When the government decided to bow to the reality of increased longevity and scrap the default retirement age (DRA) in January, it took away one of the fundamental building blocks of final salary pension schemes. The DRA officially ends on 1 October this year, but transitional arrangements kick in from the start of the new tax year on 6 April, which leaves employers little time to sort out what this means to them and their occupational pension schemes.
There are a number of questions that spring up once the DRA falls away. First is the need to sort out what has to be done to bring someone’s career with a company to an end. This is only indirectly a pensions question; it is first and foremost an employment question and an HR nightmare.
It is also, rather menacingly, an employment law issue – particularly if you get it wrong – with a hearing before a tribunal on an age discrimination claim awaiting, in all probability.
This is a new problem. Until now, there simply was no issue. You could choose to allow someone to keep working beyond retirement, but they had no right of continued employment. No dismissal was necessary. Employees just went, or they asked to stay. You said yes or no, with no possible grounds for argument from the employee’s side. All that has now been swept away.
Employers can still operate a compulsory retirement age, but only if they can objectively justify it. Physically demanding jobs would be a case in point, as would physically dangerous jobs where good co-ordination and personal fitness were vital. But for most companies with white-collar employees? Forget it.
The next question is very much pensions-related. The concept of a “final salary” is at the heart of final salary pension schemes. Scrapping the DRA does away at a stroke with that neat point in time where you could pencil in a guestimate for Joe Blogg’s final salary. That guestimate is no longer relevant and you will have little luck trying to replace it with a question like: “When, exactly, do I think Bloggs is likely to retire?”
However, Alex Waite, partner and head of corporate consulting at actuaries Lane Clark & Peacock, counsels not to make too much of this fuzziness in end dates. In reality, it has always been difficult to work out the real value of final salary scheme liabilities since no one really knows in 2011 what salaries are going to be like in 2041. We might have near-stagnant growth for 30 years, or we might have one or more intensive bursts of high or even hyper-inflation: the outcomes for each scenario would be wildly different. Add to that the fact that people have never routinely worked until 65. They often take early retirement, which throws the numbers out.
There is somewhere to look for a test case: Waite points to the fact that the US did away with the DRA many years ago, and employers worked out how to cope there.
“My stance on this is to encourage good employers to think about how they can help their employees to retire at a realistic age. Realistic here means that you have to have performance-related criteria you can judge against,” he says.
The logic of the law that now confronts employers is about performance rather than age. Companies will have to sharpen up their act in terms of specifying workable definitions of the performance that is expected from the various roles within the organisation. And they also will have to have processes in place for applying that performance-measuring standards both fairly and reasonably.
Moreover, Waite says, companies will need to change their current thinking about their goals. If employees are going to have a protracted older age with the company, organisations are going to have to think about the possibility of standing career progression on its head. They will have to start managing people down the organisation again, to less stressful and demanding, but still useful jobs.
“We are going to have to go beyond the upwards-only career path,” he says.
Unfit for purpose
Another important consequence of the scrapping of the DRA is bound to be an accelerated closure of existing final salary schemes. However, as companies shift people over from defined benefit (DB) to defined contribution (DC) schemes – which generally are worth less and attract lower employer contributions – it is going to become more obvious that retiring at 65 would not be an option for many people anyway. People will find themselves with a significantly reduced pensions pot, and they will have to find work to supplement their income between the ages of 65 and the point at which it is actually financially feasible for them to retire.
Kevin Parry, chief financial officer at asset management company Schroders, says that he welcomes the end of the DRA as “fundamentally a good thing”. He suggests it could be part of a much-needed broader revision.
“Retirement was set in law in most countries for a very long time and it has to be adjusted to reflect the realities of change,” he tells Financial Director. “Plus we are going through a change in attitude as to the contribution that older staff can make to the organisation’s business goals.”
Parry points out that the whole concept of a final salary pension scheme had its genesis in a society that was very different from the working world we face today.
“Defined benefit schemes came into existence at a time when people stayed with one employer for a lifetime, or at least for a very significant period of time. Most of us just do not work that way any more,” he says. “Those schemes were fit for purpose for a very long time, but that time has passed.”
Schroders has a fully funded final salary scheme and has managed to maintain its scheme in that fully funded state by using liability-driven investment strategies and derisking the scheme in a variety of ways. “
“Our investment management side pioneered the idea of a ‘flight path’ which takes any scheme from its current position to one where it has been managed to buyout, or to where it is no longer a concern,” says Parry. “Internally, we were among the first organisations to adopt that approach, starting several years back. As a result, we have not seen the volatility in our scheme that others have suffered in the last few years.”
However, Parry warns that finance directors have to be particularly cautious about saying that they are out of trouble with their DB schemes, no matter how good things currently look. A sudden spike in inflation can easily turn a reasonable surplus into a frightening deficit. There are also lifestyle factors – such as how long people are likely to live – that could make a scheme look vulnerable, even one that is out of trouble for now.
See you in court
Deborah Cooper, partner at consulting firm Mercer, says that there is no doubt that companies are going to have to go through a learning curve with the end of the DRA.
“We expect to see an upsurge in age discrimination tribunal cases. Employers are going to have to get much better at performance-rating their workforce and we see the end of the DRA as being extremely onerous for the small- to medium-sized company to respond to properly,” she says.
In all probability, Cooper warns, we are likely to see a whole new service industry come into being which will cater for older people who want to complain that the right processes have not been followed before their company terminated their employment. Competence and age are very difficult to separate.
“How do you decide that someone is less good now at what they are doing than they were a year ago?” she asks. And if the only way of getting rid of someone is a charge of incompetence, then that is a tragic way to end what might have been a long career of faithful service to the organisation.
Existing pension plans that have the DRA tightly scripted into them are exempted. But Cooper points out that employers have a decision to make as to how long they will continue to pay into retirement schemes.
“Age-related benefits such as permanent health insurance and group life cover will all need to be re-examined,” she says.
With the deadline so close to hand, then, how urgently are companies bestirring themselves to get to grips with the demise of the DRA? According to Fraser Buck, managing director of pensions advisory Buck Consulting, there is no real sense of urgency yet.
“At this stage, clients have a broad interest in the subject, but the amount of detailed planning that is going on is very limited,” he says. Companies have a more urgent issue than anything relating directly to pensions which they must face up to here, adds Buck – namely the fact that they are going to have to get accustomed to dealing with an older workforce. “This is something many of them have not reconciled themselves to,” he says.
It is probable that many managers are, even unwittingly, heavily biased in favour of thinking that energy, dynamism and a strong positive contribution to the organisation’s goals is the exclusive preserve of youth, or at least of people under 40. Changing the mindset of management promises to be a great deal more difficult than adjusting the pension fund dynamics.