Pension Schemes Bill

Mark Hoban Excerpts

Tuesday 2nd September 2014 Commons Chamber

[Mr Mark Hoban (Fareham) (Con)]

I apologise to my right hon. Friend the Minister for missing some of his speech and to the hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East (Gregg McClymont) for missing his. I had hoped to be here for both, but owing to the length of the urgent question and another engagement outside the House, I could not be. Nevertheless, I am delighted to be here in time to make a contribution.

On the Government’s legacy, as my right hon. Friend said, our pension reforms have been one of our key acts in government. We have done a huge amount to reform the pensions system we inherited and to implement auto-enrolment. The Chair of the Work and Pensions Select Committee, the hon. Member for Aberdeen South (Dame Anne Begg), gives the previous Government credit for auto-enrolment, but my right hon. Friend was right to talk about the practical changes we have made to make it work. He also made the powerful and important point that the take-up rate for smaller businesses during roll-out has exceeded expectations. A lot of people expected the rate to fall, but it should now be recognised that many people currently not saving for retirement see auto-enrolment as a key way of protecting themselves and their families in retirement.

The changes that my right hon. Friend the Chancellor announced in the Budget to give people control over their pension pots in retirement are also important and fit in with other reforms, such as raising the state retirement age, introducing the triple lock and uprating the state pension. We provided a state pension that is both fair and affordable in the long term. We made a change to pension tax relief, too, ensuring that it is both fair and affordable as well. The cumulative effect of those reforms is to ensure that people will save more towards their retirement, that more people will indeed save for it and that they will be rewarded for doing so. We are treating those who retire as grown-ups, able to manage their own money.

The work we have done so far is important, but I do not think the job is done. That is why the Bill is so important. We know that under defined-benefits schemes, those who worked knew that every year of their employment helped to build up a guaranteed pension income—a fraction of their final salary—thus providing certainty. In building up that guaranteed income, once the employee had made a contribution, the cost of providing the guarantee rested with the employer. If the investment return fell, the employers had to increase their contributions; if employees and pensions lived longer, the cost of the changes were again borne by the employer. In a way, of course, that guarantee sowed the seeds of the decline of defined-benefits contribution schemes, as it became increasingly expensive to provide that guarantee to employees. That accounts for the decline in DB schemes over a number of decades.

Under a defined-contributions scheme, it is of course the employee who bears the longevity risks in building up the pension pot. It is the employee who bears the investment risk, too. Certainty in retirement in return for a fixed contribution by the employee has been replaced by uncertainty, the cost of which is borne by employees.

The impact of the switch from DB to DC would have been mitigated if contribution rates had remained unchanged, but the impact of the transfer of risk has been compounded by the reduction in the level of contributions. The most recent Office for National Statistics figures I have seen show that the total contribution rate for DB schemes is 19.2%. The rate for DC schemes is under half that, at 9.4%. What does that mean in practice? As the Department’s own figures show, 11 million people between the age of 22 and state pension age will not save enough to deliver an adequate replacement income in retirement. Employees have thus seen a reduction in contributions to their pension schemes; they bear risks previously borne by their employer; and they bear uncertainty about the income they will enjoy in retirement.

Where does this Bill fit into that picture? Defined ambition can, through guarantees, help to provide greater certainty in retirement. I think the second area where these schemes can have merit is in maximising the return on pension contributions for members. The collective nature of defined-ambition schemes creates economies of scale on the costs of running a pension scheme, which should help to improve the overall returns for employees. Furthermore, the open-ended nature of a collective scheme can change the investment strategy of a fund. For an individual scheme, as the employee moves towards retirement, the fund’s objectives move from seeking capital growth towards locking in gains already made, providing greater certainty about the size of the member’s pension pot. An open-ended scheme and particularly a collective scheme should shift the investment strategy towards capital growth and away from simply locking in growth—a point to which I shall return in a minute.

The second area where defined ambition will help is through the use of guarantees to deliver more certain outcomes for employees. As I said, one of the merits of DB schemes for employees is that they guarantee an income. Depending on the scheme, people will know after a year’s service that they will have “banked” an 80th or a 60th or a 40th of a year’s salary or the salary on retirement. With a DC scheme, all people know, in effect, is that they have made contributions of X and made net investment gains of Y; and while the pensions statement will project a monthly income in retirement, it will be based on how much more they will contribute, the investment gains between now and retirement and the annuity rates at the point of retirement. The only thing known for certain about that projection is that it will be wrong.

