All in the details – inside UK pension reforms

26 November 2014

Pension reforms laid out this year are the most significant in almost a century, claim the UK Government. But amid promises of greater flexibility in the way employees handle their funds and the introduction of new collective defined contribution schemes, how prepared are we for such changes? Ross Davies meets Joanne Segars, chief executive of the National Association of Pension Funds, to gauge the current mood.

Savings and pensions represented the main tenor of this year's UK budget, delivered by Chancellor of the Exchequer George Osborne on 14 March 2014.

Speaking in front of the House of Commons, the chancellor boldly claimed that his pension reforms were the biggest since 1921 - the year tax relief was first offered to those saving ahead of retirement.

One of the measures to attract the most column inches was the removal of compulsory annuities; the insurance products - which require people to purchase an income for the rest of their lives - have long been a bugbear for retirees. Under the new reforms, which will come into play in April 2015, pensioners will be at liberty to spend their savings as they so wish.

As is the innate nature of any budget - or politics in general - the chancellor's proposals divided public opinion and the commentariat. Writing in the Daily Mail, economics commentator Alex Brummer effusively described a "savings revolution". The Guardian was more sceptical, with writer Philip Inman claiming that the reforms were "about the few, and not the many", and designed with "the richest 20% in mind".

What is clear, however, is that the landscape of the UK pensions sector is in the midst of a sea change. Automatic enrolment, which was launched in 2012, has prompted a surge in overall pension saving. According to the Department for Work and Pensions (DWP), 35% of employees in the private sector are already signed up to a scheme; as of April 2014, only one in ten had chosen to opt out.

"Under the new reforms, which will come into play in April 2015, pensioners will be at liberty to spend their savings as they so wish."

Then, in June, as the first layer of dust began to settle on the chancellor's red briefcase at 11 Downing Street, the Queen's speech laid out foundations for the use of new collective-defined contribution (CDC) schemes in workplace pensions, as proposed by Pensions Minister Steve Webb.

Webb, well known to be a fan of CDCs within pensions circles, believes it could provide a suitable alternative to the two existing schemes deployed across the workplace: defined benefit (DB) and defined contribution (DC).

Payment plans

Presently, most workers pay into a money-purchase DC scheme, which allows them to know how much they are paying in each month. However, these place the burden of risk on the employee, while an individual's retirement income is indeterminate due to being contingent on external factors, such as the performance of the bond markets.

DB schemes - also known as final salaries - that allow savers a gold-plated income when they retire, are preferable to DC, but are becoming increasing rare as a result of being too costly for companies to offer.

CDCs are commonly described as a halfway house between the two. CDC is based on the idea that employees pay into a pot shared by thousands of other workers, thereby spreading the risk associated with the DC model.

The pension subsequently paid out in retirement comes from the pooled fund, which could, in theory, include employees across an entire industry - as opposed to a single company.

Those in favour of CDCs - supporters include the Trade Union Congress (TUC) - claim that as well as being designed to avail workers with greater certainty over their incomes after retirement, such schemes can increase personal pensions by up to 30%.

Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), can appreciate why collective pensions schemes might seem attractive to workers in contrast to what's currently on offer. In particular, this relates to the idea of driving down risk - a prevalent concern in light of the financial crisis.

"The idea of sharing risk is really appealing to some scheme members," she explains. "Many are still acutely aware of volatility and losing their pension pot, which happened to some during the height of the banking crisis. I think the other core thing about CDC - and which is part of a much wider debate - is that it generates good DC provision, as you can spread investment costs."

Pros and cons

The fact that CDC schemes require sponsors to pay out the same amount every month - meaning no accompanying risk - may be an inducement for employers, too, claims Segars.

"CDCs can definitely give scheme sponsors more certainty over the pension scheme they are financing," she says. "If you take traditional defined benefit schemes, many are just too expensive. What employers thought they were initially funding has just grown and grown."

But, like DC and DB schemes, collective pension funds are not without their drawbacks or risks. First and foremost, there is no guarantee that workers will receive their target income on retirement if investments don't perform as expected. In 2012, a quarter of such schemes in the Netherlands - where CDCs are commonplace - slashed pensions by 1.9% in a bid to offset sagging finances.

"Well, that's the point about CDCs, isn't it?" says Segars. "In the case of the Netherlands, benefits have been cut because of tough economic conditions. There is an air of unpredictability to CDC schemes. You could have a 30% bigger pension, or it could be smaller. What we need to do is make schemes more robust and sustainable over time."

Question marks also linger over how CDCs will tie in with the other pension reforms announced in the March budget. The chancellor and the DWP have yet to clarify whether CDC members will be granted the same freedom as workers under DC schemes - who will be allowed to access their pension pots as they like come April 2015.

Also unclear is whether a cap will be imposed on CDC schemes. The new limit for auto-enrolment charges has been set at 0.75% a year, with the DWP estimating that this could cost the pensions industry approximately £195 million over the next decade. Some believe that figure to be a gross underestimate, and could put undue pressure on employers to modify schemes already in place.

"DB schemes, which allow savers a gold-plated income when they retire, are preferable to DC, but are becoming increasing rare as a result of being too costly for companies to offer."

"It is clear that the scale of disruption is likely to be far greater than originally forecast by the DWP," says Tom McPhail, head of pensions research at investment firm Hargreaves Lansdown.

"Employers are, in some cases, going to have to look to move their scheme, possibly within only a year or two of putting an auto-enrolment solution in place. It is inevitable that in some cases, particularly for medium-sized employers, additional fees will have to be paid to cover the cost of this work."

Government guidance

If businesses and workers are to suitably ready themselves for next year's roll-out, the government will therefore need to open up lines of communication and provide more guidance over how such schemes
can be successfully incorporated.

According to some sources, Whitehall has allocated a fund worth £20 million to assist pension firms in developing advisory services and telephone helplines in a bid to meet "guidance guarantee" obligations.

However, Segars, would like to see more evidence of governmental action. "The government needs to get its act together, and fast," she says. "While April 2015 might seem some way off, it's a frighteningly quick timetable when you think about it - especially given the primary legislations that need to be signed off. They need to work on giving schemes and employers much more certainty than they have done so far. I would also like to see greater collaboration between the government and the pensions industry."

Undeniably, pension reforms that place greater emphasis on reducing risk and flexibility, and allow retirees to draw post-employment funds of their own accord, are to be lauded - in principle.

But, as Segars points out, the government cannot afford to procrastinate in the moment. Greater clarity is needed on how exactly planned changes to the likes of price capping, investment policies and guidance guarantee will sit alongside one another.

This needs to be carried out with absolute clarity and efficiency; anything else would be to the detriment of future generations of pension scheme sponsors and members.

Joanne Segars became the chief executive of the National Association for Pension Funds (NAPF) in October 2006, having joined the organisation in 2005 as director of policy. Before joining NAPF, she was head of pensions and savings at the Association of British Insurers 2001–05.