Pensions consensus at a crossroads
The introduction of automatic enrolment and the coalition government’s proposals for a single tier state pension appears to have secured the onset of a new era in UK pensions provision. Although some of the details underneath both policies are problematic, we now have a unique opportunity for progressive change that we must grasp.
Auto-enrolment and a single tier state pension are the central tenets of what Nigel Stanley and I call the third consensus in post-war pensions policy in the UK. You can read the argument in full in our Touchstone Extra pamphlet, Third Time Lucky. The third consensus has been spluttering into existence ever since the Pensions Commission, chaired by Adair Turner, wrote the obituary for the second consensus in 2005.
But let’s start with the first consensus. In the immediate post-war era, employees could build up a generous state retirement pension through their National Insurance contributions (NICs). Outcomes were based – as they remain today for the most part – on the length of time spent in work, and the benefit kept its value once in payment through being linked to rises in average earnings.
On top of this many people at work (or perhaps more accurately many men) had the opportunity to build up an occupational pension linked to their earnings, usually their final salary. Crucially, responsible employers saw it as their duty to provide such pensions. And in the 1960s, when occupational scheme membership was at its peak, Barbara Castle added to state provision an additional pension for those with no access to an occupational pension through their work. This too was linked to earnings and was thus called SERPS – the state earnings-related pension system.
Unfortunately, the first consensus was based on a ‘male breadwinner’ social structure that bears no resemblance to modern life. Many people, such as those without a long history of labour market engagement, fell through the cracks in first consensus provision. Employers became less and less willing to provide guaranteed pensions as part of a social wage as the workforce expanded, manufacturing declined and international competitive pressures increased.
The first consensus, however, was replaced by something palpably worse. The Thatcher government eschewed collective pension provision altogether. They allowed the value of state pensions to erode, and encouraged individuals and employers to ditch earnings-related occupational pensions in favour of riskier ‘defined contribution’ investment products. Pensioner poverty levels increased enormously, and the private pensions system became engulfed in mis-selling scandals.
The Labour government in office from 1997 sought to correct some of the flaws of second consensus provision, but left its basic structures in place. They strengthened the safety net of means-tested benefits for pensioners in poverty, but left the contributory state pension largely untouched. They sought to increase access to a workplace pension scheme, but did little to regulate the defined contribution marketplace that left individuals to fend for themselves.
Saving rates continued to fall and pensioner poverty persisted. In an ageing society, both problems would soon become increasingly acute without a different approach. In pensions policy, because policy change take decades to work through into practice and outcomes, and because the system depends on the co-operation of many different parties, we must always start from where we are. This is why the Pensions Commission essentially accepted the emergence of defined contribution pensions. But they insisted that employers contribute to their workers’ pension pots above minimum levels, and they established NEST as a government-sponsored default provider to set a benchmark for the rest of the pensions industry.
The Pensions Commission also recommended that state pension provision should become simpler, to provide a solid platform for private savings, and at the same time more generous to people contributing to society beyond formal labour market engagement. The government’s plans for a single tier state pension upholds the same principles, but is far too cavalier about the messy legacy issues that convinced the Commission to establish a very gradual path towards a universal, flat-rate state pension. And it will be set at a level far too low to achieve its objectives in a fair manner, ultimately undermining people’s willingness to save privately.
Few people would design from scratch the pensions system that we have now. But going back to the drawing board is not a realistic option. Instead, we have to seize the chance to make the third consensus work. We believe we are at a crossroads between a positive path, where defined contribution pensions dominate but are governed in the interests of savers, and there is a progressive incentive structure to encourage saving – or a negative path upon which standards and contributions are levelled down to the statutory minimum. In this scenario, employers would discharge their duties through products with weak governance and high charges, and workers are unwilling to put a greater portion of their income at risk.
The key is ensuring the correct alignment of interests. Employers have a strong interest in providing good pensions for their workers, but not in shouldering unknowable risks and taking on high administrative costs. Individuals have an interest in saving more towards a decent standard of living in retirement, but not in untrustworthy products where their savings are subject to high charges. The pensions industry has an interest in the success of auto-enrolment, because it will hugely expand their customer base – but this means we must end the asymmetrical consumer/provider relationship whereby the industry can exploit the general public’s inherently limited knowledge of pensions saving.
Third Time Lucky outlines some of the policy measures that are necessary to align these interests. The coalition government is actually in the right place on some of these issues, for example the recent announcement banning consultancy charges. But on some issues, such as their plan for small pension pots, they remain wedded to a flawed second consensus philosophy.
It is also well worth reading Labour’s take on where pensions policy goes next, as outlined by shadow pensions minister Gregg McClymont in Pensions At Work, That Work. McClymont’s plans for cost transparency, trust-based scheme governance and an end to the restrictions on NEST would go a long way towards setting the third consensus on the right path.