Doubling DC pensions
Earlier today I spoke at the launch of Going Dutch – how to double the value of British pensions. This is a new report by David Pitt-Watson for the RSA that argues that the UK’s DC pensions could deliver much better pensions for the same contributions.
It’s an exemplary report – succint, well-written and carefully argued. I would urge anyone with a passing interest in pensions policy to read it.
The report argues that the DC schemes in which most people with pensions now save are extremely inefficient. There are two main areas of potential gain.
- Making schemes much bigger and ensuring that they are run by trustees in the interests of their members can deliver one lot of savings. Charges dramatically eat up investment gains – up to 40 per cent of potential pension – and if you can reduce charges through efficient management and economies of scale then you can deliver seriously better pensions for the same contributions.
- Making DC schemes collective so that members pool their resources and share risk can deliver a further increase in benefits. This would mean schemes provising their own pensions rather than compelling people to buy annuities.
All together these proposals could deliver pensions that deliver double the retirement payout, for the same contributions.
When autoenrolment starts in 2012 there is going to be a huge growth in DC pension saving. Much of that will be in NEST, but commentators often forget that much of it will be in other DC schemes. Some of these will be trust based employer sponsored occupational pensions, but the majority will be contract based group personal pensions sold by insurance companies to employers.
So while of course unions will continue to defend DB schemes where they exist, a much bigger proportion of the workforce will soon be saving in DC schemes and we need to give just as much attention – if not more – to improving these as we have traditionally done with DB pensions.
Indeed the main attraction of DB schemes to employees is that there is a degree of certainty about the pension that will be paid because the employer is underwriting investment and longevity risks. DC is at the other extreme, where the individual bears all the risk.
Realistically employers that have moved to DC for new entrants or who will be setting up DC schemes for auto-enrolment are unlikely to want to take any of the risk back (though that’s not an argument against unions making that case where we are organised.)
But the RSA proposals do allow for sharing of risk between members. Of course this has to be carefully handled, but big schemes can guarantee at least some benefits and end the annuity rate casino.
I welcomed the proposals at the launch, and said that the TUC wanted to see the potential benefits set out so well in the report made a reality.
The difficult question is how we get from where we are today to where we need to be.
We should be honest that the 40 per cent unnecessarily taken by charges goes to vested industry interests who will not want to give them up. While employers may well in theory want to see a better bang for their pensions buck, this does not mean that they will spontaneously get together to come up with better arrangements. Government has already got to deliver auto-enrolment and may well be reluctant to undertake further major reform.
It is going to take the same mixture of campaigning and consensus building that had delivered auto-enrolment and other reforms set out by the Turner Commission to achieve this vision. Supportive words at the launch from the CBI and the NAPF were a good first step. But I would make two proposals that might help achieve what we need:
- set a date for new conditions for pensions to be eligible for auto-enrolment that would include a tough cap on charges (perhaps phased in) and a requirement that pensions should be trust-based.
- use NEST as a model by lifting the cap on contributions and transfers in and out, and encouraging it to act as a collective DC scheme on the lines set out in today’s report.
If I have one minor criticism of the RSA’s work it is that it underestimates the role of NEST in the post-2012 world. It is wrong to describe it as a monopoly supplier with a state subsidy as is sometimes said. The justification for the state subsidy (which is only a soft loan, not a cash subsidy) is that NEST has a public service obligation to provide pensions to every employer, however small or disorganised.