Is a new consensus emerging on how we pay pensions?
It is not often that someone from the TUC is invited to write a foreword for a pamphlet published by the Centre for Policy Studies – a think-tank whose website is headed by an approving quotation from Margaret Thatcher.
But then it is something of a surprise – and to their credit – that the CPS would publish something critical of one of the Chancellor’s key policy initiatives – the so-called freedom and choice pensions agenda – so close to an election. The Treasury will not have been pleased to read in the Daily Mail: Pension reform ‘to have ghastly consequences’.
The pamphlet’s author, Michael Johnson, would resist a political label. On some issues – recognising market failure in private pensions provision and the unfair way pensions tax relief is skewed towards the better off – regular Touchstone readers would be likely to agree with him. On the other hand he is a fierce critic of public sector pensions.
What is significant about this pamphlet is not the detail of Michael’s suggestions – interesting through they are – but his strong recognition that we need defaults in decumulation and public policy initiatives to ensure savers get a fair deal. People can have freedom and choice to move away from these defaults if they wish – just as they can opt-out of auto-enrolment or choose a non-default fund for their savings while they build up a pot during the accumulation phase.
As I say in my foreword below, this is further evidence of a growing consensus around the need for defaults as more and more people see the potential for a free for all going badly wrong.
Working out exactly what those defaults should be is not easy. The NEST consultation and the David Blake study at the Pensions Institute are going to be very helpful in thinking that through. My own view is that those with a big enough pot to provide a reasonable boost to their income in retirement will be best served by a mix of investment risk-sharing and longevity pooling within a collective fund – though I willingly concede that the devil will be in the actuarial detail.
But it is establishing the need for defaults that is the political priority and which is why I was happy to write the foreword (not to mention taking just a little bit of pleasure in writing an attack on market excess in the 1980s in a CPS publication).
And this is what I wrote:
DECUMULATION NEEDS CONSENSUS
Nigel Stanley, Head of Campaigns and Communications at the TUC
The Chancellor was right to see that the annuity market was not working, and that there is more than one way to turn savings built up while you are working into income when you retire. His Budget announcement of the freedom and choice agenda certainly hit the headlines the next day.
But good budget headlines can melt away when policies are tested. The worry must be that leaving new solutions to a combination of market innovation and individual responsibility is likely to be a triumph of hope over experience. This, we should not forget, was the approach to pensions reform in the 1980s that failed in two ways.
First, it was a textbook example that real people do not act like the idealised ones described in the simpler economics textbooks. All of us find it hard to weigh up the benefits of giving up income today in order to take cash later in life. Combine that with the complexity and multiple choices involved in buying financial products that you cannot even tell whether or not are a good buy for decades resulted in a decline in pensions saving, only reversed by auto-enrolment.
Second, failed markets result in consumers getting ripped off. The 1980s and 1990s saw record mis-selling from which the industry’s reputation has yet to fully recover. The OFT recently described the DC pensions market as one of the most dysfunctional they had ever studied. And if the annuity market is not working – when at least it is relatively easy to see what you will get and compare products – it is unrealistic to think that a more complex product market will do better. A guidance session – however welcome – cannot fix this.
In reforming the spending part of the pensions journey, it would have been better to learn from the Pensions Commission who in establishing auto-enrolment and NEST quietly built a wide consensus across the political spectrum around profound changes in the way that we save. But it is now not possible to undo freedom and choice, even if we wanted to.
The question therefore is how can we make it work in ways that benefit consumers and give them what they want from a pension, which for the vast majority is a predictable income that lasts until they die. And that means doing what we can to mitigate what could very well go wrong: people running up big unexpected tax bills by rashly taking cash, people running out of pension before they die and people too frozen by the difficulties of deciding what to do to enjoy the retirement they deserve.
As Michael Johnson recognises in this stimulating paper, there are two key elements that we have to get right. Firstly, we should recognise that retirement is increasingly a process and not a cliff edge. And secondly, we should recognise the power of defaults. Let people have all the freedom and choice they want to move away from those defaults, but savers need a starting point for making their decisions that is designed to provide good value and fulfil the basic tasks of a pension – a lifetime income. You do not have to agree with the detail of all of Michael’s policy suggestions – and I don’t – to sign up to his broad analysis of why we need good defaults and longevity pooling to get retirement right.
I talk to people across the political spectrum and from a range of pension interests, and my sense is that even without a Pensions Commission to steer us, we are all coming to pretty similar conclusions about how to make decumulation work. Consensus is important in making pensions policy work as it has to last. This pamphlet will help shape that new consensus.