Hot on the heels of the NAPF, the Association of Consulting Actuaries (ACA) has launched its own 6-point manifesto to save defined benefit pension schemes in the UK. There are some good points here, and I want to concentrate on two in particular: “middle-way” schemes and retirement ages linked to longevity.
First, middle-way schemes. These are defined benefit pension schemes with fewer guarantees than the existing arrangements. For example, pensions in payment might not have guaranteed increases as they currently do. Given the huge increase in the cost of pensions over the last couple of decades, such schemes are eminently sensible. However, will any party commit to introducing them? There is a risk that such a commitment would be seen as a favour to companies at the expense of employees, since it would allow pension schemes to offer lower benefits than they currently do.
There is little doubt that this is the way many groups would present such a move. However, is this fair? Employers already have a way of reducing the cost of defined benefit pensions – by moving to defined contribution and shifting all of the risk onto the employees. At least the middle way gives some guarantees to individuals, in particular giving them an idea of how big their pension at retirement is likely to be. I really hope that the political parties will recognise this and promote middle-way schemes as a way of saving defined benefit provision, not devaluing it.
Linking retirement ages to longevity is also sensible, but difficult. One approach is to link retirement ages to what is called the period life expectancy. This is the life expectancy calculated assuming no future improvements in mortality rates. Such a measure has the advantage that it is known, but it is always “behind the curve” – retirement ages are based on the life expectancy of those already drawing their pensions. Providing life expectancy carried on increasing at a steady rate, such an approach would be acceptable, but an acceleration in improvements would leave retirement ages too low – and a reversal in improvements would mean retirees being unfairly penalised by having to retire later whilst dying sooner.
Another issue is that most pension schemes are unlikely to have sufficient data to calculate scheme-specific period life expectancies. This means that the longevity measure used would be population-based – and pension scheme demography can differ greatly from that of the general population.
The alternative measure of longevity is the cohort life expectancy. This tries to estimate future mortality rates by estimating the true future life expectancy for an individual with a given age – but estimates are all that can be made. As a result, it is a subjective measure, prone to manipulation unless the mortality projection methods are carefully defined.
So, there are some issues with the ACA’s proposals, but at least they are addressing the real issue at the heart of the defined benefit crisis – the unsustainable cost of such provision.