The contrast between DC and DB schemes is stark; the question is whether we can bridge the gap between the certainty of DB and the uncertainty of DC. The Government’s vision of DA or shared-risk schemes is, to quote the Government response to the consultation,

“to secure a guarantee on the income that will be received in retirement, that builds up gradually during the savings period”.

There is a great deal of merit in that. The employee has visibility and certainty of income in retirement. That is one of the great assets of DB schemes. That helps people to see how much they will have in retirement and, crucially, helps them plan for retirement. However, the crucial distinction is that, in defined-ambition schemes, the employer’s contribution is fixed. Therefore, if the income is guaranteed, the cost of that guarantee must be borne by the scheme members.

I would like to understand a bit more what the Financial Secretary expects those guarantees to look like and how he expects them to be financed. What proportion of the pension does he expect to be guaranteed? Presumably, in the same way that insurance companies have to provide solvency reserves for the guarantees that they issue, defined-ambition schemes will need to provide reserves to fund the guarantees.

I think it will be the case that the higher the guaranteed element, the greater the shift in asset allocation away from risk seeking and capital growth towards capital protection—in effect the challenge facing individual DC schemes but on a collective basis. Who will design the rules for determining the reserves to be held against the guarantees? Will it be the Pensions Regulator or the Prudential Regulation Authority? Will it depend on whether the scheme is trust or contract-based?

I believe that these measures create opportunities for a new model of pension scheme. That model will smooth some of the rough edges of the transition from DB to DC schemes. It should help to reduce the risk for employees. However, it is not without its challenges. For it to work effectively, schemes will need to reach a critical mass in terms of membership to enable the economies of scale to work their way through and to ensure that there is a sufficient flow of people coming into and out of the scheme—that there are new members and those new members balance the number of members ceasing to be active members. The formula that drives the payouts from the scheme will need to be carefully thought through to ensure intergenerational fairness, so that younger members are not subsidising pensioners.

In the Netherlands, schemes have been established on a sectoral basis reflecting the social model there. That helps to deliver the critical mass needed for the schemes to obtain economies of scale and smooth investment returns. How does my right hon. Friend the Minister think schemes in the UK will achieve that scale? Does he envisage that schemes will be built on a sectoral basis, or does he envisage some master scheme being set up that will be open to all businesses?

[Steve Webb]

I am enjoying my hon. Friend’s characteristically well-informed speech. To reassure him on industry schemes, when we visited the Netherlands to look at how the system is run there, we came across the Dutch tulip growers scheme. I can reassure him that we do not have such narrow definitions in mind.

[Mr Hoban]

I am not sure that tulips and the Netherlands are necessarily an appropriate model. One of the earliest financial crashes was in the price of tulip bulbs, so it may not be a model to follow. However, the point about sectoral and non-sectoral schemes is important. Other countries have had success where they have had a social model—a relationship between employers and employees—that we do not necessarily see in the UK. There will be questions about how to encourage more employers to come together to create these schemes. Perhaps there is a role for insurers in that regard.

Although these schemes aim to boost returns and offset some of the impact of under-saving, we need to do more to help people save more towards retirement. Auto-enrolment will help to ensure that more people are saving, but as I pointed out earlier, the DWP’s figures estimated that some 11 million people would not save enough to meet the recommended replacement income for retirement. If we look at contribution rates to pension schemes in other countries, we will see that the 8% auto-enrolment rate lags behind the rate in other countries that have established innovative pension schemes. In Australia, the contribution rate to the Super scheme is heading towards 12%, and in the Netherlands—the Minister mentioned the Netherlands, so I feel at liberty to talk about it—the contribution rate to the scheme is over 20%, which is significantly higher. We have some way to go before we match those contribution levels.

I think it would be wrong to contemplate increasing contribution rates before the roll-out of auto-enrolment has been completed, but we should not ignore the fact that people are not saving enough towards their retirement and we need to find ways to help people to build higher contributions. There are ways in which we can do that. We have not done enough to draw on the insights from behavioural economics and initiatives such as Save More Tomorrow, which has been adopted in some parts of the United States, which encourage people to increase their contribution rates when their pay rises, making a commitment today to secure increased contributions in the future. I think we can look at the way in which fiscal incentives encourage those on low incomes to save more towards their retirement, and I certainly think we can support people to make better choices on retirement. That is a significant area that we need to focus on, and it is the last point I want to touch on in my speech.

