The Death of Contracting-out, Life, the Universe and Everything

16th January, 2013

  • It would appear that the Mayans were in fact pension commentators; their calculations were not exact, just close enough for actuaries.  The end they foretold however was of contracting-out; not life, the universe and everything.  Although, having read some current commentary on the matter you would think that they were one and the same.

    We have been expecting the death of contracting out ever since the Government first started talking about a flat rate State Pension, we also knew the over reaction of the impact was equally inevitable.

    What does it actually mean?  DB schemes that are currently contracted out on a reference scheme basis will no longer be subsidised by the state to the tune of 4.8% of the band earnings of active members.  Whilst every little helps, in the current funding climate this is unlikely to make a massive difference to the finances of the few private sector schemes that are still open to accrual.  For public sector schemes (i.e. the vast majority of salary related pension provision) it makes no difference except in the accounting.

    What this does mean is that Trustees and Employers will have more freedom to negotiate future scheme design.  The current level of benefit accrual, indexation and contingent benefits will be more expensive but the government will again be responsible for providing some of those benefits.  Regardless of the political and macro economic intention of contracting out, the scheme design reason was to allow smooth amalgamation of Scheme & State benefits to target an aggregate retirement income.  If the state is providing more, the Scheme should provide less.

    There may be an educational hurdle here as the National Insurance rebate was seldom shown explicitly; many members will not recognise that this was included in their contribution rate and therefore were you to reduce accrual many will believe that they are getting less for their money.  In fact without benefit adjustment they will be paying more for well, more.

    What many employers and lay trustees possibly don’t realise is the added complexity and cost imposed by contracting out.  If they did it is possible that they would never have contracted-out in the first place.  We can but hope that the death of contracting out will open a discussion on the simplification of legacy contracted out liabilities, perhaps even the demise of GMPs.

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    • Published byGreig McGuinness

      Greig is an Accredited Professional Trustee with Dalriada having joined in 2008 from a large organisation specialising in pensions for the not for profit and charity sectors.  Since entering the industry in 1999, Greig has gained a wealth of experience...

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