Millions of employees saving into DB schemes would have to accept cuts to their pensions if the proposals were enacted.
DB schemes, through which an employee’s retirement income is guaranteed based on salary and length of service, have become increasingly cumbersome for employers, thanks to a combination of poorly performing bond markets and historic underfunding.
The Pensions and Lifetime Savings Association (PLSA) estimates there is only a 50 per cent chance that the weakest schemes are currently capable of paying out to members in full. The deficits of FTSE 350 DB schemes are reported to have trebled over the course of 12 months.
Pensions minister Richard Harrington has now said that the pension system needs radical reform because Britain is a “very different place” compared to when many of the schemes were established. He said savers would need to help “soften the blow” to DB schemes to help them remain viable.
Writing in The Telegraph, Harrington said: “I have a very clear set of criteria in mind when it comes to the future of the defined benefit sector. Any changes must balance the needs of consumers, employers and schemes and I don’t want to see it tipped in favour of one particular group.”
The PLSA and the government are suggesting forming ‘super funds’ that would enable employers to pay a one-off fee to absolve them of responsibility for their pensions, which would be assumed by the independently owned fund.
Pooling assets in this manner would protect pensions and make high-profile failures less likely, officials said, while offering better payouts than the Pension Protection Fund (PPF) – a scheme that guarantees the pensions promised by failed companies.
Tom McPhail, head of pensions research at Hargreaves Lansdown, said: “The terms of how weak employers can go into a super fund will be critical. For a super fund to be fair to the other participants, you have to apply the same entry requirements, otherwise you’re just shifting liabilities.”
One of the key reasons DB schemes are so costly for employers is that the payments increase annually in line with inflation. The government is considering allowing pension trustees currently using RPI to switch to CPI, or even to suspend increases if the company finds itself in financial difficulties.
Harrington said public sector savers had already experienced such changes. “CPI has already replaced RPI for the pensions of civil servants, the military, teachers, NHS staff and MPs,” he said. “If using a modern and more accurate measure [of inflation], which still protects pensioners against rising prices, also makes the scheme more sustainable in the long term, it is worthy of consideration.”