As I said at the start, we have introduced a series of radical reforms to the pensions system over the past four and a half years. However, to make the most of the freedoms that we need, we must make sure people have the necessary support to make the right choices both when they are building up their pension pot and when they choose to use it. That is why I am very supportive of the guidance guarantee. I know the Government are going to introduce amendments to this Bill, either in Committee or on Report, to introduce the guidance guarantee, and it is an important part of the package of legislation, but we must also think about how we can encourage the industry to go further to provide better guidance both before the point of retirement and afterwards. The decisions we make at the point of retirement are ones we would want to come to as individuals to revisit later on.

We need to find a service that will help those who feel they cannot afford independent financial advice without crowding out independent financial advisers, and we need to give people support to think about draw-down, annuities and the other products that are out there, to help them maximise their income over their retirement, and also to think, while they are saving, about what sort of lifestyle they want in retirement. Too often, people do not think about what they aspire to in retirement. They tend to shape their retirement around how much they have saved, rather than thinking before they retire, “This is what I would like to do. These are the holidays I’d like to have. This is the sort of lifestyle I’d like.” We need to give people more support in that regard.

I also believe we should be harnessing technology to draw together details of people’s savings—not just their pensions, but their individual savings accounts and bank savings—to end the complicating fragmentation of data. That should encourage people to look at the totality of their financial assets and use that information to engage with their retirement planning.

[Nigel Mills]

The one asset my hon. Friend did not mention is the house a person owns, which I suspect people will, as years go on, increasingly have to consider using for their own retirement, rather than passing that on to their children, as perhaps we all hope to do at the moment.

[Mr Hoban]

My hon. Friend makes an important point and he is right to pick up on that omission. When we think about retirement, we should be thinking not just about pensions, but about a person’s income in retirement. Some of that will take the form of state pension; some will be interest on savings accounts; and some may come through work—depending on what age we retire at, and how we phase in our retirement. Certainly housing is a valuable asset, too, and very good work is being done by a number of organisations to look at how housing can be used, but we are still some way off having something that people will recognise as a good way to use their housing assets. As I say that, I feel a letter coming on from my former colleague Nigel Lawson on this point, but there is more work to be done in respect of how people view housing as an asset and how they can utilise that asset in retirement to supplement their income. We need to build out from the guidance guarantee, and more work will need to be done on that in the coming months.

I want to mention a point that has been raised with me and that I will probably talk about in more detail when the complementary tax Bill to this comes through later in the year: we must think about what sort of outcomes we expect people to see in retirement. My right hon. Friend the Minister for Pensions referred to a decade of innovation, but he will recollect that when we introduced reforms to liberalise the open market option, and to make that more of the default, there were some unforeseen challenges from that, and we have seen some of the consequences and the report published by the Financial Services Consumer Panel. I do think there is a responsibility on industry, the Government and the regulator to do some thinking about what good looks like under the new reforms and how we can help shape that post-retirement market. That would form an important part of the work.

I commend the Government on this comprehensive package of pension reforms. They will form a key part of our legacy, and they are an important way of expressing what we have achieved as a Government in setting down long-term foundations to help people to take more responsibility for their savings in retirement, to help them to save more in their retirement and to give them the freedom and choice that they need in their retirement. The Bill is part of that package, and I look forward to seeing how the schemes develop to help to provide people with more certainty in regard to their future pension incomes, when all they have seen up to now is increased uncertainty.

[Shabana Mahmood (Birmingham, Ladywood) (Lab)]

It is a pleasure to wind up this relatively short but interesting and important debate. Despite points of difference and disagreement, it has provided some thoughtful and wide-ranging speeches from both sides of the House, proving that it is quality, not quantity, that counts. Two excellent examples were provided by my hon. Friend the Member for Aberdeen South (Dame Anne Begg) and my right hon. Friend the Member for Neath (Mr Hain).

My hon. Friend the Member for Aberdeen South made an important point about complexity and expressed her fear that increasing complexity as a result of the Government’s changes to pensions might hamper efforts to get younger people to engage with their pensions. She also rightly highlighted the increased risk of mis-selling that could result from any such complexity. I shall come back to that issue later. She also highlighted the importance of governance in relation to the collective defined-contributions schemes that are being introduced by the Bill. She was right to say that there was no obvious reason to omit those governance arrangements from the Bill and to leave them instead to be dealt with in secondary legislation. It is difficult to understand why the Bill is vague on that point, and I hope that the Financial Secretary to the Treasury will be able to illuminate the House further on that when he responds to the debate.

