In this month’s Off the Record we get down to the nitty-gritty of pensions – who pays what in contributions and how long it is likely to stay that way?
How are contribution levels set, when do they change, and are the current market conditions forcing a reappraisal of the level of contributions paid into the scheme?
No point in beating around the bush, so just how much are employers and employees paying into pension schemes?
For defined benefit (DB) plans, you tell us that on average the input of the employee is around 5.3%, with the range spreading from no member contributions at all to 8.75% of salary.
For the plan sponsor, the average paid into a scheme is 13.4% with the range running from about 8% to 20%-plus.
For defined contribution (DC) schemes the average member contribution drops a little to 4.4% with the range from 3–5.3%, while employers are averaging contributions of 11.9% – again a drop on their DB commitments.
We then asked you when decisions regarding any contribution changes are made by the scheme. The answers were relatively uniform. Most funds will take a scheme valuation – for many this is made on a triennial basis – and then decide on any changes.
For DC plans, the decision process is more fluid. Many contribution decisions appear to reflect strategic moves taken at a corporate level, such as shifts in HR policy or further need for staff retention.
In terms of the amount of time needed, however, to implement such payment alterations, there appears to be an extraordinary variety in how long this process takes.
One fund claims that implementation can be made immediately. But several fund managers complain that it is a laborious job, citing timeframes of up to a year after the necessary authorities/union representatives have been informed. On average, schemes say they need seven months to fully integrate the amount paid in to a fund.
Taking a step back, though: who makes the final decision on rate changes? A combination of different parties it seems. Most funds point to a mixture of the trustee board in consultation with the scheme actuaries, or some kind of pension plan committee.
One manager spells out exactly how this happens: “The trustees make recommendations to the employer and/or employees; negotiations may or may not follow, depending on the degree to which the recommendations are accepted by both parties.”
Moving on, a topic of much debate and some contention in recent years has been the shift from DB to DC plans.
As we see earlier, there has certainly been a downward trend in the level of contributions under DC, but is the move towards the new ‘flexible’ regime a good one?
Over half of you say that DC is definitely a precursor to lower payments by companies into pension funds. You don’t stop there though, as one manager notes: “Companies use the introduction of DC schemes to lower future cost commitments. This is in my view an extremely short-term approach to boosting profits.
Another scheme chief chips in: “That is usually the reason for companies favouring DC over DB and trying to insist on their introduction – unions are aware of this and often resist.”
Sounds like we’ve got a social struggle on our hands.
On a more practical note maybe, one manager notes that DB costs employers more: “Our DB scheme is statutory with benefits linked to inflation so we need constant real returns to offset longevity, ACT removal, fewer active members.”
Shouldn’t employers be increasing their contributions then if they transfer to cheaper DC arrangements? Or are we seeing a general tightening of the European pensions belt?
Too many questions, time for a contributions holiday? Just how many of you are enjoying a break from the regular pension payments treadmill?
The answer is not that many, and probably not as many as would like to. Only one in 10 schemes claims to have sufficient surplus to forego payments, and these are all for the employers. Members carry on paying regardless.
Recent market turmoil, though, looks like nipping the vacation season in the bud – with half of the holidaying plans set to return to normality by the start of next year.
So are contribution holidays a good idea? Opinion is divided and not just between the haves and have-nots. Half of the total respondents to this month’s Off the Record come out against the holiday principle, while only a handful speak out in its favour.
One manager is scientific in his rebuttal: “Actuarial valuations are not an exact science and so the assumptions applied change from period to period and hence so do results.”
Another manager in the UK adds a dash of principle to the equation: “I don’t think they are a good idea, since there is a large increase in the reported cost when a company has to resume contributions. At that point the merits of continuing with the existing pension arrangements are also challenged. Companies are happy to have the opportunity to reduce contributions, but not happy to have to increase them, even though over the longer term the contribution rate may effectively be stable. It’s that short-term thinking from directors and accountants again, which is exacerbated by FRS17.”
A few of you note that contribution holidays can help to store up greater future costs. One points out that members can feel they are being cheated if things aren’t handled carefully.
Criticism is not universal, however. One scheme makes a simple deduction: “There’s no point in contributing with a huge surplus.”
Alright for some!
Another adds that contribution holidays can help buffer extreme stock market fluctuations.
Next, we asked whether you had already taken a decision about the future level of contributions to the fund and how far in advance these were decided.
A third of funds have already set their levels and the majority say this is done, if not months, then years in advance. For just under a third of respondents, the change will be to increase the amount of payments. A quarter reply that there will be no change, while 13% say they will reduce contributions.
While very few funds give their reasons for the shift in payment levels, one explains why the firm will have to pay more: “This is part of an increase that is being phased in over three years, due mainly to longer life expectancy.”
On average, you say the new rates for funds will come out at 14.3% employer, 5.2% employee input for DB plans. DC plans, you add, will see an average inflow of 8.5% employer and 4% employee money.
Compare these figures to those given earlier and the trend is in the downward direction. Not good news for future retirees, it seems.
On a topical note, we decided to finish with a question about the impact of 11 September on contribution/death and disability rates.
Only a single scheme says that the market downturn after the New York tragedy will prompt an increase in contribution rates for the DB plan to maintain its pension promise – a good indicator of the robustness of the European pensions arena.
But, one UK fund chief feels 11 September may prove something of a long-term watershed: “I don’t think it will be the sole reason, but history may determine that it was turning point for many UK pension strategies.”
Certainly, there have been some interesting developments in the UK since 11 September. Nonetheless, on death and disability insurance, most of you haven’t picked up any particular trends. One manager notes: “Our disability cover is self-funded and death in service is insured but our company size indicates that insurers are still keen to keep/have our business, so rates are very competitive.”
All that remains to be said is, thanks for the contribution!