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hilary salt“We’re going to a situation in the UK, in the not too distant future, where people won’t be able to retire because they have an inadequate DC pot, and their employer won’t be able to force them out of the workplace (because of age-discrimination laws). So employers are going to have to go through competency tests, capability tests … and that’s the only way they are going to be able to get people out of the workplace, at the age when employers want to be able to move those people along.” – Hilary Salt


 

By John Devine

We’re all familiar with the three ‘Rs’ that lay the foundation of a sound education, but perhaps not as much with the four ‘Rs’ that arrive with a traditional pension, a scheme that yields benefits for employers as well as employees, says Hilary Salt of the UK’s First Actuarial.
Arguing the merits of a defined benefit plan for employees is a relatively easy task, says Salt, author of the recent paper, The Future of Defined Benefit Pension Provisions, but selling the advantages of DB for employers is a more daunting task.
The four ‘R’s aided by a quality pension plan are recruitment, retention, return and retirement. A DB plan that’s part of a benefits package helps employers recruit and retain talent, including employees returning to work after maternity leave, etc., and adequate pension benefits helps move long-term employees into retirement, clearing the way for new blood.
Without the enticement of a secure retirement, employees may feel compelled to linger in the workplace, placing employers in the difficult position of ‘managing’ older workers out the door.

“We’re going to a situation in the UK, in the not too distant future, where people won’t be able to retire because they have an inadequate DC pot, and their employer won’t be able to force them out of the workplace (because of age-discrimination laws). So employers are going to have to go through competency tests, capability tests … and that’s the only way they are going to be able to get people out of the workplace, at the age when employers want to be able to move those people along.

“Having decent retirement provision has been a way for employers not to have those difficult conversations … and we are going to be in the situation where we will need them again.”
Salt, a senior actuary who manages First Actuarial’s Manchester office, wrote the paper for the Trade Union Congress (TUC), which represents the majority of unionized workers in the UK. In it she concludes the DB model remains a viable option for pension provision, and provides key talking points for union negotiators, which include outlining the benefits to employers who offer employees a traditional pension.
The pension landscape in the UK resembles that in other Western countries, including Canada and the United States. DB is on the decline in the private sector, replaced with defined contribution schemes or none at all, while remaining relatively robust in the public sector.
As in other countries, a looming pension crisis is being warned of as millions of people approach retirement age without adequate income provision. It’s against this backdrop that the UK government introduced an auto-enrolment process to build individual pension pots, an approach that doesn’t need to adopt DC schemes, but most likely will, says Salt.
The initial employee/contribution rate is a total of two per cent, a wholly inadequate sum to generate sufficient pension income, says Salt. That combined rate is to eventually rise to eight per cent, an amount that has been identified by some experts as still being two low.
As long as employers meet certain quality standards, including the contribution rate, they are free to choose between DC or DB plans. There are many legacy DB plans in the UK, but Salt doesn’t expect many employers to open new ones when they auto-enroll.
“Auto-enrolment doesn’t mean it has to be DC … but for many employers who have no pension plan at the moment, it’s very unlikely that they will introduce a DB scheme.”
By going with a DC plan, employers could end up subjecting employees to all the pitfalls associated with that approach, including high management fees, leaving individuals vulnerable to market fluctuations, and missing out on the economies of scale found in DB plans.
Australia is another country that embarked on a national DC scheme. Critics of that strategy point out Australian retirees are running out of retirement money at 70, and contribution rates are being hiked to around 20 per cent to compensate.

“There’s nothing that Australia tells us that says DC is a sensible way to provide pensions.”

Having a small, insufficient pension pot at retirement could actually leave one worse off, says Salt, than having none at all.
“You could find that some people might build up a small amount of pension, but that small amount takes them to a level where they don’t quality for means-tested (state benefits), so they lose benefits and they would have been better off had they not made those savings.”
Salt agrees with suggestions that an effective rate for the auto-enrolment process to work needs to be at least 12 per cent. But the most effective, efficient model for pension provision remains the DB approach, although real circumstances dictate some changes to the model, such as risk sharing, changes to benefits and adapting to increased longevity levels.
She points to three main reasons why DB is better than DC. The first and most basic reason why DB is better for accumulating adequate retirement income is that members pay more into them. The second advantage, she says, is that they are collective. Doing it alone has major disadvantages, including paying high management fees and over-saving for retirement based on forecasts of what will be needed to carry you through a long retirement.
Economies of scale found in DB schemes represent the third major advantage.
“If you have economies of scale, saving in a group scheme you can pay for better advice, share administrative costs. Why is there is future for DB schemes? Because they are massively more efficient than individual DC schemes.”

John Devine writes for the Alliance for Retirement Income Adequacy. Read the ARIA blog at ariapensions.ca, and follow ARIA on Twitter.

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