There are three strands to our submission, which is essentially in favour of risk sharing between employers and employees:
- Scheme Basis - ‘cash benefit'
- Scheme Benefits - ‘living benefit structure'
- A future campaign - ‘DC risk sharing'
Cash Benefit
A cash benefit scheme can operate like a final salary or career average scheme, but with benefits expressed as a cash fund at retirement. It is a proper risk sharing vehicle and can have a high-perceived value with employees, as well as being more affordable and sustainable for employers.
There is considerable logic in this form of risksharing with, broadly speaking, the employer carrying the risk pre-retirement, and the employee dealing with it post-retirement. In addition to more certainty, cash benefit also provides members with flexibility to set up pension which will fit with their particular circumstances. The design would operate better if the law on pensions indexation (LPI) were changed.
Currently, LPI is required for cash benefit but not money purchase schemes - yet, at the point of ‘decumulation', they are essentially the same.
‘Living Benefit Structure' (LBS)
If longevity risk is to remain with the employer, LBS could make DB more affordable and sustainable. Under LBS, employee contribution rates, retirement ages and/or benefits are adjusted to reflect changes in longevity.
The design operates like a conventional final salary or career average arrangement, except that an additional element - the Change in Life Expectancy Factor (CLEF) - is written into the benefit formula.
A LBS formula could be:
1.5% X Final Pensionable Pay X Pensionable Service X "CLEF"
CLEF is a ratio like:
Age x life expectancy at the date the LBS is introduced
Age x life expectancy at the date the member retires
Example
On 1 January 2008, a scheme introduces LBS for future service. A member retires 10 yearslater and his benefit will be 15% of FPS x CLEF. If life expectancy has increased by 10% between 2008 and 2018, the effect of CLEF is to reduce the amount of pension by 10%.
The groundbreaking aspect of this design is that the whole of the benefit attributable to post-2008 service is adjusted in 2018 to reflect increasing longevity in the interim. Once the pension is in payment, there is no further adjustment. (The member is bearing the risk in respect of pre-retirement improvements in post-retirement mortality. The employer is bearing the risk for post retirement improvements).
DC Risk Sharing
The reality is that the main form of pension provision, at least in the private sector, is going to be DC. Therefore, the real challenge is risk sharing in a DC context - utilising the desirable features of DB to give employees more certainty without re-introducing cost volatility for sponsors. Watch this space.
