I am not sure that I agree with the commonly held view that the only alternative to final-salary or defined-benefit schemes is for employers to switch to groupings of personal pensions or stakeholder pensions instead. That is a step-change for many bigger employers that could be difficult for them to sell to their employees.
That is not to say, by the way, that I go along with that other great media favourite, the demonising of defined-contribution schemes. It is just that I think that the bigger defined-benefit schemes were set up for a purpose in the first place and the reasons for employers retaining at least some of the risks associated with pension provision for their staff are probably still valid and should not be ignored.
What happens with traditional defined-benefit schemes is that all the certainties are with the employees and all the uncertainties lie with the employer. As an employee, you know exactly what your pension will be related to your earnings at or near retirement and your length of service.
The employer, on the other hand, has no idea what this benefit promise will eventually cost. The two main risks being run are those of the investment return and the future cost of annuities. The argument is that these two risks are getting too difficult for employers to underwrite, so they should both be passed on to employees instead. Well, that is one way of looking at it but there is another.
Many people are now saying that there may be a soft landing somewhere between the traditional defined-benefit approach and the grouping of individual defined-contribution products and that, for many bigger employers, other options may suit their businesses better. Essentially, these options all move some of the risk or cost of the pension scheme to employees but leave the employer still bearing some of the risk too.
A good example of this – and one that has become quite popular in the US as it, too, has moved away from its traditional approach to defined-benefit provision – is where the employer passes the risks associated with annuity purchase on to employees but retains the investment risk. These schemes are sometimes referred to as cash benefit schemes and are essentially defined-benefit arrangements where the defined benefit is a certain amount of cash provided at retirement for the purpose of annuity purchase. For example, an employer could set up a defined-benefit scheme to provide a fixed sum of, say, 10 times salary at the time of retirement, which the employee could then use to purchase an annuity.
This approach provides the employee with a good level of security as far as knowing the exact amount of funds that can be counted on in the future but does not commit the employer to also underwriting future annuity rates. Such schemes are already popping up over here in the UK and I think they will become more common over time.
It seems to me that there is a good case for employers looking to their employees to contribute more towards the costs of provision if maintaining the generous final-salary benefit levels is what suits both the employer and employees. That is not to say that they should both bear half the cost but there is a case for increased employee commitment being the price for keeping schemes going where an employer is still prepared to underwrite both the investment and annuity risks.
Again, we are seeing many companies taking this route. Of course, this gives rise to some of the sillier stories in the press about employers going back on their promises and such but, hey, we are getting used to those by now, aren't we?
In reality, employers and employees are starting to look at the pension realities together and coming up with bespoke solutions that work in their particular circumstances. Our pension environment is changing, yes, but it is not as simple as DB or DC.
In my view, our future is not that polarised, even if it does make for more dramatic newspaper stories.
Steve Bee is head of pension strategy at Scottish Life