UK-Based DC Schemes Badly Under-Funded, Says Mercer

Far too little is being saved in defined contribution pension plans to provide a decent income in retirement, according to a Mercer survey of over 450 employer sponsored schemes in the UK. The survey shows that DC schemes many of

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Far too little is being saved in defined contribution pension plans to provide a decent income in retirement, according to a Mercer survey of over 450 employer-sponsored schemes in the UK. The survey shows that DC schemes – many of them newly-established – receive employer contributions averaging just 6% of salary – less than the 6.3% in a previous survey two years ago. Average employee contributions are 3.3%, producing a total contribution of just 9.3% of members’ annual salaries.

“This is what we feared,” says Tony Pugh, European Partner at Mercer Human Resource Consulting. “Contribution levels are not going up despite the increasing cost of pensions and the need for people to save more. Many will face the choice of a longer working life or a smaller retirement income dependent on the State. The main concern must be that employers are switching from final salary to defined contribution schemes and, at the same time, reducing the amount of funds they contribute. In the current economic environment, the amount is often half what they would have to provide for final salary pensions.”

Mercer says that, after allowing for reductions in National Insurance contributions, most employers with final salary schemes need to contribute at least 12% of members’ salaries to fund their pension promises. This compares to the average of 6% that employers currently pay into defined contribution plans.

“It’s understandable that many employers have cut contributions to reduce the current drain on their finances,” says Pugh. “But members need to be made aware of the shortfall this creates. In defined contribution plans, individual members have to make up the difference. Up to now, the reduction in pensions has gone largely unnoticed as, so far, only a minority of members have reached retirement age in these schemes. But this is about to change. Under new legislation next year, scheme members will receive benefit projections that will reveal the true extent of the shortfall.”

The requirement for plans to provide projected pension figures is being introduced in April 2003. In a sample case study, Mercer calculates that a 45-year-old man joining a defined contribution plan and making total contributions of 9.3% of salary, would receive an expected pension of 14% of his final salary, on retiring at age 65. This compares to an expected pension under a typical 60ths final salary scheme of 33% of salary.

Mercer’s survey shows that employers in the banking and finance sector pay the highest contributions to DC plans – an average of 8.1%. This compares with the food and drink, transport and publishing industries which contribute just 4.4%, 4.6% and 4.9% respectively.

The research also noted a change in the basis on which new, defined contribution plans are being established. Since April 2001 nearly 70% of new plans have been set up on a contract basis as either a group personal pension or a group stakeholder plan.

The launch of stakeholder pensions in April 2001 has had a profound effect on the use of contract defined-contribution plans and ‘bundled’ services,” says Pugh. “These plans are less likely to adopt active management of their plan, as they operate without trustees representing the interests of members and monitoring performance. Employers are also less able to influence operational aspects such as communication with members. Compliance with financial services regulations means that providers’ communication is often tied up with compliance and regulatory warnings.”

A further trend is that very few of the newly-established defined contribution plans are contracted out of the State Second Pension. Since April 2001, only 6% of the new plans surveyed are contracted out.

“Today, contracting-out is not an attractive option because of the regulatory complications and the fact that government incentives are seen as a poor deal,” comments Pugh. “What started as a trickle of occupational schemes contracting back in has now become a flood, as more employers switch to defined contribution schemes. It certainly flies in the face of any government attempts to shift the pension burden away from the State.”

The survey was undertaken during April and May 2002 and covered over 450 UK respondents with representation across more than 15 industry sectors. The UK plans surveyed had total assets of 4.1bn and covered 200,000 employees.