Lord McFall of Alcluith
To ask Her Majesty’s Government what steps they are taking to reinvigorate occupational pensions.
Lord Shutt of Greetland
My Lords, before the debate is introduced, I hope I may make the normal point that it is a timed debate. Apart from the mover and the responder, other noble Lords are limited to six minutes. The monitor is dark now but when it shows six, the six minutes are up.
Lord McFall of Alcluith
My Lords, I am delighted to introduce this debate on occupational pensions. Last year I was asked by the National Association of Pension Funds to set up a working party looking at occupational pensions. When the report was published, I mentioned that a golden sunset of pensions was giving way to a bleak dawn. Many millions of people will face poverty in retirement—some absolute poverty. That is the inauspicious background to this debate. People are saving less and less and there is less and less trust in the pensions system. In fact, the NAPF confidence index is presently at minus six—the lowest it has ever been since its inception.
I want to look at the issue of risk. The flight from defined benefit to defined contribution schemes means that all the risk is on the saver. In effect, the saver is often left to navigate through a pensions minefield which would puzzle the brain of Albert Einstein. The consumer is short-changed and the voice of that consumer is missing. We need to ensure that that voice and that presence is centre stage in pension provision. In the flight from defined benefits to defined contributions, it strikes me that it is not just the risk which has shifted from the employer to the employee but that the onus is on the employee—the individual—to make critical decisions about their pension which they are ill equipped to do. It is a fiendishly complex matter and they need help and reassurance from scheme trustees who promote good governance. We need good, strong, independent governance. That is central to good member outcomes. We can achieve that good governance only if we have an environment which is conducive to achieving that, and if we have proper structures. We need schemes which are of a sufficient size to enable them to reap the benefits of scale and produce low charges to ensure that we get good governance and high-quality communication.
At present, there are 54,000 separate DC schemes operated by tiny employers in this country. With the average worker now changing job 11 times, we see the proliferation of these tiny pension pots with no portability. These have two critical disadvantages. First, they lack the scale efficiencies of larger ones and have inadequate governance, and, secondly, they tend to deliver worse outcomes at higher costs. There are no compensating benefits whatever.
The Pensions Minister, Steve Webb, has put out a challenge on red tape, as he calls it. That is a welcome opportunity to reinvigorate the pensions landscape, not just by eliminating regulation but by ensuring that we have better and more appropriate regulation. The environment for employers should be one whereby they offer decent workplace pensions with a minimum fuss, while ensuring that members’ benefits are protected. A key area for government consideration is over the risk-sharing between employer and employee. The Government need to ensure that employers who want to assume some risk are incentivised to do so. The questions that need consideration are: how should the Government support and reinvigorate multiemployer- wide schemes? In what ways can they fiscally encourage employers and reward them for taking on some of the risks?
The third aspect is auto-enrolment and NEST. This is welcome because it has the potential to encourage between 5 million and 9 million people to save for retirement in addition to those who have not saved previously—largely those on a low income. First, the Government have to look at the state offering and establish a firm foundation for saving. It will not be worth while for people to save if that firm foundation is not in place. Secondly, I have a simple message for the Government: remove the shackles from NEST. Take the messages that its chief executive Tim Jones and chairman Lawrence Churchill gave to the DWP Select Committee a few months ago. The cap and transfer-in rule are preventing the best outcome for institutional savers and government. The rule stops consolidation of existing pension provision for employers into NEST, and the cap ensures that employers have to run more than one scheme—one for the lower paid and another for higher earners—if they choose NEST.
Lawrence Churchill’s remarks to the committee were telling. He said that 40 per cent of the lower paid are engaged by large employers, so already 40 per cent of those whom he called “our market” will not use NEST because of the restrictions. By impeding the volume of business for longer, the Government’s loan will take longer to be repaid. It is therefore wise for the Government to remove that contribution cap. By doing so, NEST would need £100 million less in taxpayers’ money. It should be remembered that the shackles were imposed because of a 2005 political settlement. Removing the restrictions would ensure efficient organisation, and auto-enrolment would incentivise industry to lower costs and charges.
On the issue of costs and charges, disclosure is inconsistent among schemes and providers. In fact, what is consistent is the opacity of disclosure. We need transparency on the cash impact on pension pots. I welcome the code of conduct that NAPF has established as a result of my committee’s proposals. Let us keep in mind that a 2 per cent fee over the lifetime of a pension, which is not out of line, swallows up 50 per cent of an individual’s pension pot. My message to the Government is: do not wait and see the impact on high charges; use regulatory powers to apply stakeholder charge-capped schemes that are eligible for auto-enrolment.
