Employers recognise that defined contribution schemes will provide inadequate pensions

Half of the senior financial executives who took part in a survey of their companies’ attitudes to corporate pensions have acknowledged that their defined contribution (DC) schemes will not allow employees to retire in comfort.

The latest retirement white paper from Fidelity International, the leading investment management and services group, also lays bare the challenges of managing the legacy of defined benefit (DB) pensions for UK finance directors.

The vast majority of the 100 UK companies surveyed by an independent consultancy commissioned by Fidelity said they remained committed to providing pensions for their workers. On average, when spread across the entire workforce, including those not in pension schemes, pension provision represents 6.9 per cent of salary costs.

However, this survey shows that spend is spread unevenly between employees. About 60 per cent of pension expenditure goes to the minority of the workforce in DB schemes. Of the companies polled, 35 per cent of their employees had DC arrangements, while just 22 per cent of workers were members of DB schemes. The sample represents one in ten of the UK workforce.

Simon Fraser, President of Institutional Business at Fidelity International, said: “Finance directors are in the invidious position of knowingly providing many of their employees with an inadequate pension. This may reflect the burden of resolving the DB deficit for so many companies. Employers spend, on average, 50 per cent more on DB schemes than on DC arrangements.

“Against this backdrop, one might expect finance directors to be rushing for the exit – but they’re not. Employers see value in offering pension schemes, but there is a fine balance – they need to find a way to offset their defined benefit scheme legacies by controlling costs and reducing risks – which many are doing with the increasing use of contract based plans.”

Wide disparity in contribution rates by industry sector

The study also reveals wide disparity in contribution rates across industries, in the financial sector employers in DB schemes face costs of nearly 25 per cent of salary in pension contributions, whereas employers of DB schemes in the telecoms industry make contributions that equate to an average of 12 per cent of salary. The rates payable are driven by a variety of factors, but clearly DB schemes are weighing more heavily on some industries than others.

The discrepancies may have historical causes. For example, IT companies are newer and tend not to have the same DB legacy as other sectors. Yet it remains a concern that these newer sectors do not demonstrate a corresponding level of commitment to other types of pension schemes, including DC. While it may not be a fair comparison to look at DB versus DC contributions, it is clear that with an average DB contribution of 19 per cent against the average DC contribution rate of 7 per cent, that DC schemes are a much lower cost to employers at present. (See attached table for details).

Worryingly the report also illustrates the extent to which employee contribution rates are much lower in DC schemes even though their employer contribution rates are already lower than their DB equivalent. Either the benefits of the pension scheme are inadequately communicated or employees are following their employers’ lead and paying in less.

Simon Fraser says, “Higher contribution rates do not automatically mean that employees enjoy superior retirement benefits: companies may simply be making good deficits. That said, contribution rates remain a reliable yardstick of the quality of an employer’s commitment to pension provision.

“Individuals who choose a career in IT, for example, should be aware that they will need to take a far more active role in saving for their retirement. Improving employee appreciation of pensions is critical. Communicating the benefits of a good pension scheme is key to making this happen.”