Redesigning pension benefits

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A company in the consumer goods sector was keen to retain a DB pension design but needed to manage down both the level and the volatility of the cost of future accruals under its existing DB scheme.

Making DB sustainable

Whilst the pensions industry has generally welcomed the Government’s recent focus on “defined ambition”, the reality is that there is already considerable flexibility within the existing legislative framework to design risk-sharing solutions.

Although the fine details of the company’s new pension benefits are still to be finalised, it will involve:

  • a move from final salary to career average
  • a reduction in accrual rate
  • an end to contracting-out

as well as, possibly, the following additional features.

Funded discretionary increases

In the event that actual scheme experience is in line or better than the funding assumptions, discretionary increases could be awarded. Conversely, if actual experience is poor, discretionary increases would not be awarded and the “saving” would help address any financial strain arising from the poor experience.

The funding of discretionary increases therefore creates a “funding cushion” that can absorb considerable volatility. Pre-funding also avoids additional accounting costs in the years when discretionary increases are awarded, as the impact comes through each year in the service cost.

Longevity adjustment factor (LAF)

The introduction of a LAF for future service means that the benefits paid at retirement can be adjusted if member longevity in the future is different from the funding assumption. If properly designed, a LAF can effectively remove most of the financial risk to a company of higher than assumed life expectancy in the future. However, it will not address the risk for pension earned prior to the LAF’s introduction.