularly applies to pensions in payment, whose security is prioritised relative to non-pensioner members' accrued benefits. Effectively, the government has made the employment contract provided to previous generations of worker more secure than was originally intended, at the cost of current employees.
Sustained DB pension provision requires a better balance of risk between generations. Normally, accrued benefits can only be reduced following company insolvency, when a scheme can pass to the Pension Protection Fund (PPF). A more proportionate regime would enable trustees and employers to agree to temporary or permanent reductions in benefit, if there were no immediate risk of insolvency, but employment is threatened instead.
For example, when funding falls and certain other company financial measures fall below certain agreed levels, trustees and employers could be given the ability to reduce revaluation rates on certain benefits, including pensions in payment. Although this appears to introduce new forms of moral hazard, trustee duties and the existing scheme funding regime should be sufficient to mitigate these risks.
This would work best in a scheme established on a career average basis (so with no automatic revaluation in deferment or pension increases provided in the rules). Revaluation and increases would be provided on a discretionary basis, only if the scheme's funding level permitted it. The trustees would decide, in consultation with the employer, whether to target a particular rate of revaluation in the funding valuation and members would be provided with information to help them understand the likelihood of increases being paid.
If the funding level met an agreed target level, then revaluation/increases would be granted. However, if funding fell below a lower threshold, when the sponsoring employer's covenant was also temporarily weak, it would be possible for the trustees to withdraw increases or revaluation already granted. Once the scheme's funding level and the employer's covenant had recovered, the trustees could recommence providing increases and revaluation, with priority given to restoring any benefit reductions.
When pension schemes enter the PPF, accrued benefits are cut back and their financing risk is passed to PPF levy payers - other employers who are continuing to sponsor their own defined benefit pension schemes. It seems perverse that TPR, via the PPF, can pass pension scheme liabilities on to continuing employers when there is a possibility that the original employer could continue to support the scheme, albeit at a lower level.
Deborah Cooper, head of Mercer's retirement resource group
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