The UK has the largest annuities market globally—450,000 were purchased in 2009 with a total value of £11 billion, and that will increase in the years ahead. Research since 1957 indicates that for each year of life expectancy, annuity rates have fallen by 0.56 percentage points. What does that translate into? An individual with a £100,000 pension pot in 1957 could have secured a pension of £11,000. In 2009, a similar pot could have secured a pension of £6,200 and, in 2010, £5,200. As the Minister knows, the rates offered can also vary by more than 25 per cent for a similar individual and annuity type. Shopping around should therefore be the default position, and there is a long way to go in that area. The reason that it should be the default position is that it would allow more flexibility for the changing spending patterns in old age.
The issue of Europe has been brought to me through lobbying. Lobbying by companies is very relevant because of the negotiations on Solvency II. The Government have to be vigilant here because if we do not get the right outcome, we will see the death of defined benefit schemes in the United Kingdom.
Lastly, on stability, the pensions cycle is between 40 and 50 years. The political cycle is between four and five years. We are out of sync. Since 1996, there have been more than 800 changes to pensions legislation and regulation—the equivalent of one change per week. I say to the Minister that that does not add stability. What we need to do is think about taking the politics out of pensions. A standing advisory body on, say, longevity and state pension ages, would be a good start, but we need a pension policy that is stable, for the long term and based on political consensus. I therefore suggested in our report, and suggest again to the Minister, that an independent standing commission on pensions should be established to ensure that the interests of the saver are centre-stage for the long term. If we work together in harmony on these proposals, perhaps we can assist in averting a bleak dawn for pensioners in the future.
The Parliamentary Under-Secretary of State, Department for Work and Pensions (Lord Freud)
My Lords, I join other noble Lords in paying tribute to the noble Lord, Lord McFall, and congratulating him on securing this important debate on reinvigorating occupational pensions. I am sure that noble Lords will join me in thanking him also for the skill and diligence that he showed as chairman of the Workplace Retirement Income Commission. The report was a fascinating read. It proposed recommendations on how industry, employers and the Government can strengthen workplace retirement saving. More importantly, I am relieved to see that in most of these areas the noble Lord and I are in much the same place.
The pensions landscape, which is always fluid, will see a huge change again in 2012 with the introduction of auto-enrolment, which presents a once-in-a-lifetime opportunity to transform our savings culture. However, if we are looking to reinvigorate occupational pensions, we need to go further than this. We need to build public confidence that such pensions are value for money; increase employee engagement in retirement saving; and motivate employers to provide good pension vehicles. None of these goals is easy, and they have become a lot more difficult recently.
In the past 25 years, life expectancy at 65 has increased by six years for men and five years for women. That is great news generally, but poses serious financial questions. Saving is in sad decline. In 2010, 13 million jobs had no pension provision—an increase of 2.5 million on 1997. The noble Lord, Lord Myners, uttered a lament for the occupational pension. We have seen falling annuity rates, increased longevity and a fall in the rate of return on equities. My personal belief is that some of us in this generation had a free ride because of the discovery of equity returns in the 1950s, 1960s and 1970s. I suspect that those returns were a one-off. We also saw the abolition of payable tax credits. As a result, UK pensions are no longer the gold standard that they were.
Only one in three private sector workers is contributing to a workplace pension. Other noble Lords cited different figures but basically, if one wants a £15,000 pension, it will require £300,000 of capital outlay to fund. That brings home very starkly the challenge of getting people to invest in a pension.
Lord Freud
Not at the moment, but their remuneration is going down quite a bit.
First, we must change attitudes towards pensions as a whole. Many people find pensions too complex, the incentives to save unclear and the expected retirement incomes unknown. For these reasons, the state pension needs to be reformed to provide a simpler, clearer foundation to support those saving for retirement. That is what the proposals in the Green Paper A State Pension for the 21st Century outlined: a simpler, single-tier pension set above the basic level of the means test as the primary option. I can update the noble Lord, Lord McKenzie of Luton, that, should we decide to proceed, we will set out further details as part of a White Paper in accordance with the usual process.
