Pensions industry: crumbs of comfort

Roger Mattingly, chairman of the PR Committee at the SPC, says that there are many hurdles ahead for the pensions industry, but urges it to remain optimistic

One of the key determinants for predicting the future of pensions in the UK is having an understanding of how the UK pensions landscape currently fits in with shifting demographics, a economical world order and financial markets.

It is also crucial to have some sort of grasp of the likely shape of the future workplace which will be moulded by a combination of employer and employee requirements and aspirations.

It doesn’t take a seasoned pensions industry expert to latch on to the fact that defined benefits pension provision is waning and, in the main, has been replaced, rightly or wrongly, with defined contribution.

One of the main reasons for this migration from one end of the spectrum to the other has been a lack of a 'safety valve' middle option post the dotcom bubble.

But we are where we are and defined contribution is on the up, in particular contract-based clearly overtaking trust-based which, in the early days, was a popular option – as it meant just adding a new category to the existing DB scheme.

The contract-based DC scheme could, of course, be replaced by the mother of all DC schemes – Personal Accounts – especially if the Personal Accounts Delivery Authority (PADA) project structuring goes to plan and the intricate qualifying earnings rules don’t throw the whole post 2012 reality into a bureaucratic maelstrom.

At the same time as DC develops, the withering-on-the-vine DB continues to dominate in terms of funds under management and represents an attractive prospect to the burgeoning buy-out market.

The approximately £3bn worth of pension assets bought out through various new buy-out market participants – predominantly Paternoster and Legal & General – could well be the tip of the iceberg especially if the risk-free rate of return Accounting Standards Board proposal and the long cohort Pension Regulator trigger come to fruition.

Best estimates in the short term are probably of £50-£60bn moving back into insurance contracts from the self administered pension environment over the next three years.

This completes the cycle of insured arrangements to self administered and back to insured arrangements over the last 30 or 40 years. Having said that, £50bn would represent less than 5 per cent of the total UK DB pension liabilities and it may not be until seven to ten years' time that the exponential part of the buy-out market growth phase kicks in especially when economic interest disappears – when active membership becomes deferred and pensioner membership.

At this point in the DB life-cycle the company perception is one of pure financial baggage and any chance to off-load the risk, in particular the longevity risk, will be just too tempting.

Importantly, it is for the industry and the regulators to ensure that the buyout market is not distorted by avarice and that transparency of assets, risks and liabilities remains throughout.

So where does this leave the UK working population’s expectations?

What is easy to forget is that the issues relating to DB schemes in respect of stock market volatility and increasing life expectancy all apply to DC arrangements – the only difference being that the risk is in different hands .

What these factors do create is a much greater shock factor especially when the converted pension is compared with the often attractive fund value that precedes it. The attraction of that fund value is, of course, relative and will only really be attractive both in pre and post retirement quantum if overall savings levels become ‘more adequate’.

Auto-enrolment may be part of the answer but there is a need for more creativity and empathy right the way through the pre-retirement generations. For example, providing some sort of cash outlets along the way in emergencies would make parting with the money in the first place less daunting. It is also imperative that employee moral hazard is avoided in respect of 2012 and beyond, and avoiding the 'pension sorted' mentality when actually the amounts, while welcome additions, can hardly be described as hugely valuable pensions in their own right, especially in the early days.

The danger is that once the non-pensioned are pensioned, the reserve in respect of their other finances will be severely in jeopardy. Past experiences where compulsion or auto-enrolment have been introduced have, in some cases, resulted in a reduction in overall savings because of this 'phenomena'.

So apart from expanding buy-out markets, a wilting DB environment, an increasing DC environment what else is going to change? Well, what is going to change is the need, both in terms of the time horizon and in terms of the flexibility, to accommodate the future changing work/life patterns.

Whether these expectations and aspirations will be met is of course debatable, but the human race never fails to amaze; where there’s a will there’s a way and, while the future of pensions has been rosier, there are certainly one or two crumbs of comfort.

- Pensions Age April 2008