Are Inland Revenue senior civil servant Paula Diggle's claims that the annuity providers operate as a “complex monopoly” distorting competition justified?
Stanbridge: It depends what Paula Diggle means by her statement. If she means that the market is dominated by relatively few providers, then we tend to agree with her.
If her suggestion is that providers are in collaboration so that competition is suppressed and profitability artificially inflated, then we would disagree strongly.
Profit margins on annuity business are thin. Some companies have simply decided that they do not want to operate in such a competitive market.
Others are not able to operate efficiently enough to make writing annuity business viable. The only barriers to entering the annuity market are providing the required capital and being willing to take the necessary mortality risk.
Ritchie: I assume that “complex monopoly” is a defined term but I do not know its intended meaning here. What I can say is that the conventional immediate annuity market is very price-sensitive.
The ABI and the FSA have already taken steps to ensure that people approaching retirement are told cle-arly that they have an open market option and what that option is.
The barriers to new providers entering the conventional annuity market are not created by existing players. It is the Government which (quite rightly) demands high levels of capital backing for such business, and it is prospects of further increases in longevity which make providers wary of big exposure.
Mitchell: We understand that the Revenue has subsequently amplified these remarks to make it clear that it recognises that the open market option annuity market is highly competitive but many retirees do not get access to it because of their reluctance to exercise their Omo.
Would the removal of accounting standard FRS17 stop further closures of defined-benefit schemes?
Stanbridge: FRS17 is in itself not the only issue arising for employers which will determine the future of a defined-benefit scheme.
What FRS17 does is to highlight the potential problem of two other key areas which also have an impact the costs of these schemes. These are the issues of changing mortality and lower investment returns.
There is no doubt that employers are now looking more closely at the costs of running a DB scheme.
Ritchie: Not altogether, but it would certainly be one less straw on the camel's back. Frankly, I support the sentiment of FRS17 but it could benefit from some smoothing in its application. There is no getting away from the fact that offering a defined-benefit pension is a risky business for an employer, and that should be reflected in its accounting. However, to show the full impact of stockmarket chan-ges every year is overkill. Some averaging should be allowed.
Mitchell: Removal of FRS17 might reduce the number of closures but would not stop them. As many analysts have recently highlighted, there has been a trend away from final-salary schemes over recent years as a result of concerns, in particular, over costs and the increasing regulatory burden. The fall in markets and the obvious costly knock-on in making provision for such schemes has emphasised some of these concerns.
Its removal or otherwise will become an irrelevance from 2005 onwards when UK companies will be brought in line with international standards. As it stands now, the standard introduces more transparency but does not alter the financial standing of a scheme or company.
What other options are there available to defined-benefit schemes other than closure?
Stanbridge: There are a number of options open to employers operating DB schemes with different implications as to future costs. These options include:
1: Closure of the scheme to new entrants.
2: A reduction in future accrual of benefits under the scheme – 60ths to 80ths.
3: Stop future accrual of pension benefits with past service benefits remaining linked to salary at retirement.
4: Stop future accrual i.e. make the scheme paid up with past service benefits to be based on salary to date and inflation up to retirement.
5: Formally wind up the scheme. There is the possibility here of a potential debt on the employer if the scheme is in deficit. Of course, employers may want to continue to maintain the valuable benefit they have promised to members. Increased costs could be shared with members.
Ritchie: I do not think it is realistic to expect the Govern-ment to repeal the abolition of ACT dividend relief .It was part of a package of corporation tax reform and it would be very difficult for the Govern-ment to find an extra £5bn a year through other means.
One thing that the Government could do, which would be a shot in the arm for all forms of private pension, is to improve the contracting-out rebates with immediate effect. There should be a clear incentive for most people earning more than, say, £12,000 a year to contract out – and there is not. There could also be National Insurance incentives for employer contributions. The Government must “walk the talk” when it says it wants to encourage private pensions.
Mitchell: The headlines have been grabbed by the decision of Ernst & Young and M&S but there has been little coverage of the firms which have stated their intention to retain DB schemes – the John Lewis Partnership and BAe Systems being examples.
What matters is what is best for that individual company and it should take a myriad of factors into account and not be influenced by the least-cost alternative or the short-term variations in financial reporting.
The options which may be open to a scheme, other than a complete closure, include closure only to new members and reduction in the level of guaranteed benefits for future members and service.
A further option would be to alter the scheme to a money-purchase arrangement at a specified date. The money-purchase part could be set up to provide targeted benefits. The benefits which have accrued to the date of change would remain guaranteed.
What can be done to enc-ourage employers to keep up/increase contribution levels to DC schemes?
Stanbridge: Clearly, compulsory employer contributions is the strongest sanction. The market may well see more union and member pressure on this issue. After all, a feature of DB schemes when they were originally set up is that the member's pension was deferred pay.
If, as seems to be the case, there is no maintenance of the level of contributions under a dc switch scheme, this may well cause a lot of anxiety. Continued media pressure and general awareness of the potentially low pension income may itself put pressure on employees.
Ritchie: Yes, but at what price? Any such policy has a short-term effect for today's pensioners and a long-term effect for tomorrow's pensioners. I do not know anyone who would deny that something more should be done for today's pensioners and the Government has chosen the minimum income guarantee and pension credit to do that. Both are means-tested, which is the Achilles Heel. But the IPPR proposal has an Achilles Heel as well – it would abolish contracting out. This would be another “own goal” in terms of promoting funded private pensions and would therefore be immensely damaging to tomorrow's pensioners.
Mitchell: Employers will maintain and, perhaps, increase contributions to DC schemes if they believe that they are viewed as a significant and valuable benefit by their employees.
As individuals are made increasingly aware of the need to make private provision for their own retirement, the provision of a good quality-pension scheme by an employer or a willingness to fund significant pension contributions will become an increasingly important factor in making decisions about employment.
Recognition by employers that the provision of valuable pension arrangements is a significant factor in retaining and recruiting staff should encourage them to maintain or increase contributions.
Will the Institute for Public Policy Research's recent proposals in its report A New Contract for Retire-ment to link the basic state pension to earnings combat pensioner poverty? And should the state retirement age be raised to age 67, as the IPPR is suggesting?
Stanbridge: At what level would the earnings link commence? If the initial level is low then all that will happen is that the low level will be maintained. The Mig may mean that there is little value for lower income earners to make any saving where there is a belief the state will provide. Raising the state retirement age is one way of reducing the cost of providing state retirement benefits.
However, there are lots of social and work pattern issues associated with this. The continuous mortality investigation have reported that people who work longer live longer.
Ritchie: Frankly, I think this is a side issue, and therefore I am relaxed either way. The real issue is the age at which people actually retire. We need to get many more people (especially men) over 50 to stay in work until some time in their 60s.
There are real macroand micro-economic benefits from this. People need to understand the merits of it, and barriers to achieving it need to be eliminated.
If people really want to retire early they need to understand the financial consequences when they are young, so that they can make the additional provision for it. Combined benefit statements and statutory Illustrations of money-purchase pensions may help.
Mitchell: The nature and length of retirement in the UK has changed significantly in recent years and so it is sensible to review our state pension structures.
Like any changes to our pay-as-you-go system, the acid test that these two proposals must pass is “does the benefit to those in retirement justify asking those in work to pay for them?”
Paul Stanbridge, head of corporate pensions strategy, Friends Provident
Stewart Ritchie, director pensions development, Scottish Equitable
Trevor Mitchell, senior product manager (Retirement), Prudential UK