Nevertheless, around 7 million people are not saving enough to deliver the pension income they are likely to want, or expect, in retirement. With automatic enrolment, we will start to see a behavioural change requiring all employers to enrol all eligible workers into a workplace pension scheme. I welcome the introduction of the National Employment Savings Trust as a simple, low-cost pension scheme designed to fill a gap in the market for employees on low to moderate earnings. We are already seeing NEST acting as a beacon of best practice to other providers and encouraging high standards of governance, responsible investment, effective communications and low charges. A number of noble Lords raised the issue of the shackles on NEST. We will keep that balance between competition and choice very much under review. In response to my noble friend Lord Freeman, I am pleased to report that last week the department began its communication campaign to alert individuals and employers to the reforms and to ensure that tailored information is received by those affected.
On top of this, we must restore public faith in the concept of pension saving and, behind this, pension charges are key. Individuals who perceive their charges to be high are less inclined to save, so I welcome efforts by the National Association of Pension Funds to bring the pensions industry together to improve transparency of charges information for customers and employers. My department will offer its support to ensure that real improvements are made. It is also worth bearing in mind that since departmental research places the average annual management charge in default funds at between 0.4 per cent and 0.6 per cent, with none found higher than 0.9 per cent, the case for rushing into a charge cap without due consideration carries less weight. This is especially as new entrants into the market, such as Now pensions, are offering similarly low charges. Nevertheless, I can assure noble Lords that the Government will not hesitate to deploy a cap if individuals’ pensions savings are at risk from excessive charges.
As noble Lords have pointed out, there are a lot of small pension pots. There are more than 1 million small pension pots valued at less than £2,000, and automatic enrolment will clearly increase that number further. This is a serious hazard for individuals who want to build up their pension saving. Small pots are easy to lose track of and difficult to aggregate due to the cost and complexity of transferring pension schemes. In December 2011, the Government released the consultation paper Meeting Future Workplace Pension Challenges: Improving Transfers and Dealing with Small Pots, in which potential solutions are set out to address this issue. These include radical proposals such as an automatic transfer system in which pension pots could move with the individual from job to job or be consolidated in one or more aggregator schemes.
Individuals also need to get best-value outcomes. The Government believe that individuals are likely to get the best deal by shopping around on the open market and exploring options from a range of providers before purchasing an annuity. We have been working with consumer groups, industry representatives and other government bodies to bolster the current right to the open-market option by developing a default open-market option. The Association of British Insurers is currently consulting on a new draft code of conduct which supports this aim.
One area where standards must improve is on incentivised transfer, where members of perfectly sound defined benefit schemes are being offered cash incentives to transfer out of, or modify, their existing pension arrangements. It often results in members receiving less generous arrangements and thus lower retirement incomes. We are therefore working with the Pensions Regulator and the Financial Services Authority to develop an industry-wide code of practice which will cover all forms of incentivised transfers to ensure that these practices, when appropriate, are done fairly and transparently and are communicated to the member in a balanced and easily understandable manner.
We need to make it easier for employers to provide good-quality pension provision for their workers. To help deliver this, we aim to make it easier for employers to restructure their pension arrangements without requiring the employer to pay the difference between its assets and the cost of buying out the scheme’s pensions.
The department’s private pensions legislation will also be the focus of the red tape challenge. In response to the noble Lord, Lord McKenzie, I say that this is a cross-government initiative that seeks to revoke or simplify as much legislation as possible to ease the burdens on employers and business. We will use this opportunity to look objectively at pensions policy and consider whether the legislation as it stands reflects the department’s priorities and is fit for purpose.
The Pensions Regulator has set out its principles for what a good defined contribution scheme looks like, to establish standards for design and governance of defined contribution schemes and ensure that the pensions industry is best placed to support automatic enrolment.
Looking further ahead, we need to build on the good work that the consensus of previous years has achieved. We should consider the role for government in determining scale and ask ourselves whether the high fragmentation of the UK pensions market offers good value, or whether a smaller number of larger schemes could offer lower charges and higher governance, to the advantage of members.
As defined benefit continues to wane, we must take opportunities to study alternative risk-sharing arrangements, such as systems that I might term “defined ambition”. Here the schemes aspire to a set level of benefits, rather than making a firm promise as our defined benefit schemes currently do.
We must also consider how to encourage automatically enrolled individuals to save more where they can. The minimum 8 per cent contribution should be considered as it is described—a minimum. Options such as automatic escalation, in which pension contributions increase in line with member salaries, have merit and are worthy of close examination.
I feel confident that 2012 represents a step change in how pensions in particular, and saving in general, are perceived by the public. I thank again the noble Lord, Lord McFall, and I hope noble Lords will join me in acknowledging that we have taken great strides in reinvigorating our pension system for the future.