Compulsion and consumption on the agenda at British Academy pensions conference
Earlier this week the British Academy was host to Redefined Benefits: Twenty-First Century Pensions, a one-day workshop on the government’s ‘defined ambition’ agenda organised by Dimensional Fund Advisors.
The event featured a keynote address by Steve Webb, who reiterated his support for the ‘pot follows member’ solution to the small pension pots dilemma, but the key theme among other contributors was perhaps the extent to which better retirement outcomes are dependent on greater scale within pension funds, and higher contribution rates by individuals.
There are appear to be two prevailing assumptions among the pensions industry on how better retirement incomes can be achieved within defined contribution pension schemes:
1. Larger scale funds require compulsory pensions saving – because scale, and therefore the efficiency gains, would be in jeopardy if people could opt out of saving at any given moment.
2. Irrespective of how schemes are designed, the main determinant of retirement outcomes will always be the extent to which people are willing to forgo their current income for a higher income in the future (i.e. the ‘contribution rate’).
Different stakeholders within the industry tend to emphasise one of these conditions (although not necessarily both) as more important than any of the clever scheme designs that ‘defined ambition’ might come up with. Either alone or in combination, these assumptions uphold the message that the responsibility for good pensions lies with individuals themselves, and that better scheme design might therefore rely on compelling individuals to save more.
The logic of this argument is, at best, too simplistic. Because there are a further two, more silent assumptions at work:
3. Only individuals are responsible for contributions into workplace pensions – as such the crucial role of ‘employer contributions’ is being overlooked.
4. Individuals could easily increase their contribution rate as a matter of personal preference.
Neither of these assumptions hold up to scrutiny. First of all, we have much to learn, it seems, from the Netherlands. Although Dutch pension schemes, which are larger in scale and have much higher contribution rates, are often pointed to as an ideal model for the UK to mimic, Stefan Lundbergh (Head of Innovation at Dutch pensions giant APG) told the workshop that governance is a fundamental pre-requisite of achieving scale and higher contributions.
Trade unions have persistently argued that the governance arrangements in defined contributions are inadequate, with most workers set to be auto-enrolled into contract-based schemes which are plagued by conflicts of interest when it comes to protecting members against consumer detriment. According to Lundbergh, governance comes first. It is only by establishing schemes in conjunction with social partners (such as trade unions) that Dutch employers have been able to ensure mass engagement among employees.
The pensions industry could also learn something from my colleague Duncan Weldon, whose recent post on the economic recovery demonstrated the fallacy of assuming that increased saving is a likely or even desirable outcome for the UK economy in the short-term.
We know that wages are stagnating. The cash that individuals (particularly low earners) are not saving into a pension is not exactly being frittered away. It is being used to sustain standards of living. In macro-economic terms, it is being used for consumption – and consumption is an investment in the economy that we can hardly do without at the moment, as Duncan outlines here:
[Consumption] is such a large component of the economy that even rapid growth in business investment and exports are unlikely to offset weak household spending. Simply put, to add 1% to overall GDP growth, household consumption needs to increase by just 1.6%. To do the same, business investment needs to rise by 12.6%. Even if business investment booms ahead with growth of 15% a year, it won’t be enough to secure a decent recovery unless household consumption is doing better than it is now – especially against the headwinds of fiscal austerity and a tough export environment.
Estimating the overall growth profile of the UK economy over the coming three or so years is really an exercise in estimating the profile of consumption growth. Better than expected, or worse than expected, export and investment performance will affect overall growth but the difference between a weak recovery and a stronger one will be found in consumption.
As such, the Office for Budget Responsibility has since March 2012 identified household spending as the major driver of economic growth.
So here’s an idea that might help: depending upon the lessons from the early experiences of auto-enrolment, contributions into workplace pensions could become compulsory for employers, even if employees opt out. After all, the notion of an ‘employer contribution’ is already an exercise in doublespeak, given that employer contributions into pensions are part of a worker’s remuneration, and therefore arguably belong to them even if they choose not to invest a portion of their basic pay into a pension.
Given that inducing opt-outs from auto-enrolment is illegal, employers should of course be prepared to invest into their workers’ pension pots. It would be unwise for them to expect opt-outs, and ideally they should be promoting the benefits of pensions saving among their staff.
Automatic enrolment is probably going to be a drag on earnings over time (which demonstrates decisively that pensions are an aspect of pay, not a benefit on top), but this drag will obviously be felt by workers who opt out as well as those that stay enrolled. So ensuring that employers contribute irrespective of employee contributions is arguably a question of fairness.
There is an interesting parallel here to the debate on how much the minimum wage should be in light of auto-enrolment. Employers argue that any increase in the minimum wage should take into account the costs to business of auto-enrolment – even though people earning the minimum wage or just above are unlikely to automatically enrolled into a pension scheme due to the earnings thresholds in place.
There are no easy solutions the UK’s pensions crisis. Automatic enrolment is an important step forward, but not sufficient alone. Attempting to solve pensions problems without reference to wider economic realities, and shifting the responsibility for success onto individuals rather than the operation of the pension system as a whole, would be unfortunate mis-steps as we embark upon the next phase of pensions reform.