The government has set out proposals to rebuild confidence and trust in workplace pensions.
Its paper, Reinvigorating workplace pensions, contains new ideas for sharing the risks more equally between employer and employee, and for helping UK workers get the most out of what they save in a pension.
The report includes more details on a defined ambition pension scheme, which has been put forward by Steve Webb, minister for pensions, as a way of bridging a perceived gap between defined benefit (DB) and defined contribution (DC) pension schemes. With a defined ambition pension, the risks would be shared between the employer and the employee, offering greater certainty to savers around the final value of their pension pot than in DC plans, and less cost volatility for employers than with DB schemes.
A number of potential new models for the defined ambition pension scheme are outlined in the report:
- Conversion of benefits, where the employer promises a defined level of benefit, and when the member leaves the scheme by retiring or leaving the employment, the benefit is converted to a cash lump sum of an equivalent value, either to purchase a retirement income, or transfer to a DC scheme.
- Moneyback guarantees, where a guarantee ensures a saver gets back at least what they put in, could encourage more people to remain in a pension and save for their old age. One way of doing this would be to have a moneyback guarantee funded by a levy on members’ funds. While an employer might opt to pay the levy for an individual, it is likely the payment would be made by the member, relative to their funds. The cost could be kept down if this were a mutualised fund guarantee, for example, provided as not-for-profit by the private sector, or a government-sponsored but industry-funded body, similar to the Pension Protection Fund.
Other recommendations in the report include:
- Monitoring pension charges regularly across the pensions industry. The minister would reserve the power to cap charges if such action becomes necessary.
- Exploring the idea of a ‘star-rating’ system for pension schemes with the industry. This could include charges, good governance and transparency.
- Working with the pensions industry to look at whether a pensions market with a smaller number of larger scale, multi-employer pension schemes might offer both employers and employees value for money.
- Escalating pension contributions. Automatic escalation would be a way to encourage people to contribute beyond the statutory minimum that is required with auto-enrolment.
- More transparency around annuities, following on from the Association of British Insurer’s consultation into a compulsory code of conduct.
Webb said: “Automatic-enrolment is a huge step forward, but it’s only the start; we must ensure people are saving in high-quality, value-for-money pension schemes.
“For nearly half a century, we have seen declining numbers of people in workplace schemes. I am determined to reverse this trend and ensure we have pensions that are affordable to employers and attractive to employees.
“To rebuild confidence and restore trust in our pensions system, we need better value-for-money, good governance and greater transparency. The ideas we are publishing show the progress we are making on these issues.
“Now is the time to reinvigorate workplace pensions, if we simply stand by as too many previous governments have, another generation could miss the chance to put something by for their old age.”
The paper draws on extensive discussions with pension providers, actuaries, investment firms and lawyers, including an industry working group led by Andrew Vaughan, chair of the Association of Consulting Actuaries.
On government guarantees for pensions, why should we trust them to deliver the benefits? Just look at history – guarantees handed out by politicians have turned to dust in the hands of the electorate.
The truth is that the state pension scheme, which is unfunded and with huge future liabilities, cannot go on forever with an aging population and fewer workers, but nor are the alternatives appealing, given the low returns and poor expectations of private pension schemes. In the meantime, governments change, or change their minds.
Shrinking pension values have very little to do with a stock market gone sideways or the failures of insurance companies to perform. By far, the biggest impact has been from falling annuity rates, partly, but not wholly, due to quantitative easing. If the annuity rate was 10% and is now 5%, then a person’s pension is worth only half the value it used to be, unless a fund manager has somehow worked miracles. That is a near impossibility with the current economic uncertainty.
We need a ‘can do’ approach to designing tomorrow’s pensions. All too often, when we have proposed new pension designs, we have heard the comment from one quarter or another that ‘you can’t do that!’
With ‘good’ provision in steep decline, as evidenced by the recent ONS report, we need to have the Roosevelt response – ‘don’t tell me what we can’t do, tell me what we can do’.
We welcome the inclusive approach being operated by DWP in respect of pension policy developments, and the ACA looks forward to its continued active involvement in the process.
The most important attributes of defined ambition (DA) pension designs are that they should include greater certainty for members than a pure DC scheme and less volatility for employers than current DB schemes. Importantly, sufficient flexibility needs to be built into the designs, so costs can be controlled long into the future to cope with changes in economic circumstances and demography. Our working group envisages that there will be a range of DA designs – no single approach – so employers can select schemes that suit their business and their employees’ best.
There will be those who say the move by employers to pure DC pensions, where 100% of the investment, longevity and inflation risks fall on members, will continue unabated, but our research over a number of years has shown many employers are concerned about the impact of this trend on members.
However, at present there are no risk-sharing designs that can readily sit in the space between the DB and DC legislative regimes, unless they are hybrid schemes, which in regulatory terms fall under both regimes, an understandably unpopular administrative outcome.
Because legislators have in the past placed increased costs on schemes, undermining their ability to control pension costs, DA designs need to encompass ‘no extra cost’ exits for employers so regulatory creep is discouraged.