My right hon. Friend the Member for Neath, who is not in his place at the moment, made a powerful contribution to the debate, in which he set out the challenges posed by a rapidly ageing population. They are one reason why so much attention has been focused on pension arrangements. He also noted the challenges posed by the greater need for adult social care that results from a rapidly ageing population, the interplay between those changes, and the increasing burden on the present younger generation and future generations. He talked about our expectation of what those burdens would be like in the coming years. He was right to give us an historical perspective, particularly in relation to mis-selling during the years before 1997.

Pensions are an important issue for people. They worry about their retirement and their personal social care needs, and about whether they will be able to cope with those needs as and when they arise. They also worry about whether they will be able to leave anything behind for their children. As people live longer, it is more important than ever that they should make the best possible choices for themselves. As legislators, politicians need to ensure that the range of options available to people and the breadth of the arrangements they can make for their retirement are fit for purpose, especially as we are all living much longer. That poses great challenges for us all.

In that context, the Bill’s establishment of collective defined-contributions schemes—CDC schemes—is a welcome step in increasing the range of options available to people as they plan for their retirement. We will therefore not oppose the Bill on Second Reading, although there are areas in which we might seek to extend or strengthen it in Committee or on Report.

As I said, we support CDCs in principle. In sharing risk, they have the potential to give people a more adequate and reliable retirement income than individual defined-contributions schemes, because, unlike those schemes, CDCs can pool risk across and between generations. Given the difficulties and anxiety that many people feel about their living standards at the moment, we want to support working people who are struggling to set money aside for the future. We need to ensure that they have access to pension schemes that they can trust to give good value for money and a decent income in retirement.

CDCs are also well supported by the public. Research by the Institute for Public Policy Research carried out at the end of 2013 found that there was strong public support for a collective pension. It was the most popular of the options the IPPR tested and it appealed across those with different income levels, life stages and ages. If CDCs are to be well taken up and succeed, strong governance arrangements clearly need to be in place—that point was made by my hon. Friend the Member for Aberdeen South. As my hon. Friend the Member for Cumbernauld, Kilsyth and Kirkintilloch East (Gregg McClymont) said, the Bill is currently silent on governance arrangements for CDCs. The highest standards of governance are needed for schemes that are even more opaque than defined-contributions schemes because they have to manage pooled assets and conduct smoothing.

The silence in the Bill occurs despite the Government’s consultation “Reshaping workplace pensions for future generations”, which stated:

“Collective schemes are complex and can be opaque—because of the indirect relationship between contributions and benefits. This necessitates strong standards of communication and governance. We intend collective schemes to be overseen by experienced fiduciaries acting on behalf of members, taking decisions at scheme level and removing the need for individuals to make difficult choices over fund allocations and retirement income products.”

Failure to require all schemes to have trustees means that we will potentially have some CDCs run by trustees and others offered by private firms that seek to maximise their short-term returns.

The Minister will know that we have consistently argued that all workplace pension schemes must be run by trustees and have a legal duty to prioritise savers’ interests. Governance arrangements remain an issue for other defined-contributions schemes, which make up the majority of what is available. The Government could have taken more steps in the Bill to strengthen the governance of those schemes. The Government have declined to impose trustee boards, but have instead opted to require independent governance committees. We are concerned that they will be neither independent, nor governing in nature. In any event, IGCs contain serious conflicts of interest, so we will argue in Committee that the Government should instead follow Labour’s lead and require all pension schemes to have trustees and a legal duty to prioritise the interests of savers above all others.

Another issue discussed in the debate, which the Opposition will continue to press the Government on in Committee, is scale. The issue was raised by one Government Member and the Minister did engage with it when the point was made about whether small and medium-sized enterprises might be able to introduce CDCs or whether this would be the preserve of larger employers. He rightly said that it was going to depend primarily on scale and how popular these schemes end up being. The Bill, however, contains no measures that will help promote the scale which most independent observers believe is necessary for CDCs, and workplace pensions in general, to do the best they can for employees. We have long argued that measures to promote scale are vital to ensure the best possible outcomes for savers. So the Government could, for example, require that automatic transfers default into aggregators and the criteria necessary for qualifying as an aggregator should include scale. One or more of those schemes which met the qualifying criteria to be aggregators under our approach may then opt to be a CDC pension scheme.

