Employers might want to improve intergenerational fairness by moving surplus assets from their DB to their DC section, one consultancy has proposed. Could this be a viable solution to closing the financial gap between generations?

The differences in pension wealth between DB and DC members are stark: on average, a DB member has £150,000 worth of benefits, while the pots of their DC counterparts are worth just £4,000. Even accounting for age differences, the gap is huge. Old-age poverty seems programmed for younger generations.

To address this cliff-edge in retirement wealth, consultancy Hymans Robertson has devised a model dubbed ‘optimised run-off’. 

The model “is not going to be working in every circumstance, but trustees in particular circumstances might want to be thinking about it”, explained Alistair Russell-Smith, head of corporate DB, speaking at the Pensions and Lifetime Savings Association Trustee Conference held on Thursday.

The model not only requires a paternalistic employer and the company not targeting DB buyout, but also needs DB and DC schemes to be in the same trust, which is increasingly rare, and a rule allowing for assets to be moved between sections. Then, if the employer and trustees were willing, a scheme could shift surplus assets from its DB to the DC section.

Russell-Smith admitted that the proposed model goes against current market trends, such as moving DC schemes to master trusts, but explained that part of the attraction of the solution would be that the employer could hold on to assets which would otherwise form profit for an insurer taking on scheme liabilities. Hymans believes that £367bn of value could be generated in this way.

By allowing any DB surplus – created by taking slightly more risk – to benefit DC members instead, employers might also be less reluctant to fund their DB scheme, as they could employ the surplus to motivate current employees. 

The approach would only work for schemes larger than about £100m to ensure the running costs are not excessive for the size of scheme; and only DB schemes with strong or ‘tending to strong’ employers would be suitable, of which there are around 800, with £900bn of asset, Russell-Smith explained.

He said given these figures, the value generated under optimised run-off would be £201bn. Bearing in mind that employers might want to see some of this value for themselves, he estimated about £72bn could be passed across to DC schemes, helping to bridge the gap to a decent retirement for DC members.

But he seemed under no illusion that a fundamental change in attitudes is needed before something like this can happen. “A key thing for this to take off is a shift in mindset,” he noted.

Daniela Silcock, who heads up the policy research team at the Pensions Policy Institute, believes adoption of the Hymans model is not impossible but listed a number of obstacles – not least the fact that employers are more concerned about their business than their pension scheme and, since Carillion and BHS, have become very risk-averse when it comes to pensions.

“While they care about pensioners, it’s the business that matters most” for employers, she pointed out, and therefore it would be a “relatively hard sell”. 

But, she added, that doesn’t mean it can’t be done. “Some employers are regretful about going all the way from DB to DC,” she believes, arguing that the proposed model “can almost be sold as a hybrid or collective scheme” which offers risk-sharing.

Not just employers, trustees might also have concerns about funding in case there is a market downturn, and because they will need to justify any decision to take extra risk if something does not work out. Members’ reaction may depend very much on what kinds of benefits they are entitled to, with those on DB only least likely to be in favour of moving assets to DC.

The seismic DB to DC shift that has taken place among the membership was illustrated by John Murphy, a trustee and HR director for South East Water, which has two mature schemes. Just nine years ago, a large number of employees were in DB, while only a few were in DC and a large group had no pension. 

As of 2019, the vast majority are in the DC scheme, with around half that number in the auto-enrolment scheme and very few having no pension, while DB was closed.

Murphy said about the Hymans model that “this opportunity should be used by any scheme to look after its people for a long time to come”.

One of the flaws of optimised run-off is that if a scheme were to adopt the approach, it could only distribute a DC top-up from the DB surplus for a period of time – until the surplus is used up. The model would be unable to benefit DC members more long term.

The approach, while showing good intentions in a world where DC members have drawn the short straw, has the characteristics of a sticking plaster - the real issue is the level of minimum DC contributions. 

Despite this, Silcock argued that optimised run-off, while temporary in its benefits, would be particularly useful at the current time because of the gaps in provision before auto-enrolment was introduced, appearing convinced that coming generations of DC members would benefit from future policy changes in the direction of higher contributions.