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A new type of pension scheme promises a compromise between defined benefits schemes – where the employer runs the risk – and defined contributions schemes – where the employee does. Stephen Spurdon reports.

While not so long ago the major concern was over personal pensions, now occupational pensions are in the spotlight. The move from defined benefits to defined contributions has been portrayed by employee representatives as a betrayal of promises made by employers.

However, the employer sponsors of occupational schemes have been hard pressed to justify the maintenance of such schemes to shareholders in the face of soaring costs through increased longevity, declining investment and income returns and the impact of FRS 17 on balance sheets.

And now we have had our first “pensions strike”, held last summer by workers at steel company Caparo. Speeches made at September’s TUC Conference show that this may not be the last attempt by members of existing final salary pension schemes to preserve their benefits in the face of an escalating withdrawal by employers from such schemes.

Compromise
In such a polarised situation some compromise has to be found and it appears to have been delivered in the form of the shared risk pension – a “middle way” between the employer having all the risk in a defined benefits scheme and the employee shouldering the risk in a defined contributions one.

There are two approaches to this. The first has been to ask scheme members to pay more for the privilege of being in a final salary scheme. The new development is to look to a more fundamental rearrangement of these schemes to share the risk more effectively. The new type of shared risk pension is based on one of the following two models:

Career Average Revalued Earnings Schemes
In year one the member has a pension as a given percentage of final salary. In year two the year one entitlement is revalued according to retail price index (RPI), and the next tranche of pension is added on. This goes on and on until the end of employment. The employer still keeps risk but at a lower level, partly because this may have the effect of smoothing out the hikes in earnings that some particularly senior people get towards the end of their employment.

Cash Balance Schemes
The company credits a lump sum each year equal to a percentage of the salary – which is increased by a percentage such as RPI. In this case it is the employee who usually takes the annuity risk.

We already have a few schemes operating under these principles. For instance, leading supermarket chain Tesco operates a career average scheme, where the benefit is based on a year-by-year build up of entitlement rather than having an income being based just on final salary. Meanwhile pharmaceuticals giant Astra Zeneca has a cash balance plan where the defined benefit is a lump sum rather than a pension.

Where Next?
The Green Paper published by the Department for Work and Pensions (DWP) shortly before Christmas has taken up many of the ideas put forward by Alan Pickering in his report to the Government on the future of pensions. The Green Paper accepts that the sheer complexity of administration concerns employers. The DWP rejects the idea that contracting out should be abolished altogether but agrees that arrangements need to be simplified. Other ideas put out for consultation include reforms to the administration of guaranteed minimum pensions and allowing all contracted out schemes to be able to choose whether to calculate pensionable salary on a career average or final salary basis.

Aaron Punwani, partner at Lane Clark & Peacock, said he felt that cash balance plans were a particularly attractive compromise between traditional final salary and money purchase schemes. “Many employers may feel it is intuitively reasonable to bear the financial risks in relation to their current employees, but that this responsibility should be removed at the point of retirement.”

Stephen Spurdon is a freelance journalist

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