Good news on pension charges
Pensions Minister Steve Webb has published a consultation paper on charges for auto-enrolment pensions today, and the TUC has welcomed it.
Of course it is only a consultation so far, and there will no doubt much to watch for in the detail of the eventual proposals. It could also have happened a lot earlier – a point that applies to pensions ministers in both this and the last government. And the proposals could be tougher.
But this is still a big step in the right direction. From a big picture strategic standpoint it is right therefore to give it a welcome.Readers who have struggled through Third time lucky, the Touchstone extra pamphlet written by Craig Berry and myself will be familiar with our argument that we are slowly building a third post-war pensions consensus that can be made significantly more progressive than the second consensus, largely built during the Thatcher years.
The fundamental difference between the second and third periods is that in this new era we do not expect individuals to act as rational market consumers choosing to save now to build up a pension when they retire.
This second period assumption was a catastrophic failure and led to two out of three private sector workers making no contribution to a workplace pension. It did not work for two main reasons.
- Firstly people do not act in this rational way. Behavioural economics tells us that we simply do not make thought-through decisions to trade off income today against pension in the future.
- Secondly markets do not work for pensions. The recent OFT report was pretty scathing. Workplace pensions are chosen by employers not by the ultimate beneficiaries, and providers are far more powerful than employers. Mis-selling scandals have demonstrated how easily consumers can be ripped off.
Auto-enrolment – putting workers automatically into pensions, but with the right to opt out – is a recognition that market incentives to save for retirement do not work. It also compels employers to contribute to pensions for the first time – a big win for unions.
But if we are to use inertia to drive behavioural change we need to make sure that workers are enrolled into good quality and well run schemes.
There has been broad support for the structural changes underpinning the new arrangements – that’s why we can speak of a consensus. But it is taking time to think through all the implications of the new arrangements. I see a charge cap as a logical implication of the work done under the last government by the Pensions Commission, but if a cap had been proposed at that time it could well have derailed the patient consensus building that was needed, which in turn could have stopped the whole project being taken forward by the coalition government. Even the OFT report, despite much clear thinking, came out against a charge cap, so we sometimes have to wait for the logical consequences of the new approach to work through.
But while it is possible from the great height of my kind of broad policy perspective to warmly welcome the direction of today’s announcement, we need to take care of the detail. Too many players in financial services have a long history of gaming regulation and getting round the spirit of reform.
So here are some more detailed points on charging that must be got right too:
- A 0.75 per cent cap would not be a bad starting point but it will need to come down over time. Both NEST and some commercial providers are already offering 0.5 per cent, and while both capacity constraints and costs will deter many suppliers from offering schemes to the smaller employers yet to auto-enrol (the process is being staged through til 2017), it needs to be made clear that 0.75 per cent is only a starting point.
- We need to have a comprehensive definition of charges. At present some costs of running pension scheme investments -such as the costs of buying and selling assets – can be paid through reduced returns rather than a transparent charge.
- We need to ban any attempt to recoup costs to employers or fees paid to employer advisers through commission or charges deducted from – or on top of – the capped charge.
- We need a ban on deferred member penalties – higher charges for people who leave their savings in a previous employer’s scheme to which they no longer contribute, charmingly known as active member discounts by the pensions industry.
As well as getting these details right we should also press for all such regulations to be part of a wider strategy to fully realise the potential benefits of third consensus institutions. This means testing all proposals against a number of criteria:
- Will they drive scale? Big pensions schemes are cheaper per member to run.
- Do they drive good governance? A large part of the market failure in pensions flows directly from the fact that contract based pensions are not run by people whose first duty is to scheme members. Schemes run by Trustees have this as their primary duty. Welcome though much of the OFT report is, they do not do enough to drive this alignment of interests.
- Will they produce better pensions? The key here is increasing contributions, but reducing charges, sharing risk and improving the way that pension pots build up while working are turned into post-retirement income are also vital.
Next week the minister is due to publish more on plans on so-called defined ambition which we hope will be another stage in realising the full implications of the new approach.
One of the iron rules of modern politics is that the role that unions and the TUC play in shaping public policy is never acknowledged. For some unions are simply the devil incarnate while even those more on our side are nervous of paymaster taunts. Yet just as the minimum wage is now consensus, so is now a new approach to pensions based around auto-enrolment, a recognition of market failure and the need for consumer protection through strong regulation. Of course unions have not been the only organisations advocating this new approach, but we can be proud of the role we have played while never complacent about how much there is left to do.