But government should be under no illusion that there remains a pressing need to ensure people understand the importance of retirement saving and it will need to provide incentives (e.g. tax reliefs) to help employers and employees alike to find the extra cash for the levels of savings needed to finance adequate provision.
We have been calling on the government to take action to reinvigorate workplace pensions for some time, so it’s good to see them setting some ideas out for debate.
This is a clear and timely paper that is asking the right questions as we move ahead with auto-enrolment. It also recognises that building scale and having fewer, larger schemes could be vital to delivering well-governed, value for money pensions for workers.
Pensions are now very polarised, particularly in the private sector, with older final salary pensions at one end, and the newer defined contribution (DC) system at the other. Either the business bears the risk of paying a final salary deal, or the saver carries the risk of not knowing exactly how much they will get.
There could be room for a middle way where that risk is shared. It is certainly worth exploring and the NAPF has been involved in the debate. Larger employers in particular might be interested in defined ambition, and some already offer such pensions.
Defined ambition is not going to be for everyone, and millions of people are going to be automatically put into a DC pension, many for the first time. It is important that we do not get distracted from the task of getting good value for money out of the DC pension model. We need to improve transparency around charges and explore economies of scale.
We agree that people need a simple way to identify a good pension. That framework already exists and the NAPF launched it around three years ago. Almost a third of a million workers in 165 different companies are in a DC pension that is approved by the Pension Quality Mark (PQM). The PQM distinguishes well-run pensions where contribution rates are good and where benefits are clearly explained to staff.
The key area of interest in the paper is the defined ambition section. It will be very challenging to reconcile the DWP’s various ambitions here.
Robust guarantees are expensive, yet the DWP wants good value for money; collective risk schemes mean subjugating individual rights, yet they want full transparency; and they want certainty for members, yet they are contemplating variable guarantees.
The government can’t just wave a magic wand and expect the industry to conjure up transparent, low-cost, secure, guaranteed investments providing a good rate of return: If it was easy, then the industry would be doing it already.
In the meantime, we believe that much more can be achieved by engaging investors in a sensible ongoing dialogue around how much they are saving, where their money is invested, how it is performing, when they might be able to afford to retire and how they can draw their income.
I support the policy objective but I worry that this is beyond the capability of DWP to solve. I question whether Steve Webb is asking too much of its staff.
He needs to deliver two policy objectives that form the foundation for UK pensions.
1. Reform State pension
This project is late. From limited sound bites released it does not appear to link to other welfare benefits paid in retirement such as housing & council tax benefits.
2. Define the minimum standard for a scheme to qualify for auto enrolment
This piece of work is woefully late. People are being put into schemes without this in place. DWP have had 7 years to produce something.
As for stimulating innovation, I’m afraid Whitehall is the wrong place to start. I agree with Tom McPhail in what he says here.
Complete these 2 pieces of work first Steve and then allow the private sector some breathing space from further changes. If the scheme meets the minimum standard then it should be free to develop solutions that people value.
Striking a balance has to be at the heart of designing new schemes. If risk-sharing is to work, the government needs to focus on the kind of schemes that employers really want to offer to employees and the products that insurers are actually prepared to offer to savers. Equally, we need simple products that savers feel they can understand. It’s futile legislating for savings vehicles that no-one will actually offer, or, pay into.
The nature of the pension promise should not be at the heart of the debate. We could argue for defined benefit (DB), defined contribution (DC) or defined ambition (DA) until the cows come home, but all this is secondary to how much money is actually put in the pension pot.
The number one reason why many members of DC schemes may end up with low pensions is that little money is being put into them in the first place, relative to members’ retirement objectives. Unless this fundamental point is recognised, then no matter how a scheme is designed, it will not provide for the pension that workers, their employers or the government are striving for. While the intention behind guarantees and insurance is to protect returns, these options inevitably come with a price tag, for either the member or their employer, and may simply guarantee low pay-outs.
Risk-sharing between employer and employee is, on the face of it, an attractive proposition, but employers are likely to be wary. Many of today’s private sector final salary schemes started off as ‘defined ambition’ packages, with targets, aspirations and safety valves, but few guarantees. But the ‘ambition’ element has fizzled out over the last 25 years, as policy has been shaped and reshaped by successive governments, increasingly providing more certainty to members and leaving employers to pick up the tab. As a result, companies have increasingly sought to pass on all of the risk to employees, leaving the legacy of a very polarised pensions landscape. The success of any new ‘defined ambition’ schemes will depend upon future UK governments protecting the middle ground between DB and DC.
I cannot see anything in defined ambition that has not been considered before. Legislation is not required to enable defined benefit cash schemes to operate however it will need a new test for auto-enrolment. These schemes were operated 40 years ago and the problem is that changing economic conditions produce a variety of results as do DC plans, hence in high inflationary times we moved to final salary pensions. The one thing that did not exist 40 years ago was the opportunity to have drawdown.
The Minister should also consider the concept of rollover funds whereby a member can choose to invest his retirement fund in government bonds for a certain period post retirement with added tax advantages to be decided by HMRC.
In summary we do not need the Government to show us how to design we need the pension providers and consultants to offer the options. It is not very difficult to grasp the concept of defined cash rather than defined pension..
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