Will the coalition destroy the 2012 pensions consensus?
The Government’s review of workplace pension reforms is now on its final stretch, and is due to deliver its final report towards the end of the month.
I have no insight into what they are likely to say, although there is clearly heavy lobbying from the pensions industry to rip the settlement to pieces. Here’s an example from today’s Daily Telegraph.
But I do hear disquieting rumours that substantial changes for the worse are being considered by the review. If these are true and the government accepts them then it is hard to see how we will be able to talk of any kind of continuing consensus around pensions reform.
This is an important issue, but inevitably full of somewhat technical detail. It’s probably best therefore to have a brief recap of what is currently planned for 2012.
The changes flow from the recommendations of the Pensions Commission chaired by Adair Turner (in the news this week as it was the cause of one of the biggest Blair/Brown rows). The Commission recommended a new pensions system based on a better state retirement pension as a foundation and then a workplace pension on top of that.
The improvements to the state pension have now largely been adopted. Qualification rules have been changed to make it easier for women to qualify for a full state pension and from nest year it will once again be linked to the higher of earnings, prices or 2.5 per cent. (Though it is not all good news as prices – the only measure for uprating the state second pension/SERPS – will now be based on the meaner CPI measure) .
There are two main planks to the workplace pension reforms:
- Nearly every worker will be auto-enrolled into a pension scheme by their employer when they start work (exceptions include the young and the very low-paid). Both employers and workers will then pay contributions on a band of earnings (roughly £5,000 to £35,000), unless the worker makes a positive decision to opt-out. The contribution rate on the earnings band for employers is three per cent and for employers four per cent. The government will contribute a further one per cent in tax relief.
- A new low cost pension scheme particularly designed to serve the needs of low to medium earners will be established. While set up by government, it will be run independently by trustees. It will be the default option for employers who do not choose an alternative pension scheme and for employers who commercial pension companies would not serve as they would not turn a profit. This scheme, now called NEST, is gearing up for launch.
Whatever emerges from the review some element of auto-enrolment will survive as this is included in the coalition agreement.
But almost everything else is up for grabs.
This is the worst case scenario.
Firstly small firms are exempted so that employers with five or fewer staff do not have to auto-enrol. At a stroke this stops the reforms adding up to a new pensions system for everyone at work. It also introduces a bizarre incentive for small businesses to remain small. Take on that sixth member of staff and you will have to pay contributions for the lot.
Secondly low earners are excluded by raising the auto-enrolment threshold to £10,000 or even £15,000. Most of these will be women working part-time thus ending the particular efforts of the Pensions Commission to give women a fairer deal and more economic independence.
At present the auto-enrolment threshold is the same as that of the bottom figure of the earnings band for contributions. Anyone who earns more than £5,000 is signed up for a pension, and then pays contributions on every pound they earn over £5,000 (actually the figure will be higher by the time the scheme is due to start, but round numbers make this easier to grasp).
If the earnings band is also raised to a new higher threshold then it will very significantly reduce the value of the pensions that people build up. This would fail to meet the Pensions Commission’s target for income replacement, and mean most savers would retire with a much smaller income. If the earnings band stays at the same level and the auto-enrolment threshold goes up then we have some further perverse disincentives. Employers will want their staff to earn less than £10,000 a year as then they won’t have to auto-enrol them. Workers may be more tempted to opt-out as when they go over the threshold they will see a significant chunk of earnings removed as they 4 per cent of all their earnings between £5,000 and £10,000 is taken out of their pay packet.
I suspect this latter scenario is the right one.
First reducing everyone’s pensions as raising the earnings band would inevitable do might be popular with employers but would likely go down badly with voters and the press.
Secondly it would give sections of the pensions industry and those parts of the political right who cannot accept that state action is ever required to remedy market failure what they want – which is the abolition of NEST. At the moment most pensions companies concede that the industry cannot provide a universal service to all employers, however small and disorganised, and millions of low paid employees with small pension pots.
But take away all the difficult small businesses and all those low paid part-time women workers and perhaps they can make a profit after all.
Auto-enrolment then gives the industry a huge boon. They no longer have to persuade individual savers that their pension products are right for them. They merely have to convince their employer who will then happily auto-enrol their staff in their pension product.
In the past workplace pensions were almost all run by trustees, with a legal duty to look after scheme members. But in recent years almost as big a change in the pensions landscape as the switch from DB to DC has been the switch from trust-based DC pensions to contract-based group personal pensions (GPPs).
In some way these look just like traditional DC schemes as employers and employees still make contributions into a fund run by an investment manager. But legally they are very different as they are really an aggregate of individual personal pensions. They do not really have members – or at least members with any meaningful rights as members – and crucially lack the protection of a trustee board.
You can see the attraction for the pensions industry – millions of new customers with little member protection acquired with minimal marketting costs and easy qualifying rules for schemes to meet the criteria for auto-enrolment.
If the pension industry had an enviable record for treating its customers well, rather than one of mis-selling and big fines, there might be an argument that this lack of safeguards is acceptable.
But they don’t, and it is very worrying.
Of course even with NEST, some staff would have been in GPPs. But the mere existence of NEST would have set standards. Its work on what kind of default investment fund best suits low earners and its low charges would have helped keep the new system honest.
But if NEST goes and million are excluded from auto-enrolment then the consensus starts to collapse. It is hard to see how unions and consumer groups can continue to support the new system if it is transformed from one that serves consumers to one that delivers easy customers to the pensions industry at the expense of the low-paid and women workers.
Consumer groups however are not without some power and influence. EU law protects consumers from inertia selling. Enrolling someone in a pension without asking them is a clear example of inertia selling.
However after the government and almsot every stakeholder group – including the TUC and other consumer groups – wrote to the EU saying that the UK reforms were not about inertia selling but introducing a new comprehensive pensions system, the EU wrote a “letter of comfort” saying that they would not ban auto-enrolment into GPPs.
While trust based DC is better, the TUC and other consumer groups joined this approach because of the quality safeguards we were promised, the existence of NEST as an exemplar and the strategic gain of a new comprehensive pensions system that compels employer to make contributions.
But under the worst case scenario it is hard to see how we could maintain support for the “letter of comfort”. The EU would be very likely to reconsider if the UK’s consumer groups objected to an exemption from what – after all – is a consumer protection measure.
And if this isn’t long and technical enough, you can read the whole TUC submission here on the spanking new TUC website.