Farewell to the decade and the defined benefit pension
In the 2,000 years since the Emperor Augustus first handed Roman soldiers returning from war a lump sum in a bid to quell unrest, pensions have grown considerably more complex.
But since the Second World War and the rise of middle class retirement, few decades have been quite so disruptive as the 2010s.
Almost everywhere in Britain, the decade marked the end of a guaranteed, employer-funded pension based on a worker’s final salary to fund their retirement.
These so-called defined benefit pensions tied companies to their workers for decades after they left. They are now being phased out in favour of a far less secure defined contribution model where each worker and their employer pays into a pension pot and invests the funds in the stock market.
The size of this personal pot on retirement will broadly determine the income a pensioner can receive for the rest of their days, and will heavily depend on the performance of the market.
Data from consultancy Barnett Waddingham shows that FTSE 350 companies shut 36 defined benefit schemes completely in the past 10 years.
Those that remain have almost all been closed to new joiners and only allow existing workers to continue building up their benefits.
This change is freeing companies of the risk and life-long expense of looking after former employees. On one level, it makes sense.
“Underwriting how long your employees live is completely bonkers,” says independent pensions consultant John Ralfe.
“It cannot possibly be a core function of a company.”
However, it also means employees now bear the burden of ensuring they save enough for old age and exposes them to the risk of a lower income than expected if their investments turn sour. That raises questions about whether individuals are best placed to manage the responsibility of saving for their own retirement.
Three in five 22 to 29-year-olds are saving below the recommended level for a comfortable retirement, and 14pc are not saving anything, according to the latest Adequate Savings Index report by Scottish Widows.
“There is absolutely no question that defined benefit is dead and buried,” says Ralfe.
The first reason for firms shutting down defined benefit pensions is the spiralling cost of funding them in a world where the average person’s retirement lasts decades rather than years, after a surge in life expectancy.
Another driving force has been ultra-low interest rates since the financial crisis, which have hit returns on funds’ investments and forced employers to squirrel away extra cash to guarantee they will be able to meet the cost of future pensions. The Bank of England rate, for example, has been below 1pc for over a decade.
As well as eliminating the guarantee of a fixed income for workers upon retirement, in the latter half of the decade firms have been paying insurers to take on the risk of funding existing defined benefit schemes.
The market for these buyout transactions is booming. In part, the deals have been made affordable for companies because their pension fund deficits – the gap between what they are expected to owe pensioners and the value of assets they own – have narrowed sharply. Total FTSE 350 pension deficits have fallen more than a third since 2009.
That makes it far more affordable to pay an outside investor who will take on pensions risk.
A fifth of FTSE 350 companies could now eliminate their pensions risk using less than 10pc of the cash on their balance sheet, Barnett Waddingham research shows.
The flipside of the decline in defined benefit schemes is the explosion of their defined contribution counterparts following former chancellor George Osborne’s groundbreaking auto-enrolment reforms, which mean workers now automatically pay into a scheme unless they explicitly opt out.
Among companies that have been in the FTSE 350 between 2009 and 2018, the level of contributions through auto-enrolment more than doubled from £3.2bn to £8.1bn.
The number of active members of private sector defined contribution schemes has jumped 10-fold from about 900,000 in 2010 to 9.8 million in 2018, figures from the Office for National Statistics show.
Getting people enrolled in pension schemes was the first phase of pensions reform, says Royal London’s Sir Steve Webb, pensions minister from 2010 to 2015.
He says the Government’s lack of urgency in moving to phase two is a cause for concern. This should include nudging employees to save more, he argues, including by automatically increasing employees’ contributions when they get a pay rise.
The minimum contributions required of employers should also rise to be at least in line with the 5pc of salary that employees automatically pay in, he says. At present, firms only have to contribute 3pc.
The counter-argument is that any increase in employer contributions could lead to a slowdown in salaries as companies avoid hiking wages to keep their bills down.
“You can’t magic pension contributions out of thin air,” says Ralfe.
Whatever the disagreements on policy, what is certain is that the inexorable shift away from defined benefit schemes will continue through the 2020s.