Defined contribution pensions: An update

Personal accounts and a consultation exercise by the Pensions Regulator are set to influence the future look of DC schemes

Defined contribution (DC) pension schemes are going under the knife. A huge transformation is set to take place in the pensions market, with government proposals for a new low-cost national pensions savings scheme of personal accounts and a consultation exercise on DC pensions being carried out by the Pensions Regulator. These are likely to influence the way that DC schemes look in the future.

The proposed system of personal accounts is due to spring into life in 2012 and force all employers to automatically enrol staff above the age of 22 years into a pension scheme, whether that is in the system of personal accounts or an existing occupational scheme.

If staff are to be enrolled into the employer’s existing DC scheme, then it is expected that the contribution rates will have to at least meet those for personal accounts. By 2015, these will stand at 4% for employees and 3% for employers.

But there are concerns that employers that currently provide DC schemes with contribution rates above the proposed minimum standard adopted for personal accounts may see this as an opportunity to reduce them. Some employers may take the view that this is necessary to counter the effects of increased take up through auto-enrolment.

While some organisations offering generous DC schemes may currently obtain take-up rates of around 40%, for example, come 2012, this could potentially leap to 100% if no employees decide to later opt out.

Emma Douglas, head of DC pension schemes at Threadneedle Asset Management, explains: “Potentially, the danger is that the [personal accounts] cannibalise the existing market of employers with generous schemes.”

If employers do decide to level down contribution rates to existing DC schemes, such as stakeholder or group personal pension plans, then this will make the benefit less attractive when it comes to recruitment, retention and motivation of staff.

Some smaller employers may well remove at least one DC scheme altogether, as the administrative burden of running several schemes may be too much, says Damian Moorish, principal, employee benefits at Punter Southall Financial Management.

“The problem is that if a company has closed its final salary scheme, replaced it with a stakeholder scheme, and then introduces [personal accounts] in 2012, they will be operating three pension schemes. The danger is that the stakeholder will lose out,” he explains.

Others agree that the workload involved in administering and managing a DC scheme may prove enough to warrant getting rid of it altogether. Mark Polson, head of corporate business at Scottish Life, explains: “A bunch of employers will say ‘we don’t have huge take-up rates anyway so we may as well just go with the government scheme’.”

The fund management charges associated with DC schemes could also end up changing to compete with personal accounts. The charging structure for personal accounts will start at 0.5% in 2012 and is targeted to fall to 0.3% by 2015. This is extremely competitive when compared to the current stakeholder charges which tend to range from 0.75% to 1%.

Steve Herbert, senior consultant at Truestone Employee Benefits, says: “The charge is key. It is good and it will bring the costs down of DC schemes.”

However, some DC providers and consultants believe that existing plans will be able to hold their own on costs going forward. Although the charges may appear higher, in many cases, employees, they say, get what they pay for. Although a 0.3% charge may seem appealing, stakeholder schemes provide fund advice and a multitude of fund options that the personal accounts will not offer.

“The problem with [personal accounts] is that members have nowhere to go for a chat for some advice from a consultant and, without this, they may not be able to make informed decisions around their pension scheme,” says Moorish.

Employers are also wondering just what a low charge of 0.3% will provide members of personal accounts. Jim Harwood, compensation and benefits manager at Benfield, says: “This is being run at a fantastically cheap rate as far as personal pension plans are concerned, for example, but obviously it raises questions about how money will be invested and what kind of investment manager you are going to get.”

What is more, due to auto-enrolment, staff will be forced to join either an existing occupational pension or the system of personal accounts in 2012 and some, unless they opt out, could on retirement end up with a very small pension pot and, due to means testing, miss out on receipt of state benefits such as housing allowances.

“This is clearly an issue, because if you have someone that is forced to enrol into a scheme at 55 [years old] and they have no other savings, they’ll end up with a very small money pot, and it will be offset against certain state benefits they were due,” says Herbert.

This could influence the design of occupational DC pensions going forward as staff are unlikely to remain in a scheme that effectively deters them from saving, therefore pushing opt-out figures up. “There does need to be some sort of thought process around this down the line, and it is possible, but now the advice would be don’t join [such] a scheme,” says Herbert.

But it is not only the forthcoming introduction of personal accounts that is currently shaping DC pensions. The Pensions Regulator is currently conducting a consultation exercise into DC pensions and has published the paper How the Pensions Regulator will regulate defined contribution schemes in relation to risk to members. It will announce its findings in May.

One specific issue highlighted in the report is the impact technology is having on employers and DC scheme members. It points out that organisations can use technology to help educate staff about schemes, and make DC schemes more user-friendly.

“Education around DC schemes is absolutely fundamental because the emphasis falls very much with the individual making decisions and choices,” says Herbert.

The paper also highlighted the fact that technology can make scheme administration easier, avoiding the need for employers and pensions providers to both input the same contribution data.

“Quite often, there was a mis-match of information and it cost time and money to get the insurance company’s amount to tally with the company’s total,” says Herbert.

Technology can therefore make the administration of DC schemes slicker and information about the plan and available investments easier to access. The next few years, therefore, promise to be a time of change for both employers and providers of DC schemes as they adapt to the new system of personal accounts and deal with any new regulations around scheme administration and financial education.

What’s happening to DC schemes?

The Pensions Regulator is encouraging employers and trustees to embrace new technology and to make way for more efficient DC schemes. Some employers are already taking advantage of technology that allows members to move their own funds around online.

The charges associated with schemes are being reduced. With plans for the system of personal accounts to charge individuals just 0.3%, DC scheme providers may reduce their charges to compete.

Employers could be tempted to lower their contribution rates to existing DC schemes to match those of personal accounts. The system of personal accounts will introduce standard employer contribution levels of 3% and employee rates of 4%.

The current practice of means testing for receipt of certain state benefits and proposals for the automatic enrolment of staff into a system of personal accounts that kicks in from 2012, could result in some employees ending up with less money on retirement. Going forward, DC schemes may be re-designed to accommodate the impact of means testing on members.

Case study: Benfield

Independent reinsurance and risk intermediary firm Benfield operates a group personal pension scheme, and has embraced the wave of new technology that has re-shaped defined contribution (DC) schemes.

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Using an online system, it offers staff the chance to view the different fund options available and to move funds around. Jim Harwood, compensation and benefits manager, explains: “Members can move to cash or fixed interest [investments] and then three days later move back. Our whole scheme is managed online and all staff have been accessing their pension this way since April 2006.”

The company is also in the process of incorporating automatic enrolment into its rules, so it will be perceived as a ‘good scheme’ by the time 2012 rolls around. “I can’t see [the system of personal accounts] affecting the way that we run our scheme,” adds Harwood.employee benefits, occupational pensions,