Share the risk

Collective DC is back in vogue. All we need now is for the Government to approve it, says Gill Wadsworth

Just when it looked like pensions risk sharing was dead in the water the debate has been given the kiss of life from several quarters.

First John Hutton’s Public Sector Pensions Commission made clear its support for redistributing the burden of providing retirement income between employer, taxpayer and employee. Then, at the start of December, an industry report produced by the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) found collective defined contribution (DC) schemes to be the ultimate solution for the UK’s future pension provision (see box).

The coalition government has been credited with much of this new flourishing of interest, after the previous Labour DWP incumbent failed to grasp the nettle during its rolling deregulatory review. Since coming to power the Conservative and Liberal Democrat administration has made clear its desire to overhaul the pensions system, placing innovative workplace solutions at the heart of the new regime.

James Walsh, policy adviser for workplace pensions at the National Association of Pension Funds (NAPF), says: “The debate about risk sharing has been given a moderate boost by the new government taking a different approach. It is widely accepted in the pensions industry that the deregulatory review hadn’t achieved a great deal and had run into the sand.”

Walsh adds: “The door is certainly open in Whitehall for proposals to take risk sharing forwards. There is a long way to go from that goodwill to making something happen, but I think there is an opportunity.”

This renewed stance will be critical to driving the risk sharing agenda since it is the complex and cumbersome legislation that is largely blamed for the relatively few hybrid schemes currently in existence. At the last count in the NAPF 2009 survey, just 8 per cent of employers had adopted some sort of risk sharing arrangement.

A key motivation for dropping defined benefit (DB) provision in favour of an alternative arrangement is getting away from onerous regulations, yet moving to a risk sharing scheme would not release employers from any legislative burden since any remaining DB element would still be subject to the existing regulatory regime.

Walsh says: “If a scheme is part-DB it still gets hit with the full panoply of DB regulations. In fact it can be worse since you also incur the DC regulations, leaving you with a more complex regulatory regime than you had before.”

Consequently the NAPF along with other industry stakeholders have called for government to review existing legislation and consider how policy can be amended to make risk sharing more palatable and easier to implement.

A recent report from Ignis Asset Management concludes: “The government should launch a review of existing legislation and regulations which may prohibit the growth of risk sharing in pension schemes. There may well be scope to support DB and risk sharing arrangements through changes in policy.”

In response, the Department for Work and Pensions tells Corporate Adviser that it has been in discussion with industry bodies and employers to “discuss how risk sharing could be made easier and how obstacles could be removed”.

The spokeswoman adds: “Some representatives would like to be able to risk share on accrued rights but that is not possible under current legislation. However new scheme designs introduced from a certain point for future accruals only (for example longevity adjusted DB) can provide a useful risk sharing model.”

While legislation is undoubtedly burdensome and even hinders the take up of certain hybrid schemes, the current regulatory regime does not prohibit or make impossible risk sharing in its entirety. Consequently there remain other obstacles to take up, the most obvious of which is the employer’s retention of some financial responsibility.

In a survey of employers conducted by Ignis in October, the asset manager found that employers view hybrid schemes in a negative light and they are unwilling to move to risk sharing when there is the opportunity to simply pass the financial burden to employees.

One pensions administrator at a construction firm, who was responding to the Ignis survey, said: “Hybrid schemes are pretty laudable from an employee point of view but they’re a non-starter because they still pose a financial risk of some kind.”

A second administrator added: “The direction of travel is very much towards the DC system. Employers are disillusioned with the risks of the costs and legislative burden of DB schemes.”

Walsh says ‘soft barriers’, such as additional communication and education programmes, also make it difficult for employers to implement the existing hybrid schemes.

“Soft barriers include concerns that it might be difficult to change the scheme in the future or that the complexity [of a hybrid scheme] makes it difficult to explain and communicate to the employees and members,” he says.

To help break down some of these barriers the key is developing solutions that are easier to communicate to a workforce and which don’t involve layers of additional cost either for the individual or the employer. There are numerous hybrid solutions available – Ignis identifies 10 in its October report ranging from career-average to collective DC and fixed final salary arrangements – yet all these require much more explanation to staff and commitment from companies than a bog standard DC plan.

Walsh says: “One of our top priorities is to help the government implement their pledge to reinvigorate workplace pensions and that really means finding new models for workplace pensions that will be straightforward and practical for employers to implement and that will be attractive to employees.”

For organisations such as the NAPF, finding suitable alternatives that work on a risk sharing basis without the complexity is a top priority yet they need support from advisers and providers if this is to be a success. The RSA report found that just 50 per cent of individuals in the UK save into a private pension, deterred by complexity and cost, which suggests a huge untapped market crying out for both products and advice to help them save adequately for retirement.

Now is the time for the industry to take advantage of a receptive government and propose solutions that might work not only for the private sector but also the beleaguered public sector, too.

The DWP spokesman says: “Government is always willing to hear ideas from industry, employers, trustees or unions on new scheme design. We would want real evidence that changes would help defined benefit schemes to stay open.”

The case for collective DC

After two years of research David Pitt- Watson, chair of Hermes Focus Asset Management, penned a report for the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) proposing collective DC schemes as the future for workplace pension provision in the UK. 

Pitt-Watson argues that savers in the UK are unaware of just how costly pension saving is – claiming 38 per cent of funds are eaten up by fees – and points to the collective models in the Netherlands which leave Dutch savers 50 per cent better off than their British counterparts.

  Pitt-Watson states: “The current architecture of pension provision is deeply flawed and very expensive. Estimates vary, but it is our belief that for no additional cost, pension outcomes could be improved by 50 per cent or more, compared to a typical DC pension which might be offered today.” 

The answer lies in collective DC schemes, according to Pitt-Watson, something for which he has ‘broad consensus’ and irrespective of the previous government’s dismissals to these types of arrangement as to legislatively complex, he argues that they can be set up with relatively little regulatory change. 

Pitt-Watson says individual DC products are flawed in terms of cost, returns and product design and that by moving to a collective arrangement not only are fees much lower but governance is improved and returns are less volatile. And it appears the Government Actuary’s Department agrees, reporting that a collective arrangement can yield as much as 39 per cent more than an individual DC plan.


The RSA has broached the proposals with the industry across Europe in a bid to find providers able to offer such collective arrangements and reveals Dutch pension giant APG as keen to assist on collective arrangements in the UK as is the Danish provider ATP. 

He says players in the UK are less willing to step up to the mark but, at the same time, claims they are more than capable of providing the suitable architecture for collective schemes and dismisses suggestions that they are resistant to change because it undermines their existing business models. 

He adds: “We believe that, given the right architecture, UK pension providers will rise to the challenge.”

  The RSA proposals should make happy reading for the government since they advocate auto-enrolment and a product design not dissimilar to that of the National Employment Savings Trust. 

However, Pitt-Watson argues that Nest’s contribution limits means savers need alternative options and completion outside the government’s offering. 

The RSA has sent its report along with an open letter to pensions minister Steve Webb inviting him to meet with stakeholders and the Dutch and Danish providers. Whether this amounts to anything remains to be seen but the case for collective DC schemes is undoubtedly back on the table.