Robin Hames explains how cash balance already has many of the benefits defined ambition is trying to achieve
There is a famous tale of how Nasa spent millions developing a ballpoint pen to work in zero gravity while the Soviets simply gave their cosmonauts pencils: the desire to create something new and exciting meant that prosaic existing solutions were overlooked.
Similarly there seems a danger that in its desire to create defined ambition, the DWP focuses on developing new concepts rather than considering how to make existing ones more attractive and workable for employers and trustees.
A case in point is the cash balance scheme. Cash balance schemes can be structured in a number of ways, but usually involve the employer guaranteeing a pot of money with the employee deciding how to apply it at retirement. Risk is shared, the ambition within defined ambition.
A criticism levelled at cash balance scheme is that they may not necessarily provide a better outcome for younger members, when compared to a pure DC model. In other words, the guarantee may be too low particularly if investment returns are good over the long term or if real wage inflation returns.
For many this may be an acceptable trade-off. There is now a body of evidence from behavioural finance that suggests most people are fundamentally loss averse and this influence can be increasingly seen in the design of some DC default structures. Many would accept a guaranteed positive return even in the knowledge that greater returns could be achieved through greater risk.
However if this is not seen to be acceptable, the flexibility of cash balance scheme design can seek to improve the lot of members further. For example, the way of crediting accounts can vary by age, by job status or according to the level of contributions paid by the member.
Indeed the increase rate applied could have both an underpin and a link to the investment performance of the underlying assets. While this means that the employer may lose the windfall of investment outperformance, but it may be seen as a fairer way of allocating the risks and rewards.
One wrinkle is that cash balance schemes are DC from an HMRC perspective but DB from the DWP’s viewpoint; DC for allowance purposes but subject to DB funding rules generally, covered by the PPF and subject to DWP requirements such as disclosure, preservation, revaluation, transfer values, MNTs, debt on the employer and equal treatment.
This mix and match of treatment does afford greater protection for the member and in an employer-related twist does mean that early leaver refunds should still be available when the scheduled DWP reform of DC refunds is actually introduced.
The issue of age discrimination has been raised more than once in connection with cash balance schemes. Cash balance schemes are more prevalent in the United States, and age discrimination was an issue under US law. However, cash balance was ultimately held to be non-discriminatory in the US. The DWP has also confirmed that the structure of a cash balance plan can easily fall within an exemption from our own age discrimination legislation.
Conclusion
Cash balance takes away the investment risk, together with the difficulty of making investment decisions, from the members. And cash balance takes away increasing longevity risk from the employer.
The concerns expressed, particularly by a number of the Trade Union bodies, for younger members can be addressed by teasing out the best combination of options from the flexibility already afforded under cash balance.
The trick is to ensure that scheme design does indeed create a better chance of producing better member outcomes than the pure DC model. Well-known household names have already adopted cash balance – Morrisons, Daily Mail and General Trust, Barclays – so it does seem a missed opportunity not to include this existing alternative more prominently in the defined ambition debate.
Robin Hames is head of marketing and research, Capita Employee Benefits
