We have many kinds of pension schemes in the UK, covering Defined Benefit (DB), Defined Contributions (DC), CARE (Care Average Revalued Earnings) and various hybrid schemes too, and that is just in the private sector. We then have public sector schemes, often unfunded, and the State Pension system itself. It doesn’t seem to be an adequate range though as we have talked about adding on Defined Ambition schemes and are currently introducing a Collective DC (CDC) option. It’s clear that pension schemes face a number of challenges but surely one of these models will be robust enough to be sustainable over the long term that people need to save for retirement. Won’t it?
DB schemes have been the cornerstone of private pension provision in the UK for decades. In 2006, there were 3,500 open DB schemes in the private sector, covering 3.6 million employees earning benefits. By 2016, this had fallen to under 700 schemes covering 1.3 million employees. Analysis from the Institute and Faculty of Actuaries suggests that a private sector worker born in the 1960s is four times more likely to have a DB pension than a similar worker born in the 1980s. That trend is continuing and shows no sign of stopping, though perhaps DB schemes might still be sustainable for a handful of employers in the future.
The obvious problem in DB schemes is the open ended financial commitment for the sponsoring employer. When times were good, companies were able to take contribution holidays but were also forced to accept higher benefit levels, with requirements to revalue and increase pensions that made schemes far more expensive than was ever intended at the outset. Those extra costs were exacerbated by people living longer, stubbornly low interest rates, legal rulings like the Barber judgement (and the more recent Lloyds case), and understandable pressure from The Pensions Regulator to improve funding levels. What employer in their right mind would leave their company’s financial prospects such a hostage to Government meddling and market conditions by ever setting up a scheme like that again?
The public sector still has DB schemes so perhaps state backing makes these schemes more sustainable. Sadly, that doesn’t seem to be the case. The Universities Superannuation Scheme (USS) employers have been paying contributions of 18% of salary to their scheme (alongside 8% from members), and are being asked to increase that substantially to a combined rate of 33.7%. I’m not an expert on university funding but I don’t get the impression from the news I see that there is lots of money floating around to cover such an increase!
The NHS Pension Scheme moved its Normal Retirement Age to 65 in 2008 and introduced CARE benefits in 2015 but members can still get a guaranteed pension of around 2% of Pensionable Salary for each year of service, and that is a very expensive benefit to provide, as is the 1/57ths of salary pension available from the Teachers Pension Scheme.
Ultimately these public sector benefits have to be paid from tax revenue and there may well come a time when private sector workers chafe at providing gold plated benefits to the public sector that they can never hope to get themselves.
I mentioned the NHS move to CARE benefits, which seems particularly appropriate given the nature of their work. Sadly the punning opportunities are outweighed by the fact that this change is akin to Nero fiddling while Rome burned (or rearranging the deckchairs on the Titanic, whichever analogy you prefer). CARE schemes do partially mitigate the risks of a full blown DB scheme but it’s only a marginal improvement by limiting the exposure to salary escalation, including particularly the accrued costs from promotional increases. Despite remembering the infamous Cedric Brown saga from the mid-90s, I simply can’t see that removing one risk from DB schemes transforms CARE benefits to be sustainable in the long term.
Turning to the State Pension, we have a benefit that is not only Government backed but it’s also practically universal so there is no real danger of squabbling between recipients. Does that give us a sustainable model? The statistics suggest not.
There were 9.1 million people in the UK over age 65 in 1991. That had risen to 11.8 million by 2016. The Office of National Statistics (ONS) say that 15.9% of the population was over 65 in 2007, rising to 18.2% in the decade to 2017 and projected to rise further to 20.7% in 2027. Longevity has also improved over that period so the burden on the decreasing number of working taxpayers is suffering a classic double whammy.
The good news is that successive Governments (of various kinds) have broadly recognised this demographic time bomb and have taken steps to reduce the strain, for example by increasing the State Pension Age. The bad news is that the Office of Budget Responsibility (OBR) has projected that the cost of State pensions will rise from 5.0% to 7.1% of GDP over the next 45 years, an increase of over 40%. That hardly seems sustainable, particularly when coupled with the additional budgets needed for more health and care costs for this ageing population. The House of Lords Intergenerational Fairness and Provision Committee has recently recommended the removal of the triple lock for pensioners (joining GAD and the DWP who have said the same previously), but this remains a toxic political issue, albeit that the Committee dampened down the negative public reaction by monopolising all the headlines with the even more controversial proposal to remove free TV licences for those over the age of 75.
Finally, the shining light of current pension provision in the UK is autoenrolment with 10 million savers benefitting from this. However, there are 5 million selfemployed people (15% of our total workforce) who aren’t covered by autoenrolment and only an estimated 10% of those pay into a pension.
ONS figures suggest that 45% of self-employed workers aged between 35 and 54 have no private pension provision at all. The minimum combined contribution to a DC scheme to satisfy the auto-enrolment rules is 8% of ‘qualifying earnings’ (some way below full salary), and the median employer contribution to DC schemes fell from 10% in 2012 to 4% in 2016.
How sustainable will these DC schemes be when people retire after years of contributing only to discover that they still can’t afford a decent retirement?
Senior Trustee Representative – Dalriada Trustees Limited