At present pension schemes can be broadly divided into two types:
Defined Benefit (DB) Schemes which typically offer a retirement income, or a specific level of pension savings, based on a formula related to an employee’s salary and/or the length of service in the scheme. The classic example is the occupational scheme that offers 1/60th final pensionable salary for each year of service.
Defined Contribution (DC) Schemes which are more akin to savings plans. A DC schemes builds up a fund from invested contributions that are converted to a pension at retirement. Personal pensions and the government’s default auto-enrolment scheme, NEST, are both DC arrangements.
DB schemes place inflation and investment risks solely with the employer and, as a consequence, have been disappearing from the private sector for some years – the latest report from the Pensions Regulator says less than one in seven private sector DB schemes still accept new members. In DC schemes, the risks are all left to the individual member, which can have unwelcome consequences if poor investment conditions coincide with their retirement date.
The government, and in particular Steve Webb the Pensions Minister, have been struggling to find some form of compromise between DB and DC. The result, now put out for consultation by the DWP is DA – defined ambition. To quote the paper, “A DA scheme would be a scheme under which members are given some form of guarantee in respect of their pension, but not complete certainty of the level of income that they will receive from it in retirement, or when it would be paid.” For example, it is suggested that an occupational scheme could offer a guaranteed level pension, but leave any inflation-proofing as a discretionary benefit, to be reviewed each year. Similarly a scheme could promise a particular rate of pension accrual, but reserve the right to change the retirement age to reflect rising longevity.
The paper has only a brief consultation period of six weeks, with draft legislation promised in the New Year. How much interest employers and pension providers will take in developing DA remains to be seen, particularly with all the other developments going on in the pension area. For now, the prospect of DA will probably do little to stop the move to away from DB to DC.