The CBI’s strange position on NEST charging
I’m genuinely puzzled by why the CBI published this. Not only are its arguments flawed, but I do not see what purpose it serves.
But first here is a little background. NEST is the body set up by government to provide low cost pensions to employers who do not choose another pensions suppliers once the duty on employers to auto-enrol their staff and then contribute to their pensions starts in 2012.
While independent of government, it has a very definite public policy purpose and mission set by the various recent Pensions Acts. Its duty to be the default provider of pensions means that it has a public service obligation to accept any employer however small, disorganised or expensive to service. It will be the only pension provider that is both limited in the contributions it can receive (with a maximum annual contribution) and forbidden to accept transfers in or out. It has a mandate to target low to moderate earners who have been comprehensively failed by the existing pensions industry.
But although it has these limitations and public duties it is expected to be entirely self-financing. The Pensions industry lobbied hard to ensure this – much of which is made up of CBI members. They had the support of the Conservatives, and there may be EU state aid issues as well.
That means that NEST needs to borrow money to set itself up and repay the loan from charges to its savers.
The traditional way of charging for pensions is through an Annual Management Charge (AMC). This takes a percentage from each person’s pension pot every year. To give an example stakeholder pensions that were set up in the early years of the Labour government as a low-cost product are capped at 1.5% for the first ten years and 1% thereafter.
The target charge for personal accounts (which is what NEST pensions were once called) in the Turner Commission report was 0.3 per cent AMC.
But NEST has a particular problem in raising funds from an AMC. Initially funds will come in very slowly as contributions are being both phased and staged. The pre-budget report extended this by a year so that full contributions will not be paid until 2016. There will be a good few years when only some employers and employees are paying only one per of their earnings.
An AMC of 0.3% of not very much raises diddly squat, leaving NEST highly leveraged and landing ASMC payers with a high borrowing costs. The decision was therefore made to add to a 0.3% AMC a 2% contribution charge in NEST’s first 20 or so years. This has the advantage of raising more money in the early years as a contribution charge does not depend on funds building up within NEST.
(I welcomed the charging structure here.)
This means that early savers will be charged 2% of their contributions plus 0.5% of their pensions pot each year. However it should not be forgotten that the state will also be paying tax relief into the pension pot. When contributions have built up to their full amount employees will pay 4%, employers 3% and the state will pay 1% of a band of earnings. The state is therefore paying 12.5% (one eighth) of total contributions.
You can’t simply work out what the dual charge would be is it was changed into just an AMC as it will vary over time, but on average it is probably around 0.5% to 0.6% – more for short-term savers, less for long-termers.
The CBI’s case is that:
The Government’s new workplace pension scheme could deter millions of savers because of its high and complicated charges…
Businesses are worried that staff, and particularly the lower paid, will baulk at the proposed charging structure of the National Employment Savings Trust (Nest), which loads fees towards the earlier years after a pension is opened.
And in the brief they say:
Low cost private schemes will deliver better value for money for a long time
I think these claims are nonsense – and worse – the CBI do not say what should be done instead, which does seem to be a basic duty on players in public policy debates (though I am sure there are examples where we have just whinged too!)
First I do not think that anything other than a tiny minority of savers understand the charging structure of pensions, so the idea that a dual charge in itself will deter seems to me to be very contentious.
Second, it is misleading to say that NEST savers could easily find better value. NEST pensions are inevitably going to be mainly taken up by small employers and the low paid. This is precisely the group that the pensions industry does not serve – it’s the market failure that led to the wide consensus for setting up NEST in the first place. The best this group can get are stakeholder pensions – and they start with a 1.5% charge.
I am not the only person puzzled by this stand. Here is the much quoted Tom McPhail of the mega-IFA Hargreaves Lansdown, who is not always on the same side of arguments as the TUC.
Hargreaves Lansdown head of pensions research McPhail accused the CBI of being divorced from reality – arguing that the average scheme member had “precious little understanding” of the minutiae of pension charges.
He also hit out at the business representatives claim that NEST was poor value compared with “a pension with significantly lower average charges”.
“Let’s ignore for a moment the logical absurdity of making such a statement and consider where investors are supposed to find such a pension? If such an option does exist, then it is keeping a remarkably low profile.
“By comparison with NEST, stakeholder is obscenely expensive. The people NEST is designed for are not currently being offered a low cost, top of the range company pension scheme – in fact most of the time they aren’t being offered anything at all. Even with the 2% initial charge, NEST works out at the equivalent of 0.5% per annum and that is very good value.”
And what would the alternative be?
There is a strong case for paying at least some of NEST’s start-up costs from taxation because it is serving a public policy purpose and because its ability to compete with existing pensions schemes has been hobbled by industry lobbying. But I doubt that this is the CBI’s position. It certainly wasn’t when the legislation was going through parliament.
I suppose we could have had a higher AMC but that would mean that NEST’s borrowings would be higher for longer – and that would not help the deficit, which the CBI is keen to see come down quickly.
While I am critical of this particular CBI initiative, it is right to say that they did get the much bigger question right.
Their support for auto-enrolment and a compulsory employer contribution was crucial to making the 2012 settlement a reality. And while we have not always agreed about the detail of implementation there is a strong core of agreement between the TUC and CBI on making 2012 work. This has led to some constructive give and take on both sides as plans have become reality – some real social partnership you might say – and I am sure that spirit can survive this issue as there are other issues where social partnership needs to work for pensions – such as improving DC.