As my hon. Friend the Member for Cumbernauld, Kilsyth and Kirkintilloch East noted, the House of Commons briefing note on the Bill also says that

“certain conditions, such as large scale and strong governance, appear necessary for—

CDCs—

“to operate successfully.”

Three-quarters of respondents to the consultation prior to the Bill thought that Government intervention would be needed to create the scale necessary for schemes to offer guarantees. We will look in detail at issues around scale and governance when the Bill is considered in Committee.

We will also look at the National Employment Savings Trust, which is a trusted body for providing workplace pension schemes. It could potentially offer retirement income products or CDC and in doing so help constrain the industry and ensure that it provides decent products to all savers. However, to do so most efficiently, it would need to have its restrictions lifted. As was mentioned earlier, the Government said in July 2013 that they would legislate to lift the restrictions as soon as possible, but they have not yet done so. It would be helpful if the Minister told us whether that is something that will be taken forward by the Government, and when it will be discussed in Committee.

The second part of the debate dealt with the new arrangements around flexibility. As my hon. Friend the Member for Cumbernauld, Kilsyth and Kirkintilloch East stated at the outset, we have supported greater flexibility in relation to pension arrangements, but we have set out three tests for the new flexibility. First, is there robust advice for people who are saving for their retirement? Secondly, is the system fair to those on middle and lower incomes who want a secure retirement income? Thirdly, are the Government sure that the changes will not result in extra costs to the state either through social care or by increasing housing benefit bills?

In relation to the first test, the expectation is that the Government will propose an amendment to the draft Bill around the guidance guarantee. As it has not yet been published, it is not clear whether it will be robust enough. It would be helpful if the Minister gave additional information to the House now so that we are not waiting until the Bill reaches Committee before we know what is happening about guidance.

As many Members noted, guidance will have to be well thought through and reflect the practical steps that people take as they move towards retirement. To be effective in practice, guidance will need to include a discussion of the effects of drawdown on the individual’s tax situation. It will also need to explain the consequences of decisions regarding the different forms of saving on the extent to which local authorities can seek to recover sums for long-term care. The Government’s response to the consultation “Freedom and Choice in Pensions” indicates that drawdown is likely to be treated similarly to annuities in that income and not capital is assessed. Again, that is something that we will have to look at and examine further in Committee.

Some specific questions arise as well. For example, if guidance is a single event, how will it assist an individual seeking the necessary later event, perhaps 20 years later, of switching from a drawdown product to an annuity? Draw-down products are likely to be insufficient on their own for savers and individuals will need to insure against longevity risk to ensure that they do not run out of money during their retirement. Will there be a requirement for products to include a regular review of when the optimal moment for switching to an annuity should occur?

We have had a number of debates, both on the Floor of the House and in Committee, around the issue of advice and guidance and the very clear difference that there is between the two. There is a fear among many Members across the House that guidance on pension changes alone might not be enough to help people make the best possible choice. Ultimately, the course that the Government choose will have to be carefully scrutinised and reviewed. As I have said, this matter is of great interest to Members on both sides of the House.

[Mr Hoban]

Will the hon. Lady make her position clear? Is she saying that what should be offered to every person retiring is regulated advice?

[Shabana Mahmood]

No, we have not called for regulated advice, but I am sure that the hon. Gentleman will agree that these are big decisions for people. We must ensure that what the Government envisage will be up to the job of ensuring that they have all the information they need before then to make the best possible choice. As I have said, we have had a number of debates on this subject and the Government have given us some idea of the guidance they envisage, but I think we will have to return to these issues in Committee to ensure that that guidance is as robust as it can possibly be.

[Mr Hoban]

I am grateful to the hon. Lady for giving way, as she is being very generous. If she does not want to see regulated advice given, what is she looking for?

[Shabana Mahmood]

To the extent that we have this debate about advice and guidance, I am sure that the hon. Gentleman will recall that it was the Chancellor who said in his Budget speech that advice would be provided to people about making their decisions. We then moved quickly into the world of guidance and the two are, as I am sure the hon. Gentleman will acknowledge, very different. That is why we are concerned that the guidance on offer will not be quite as good as we might expect if advice were on offer. That is why it will be important that Members on both sides of the House stress test the final package that the Government come up with.

The TUC has rightly questioned whether guidance on its own is sufficient. It states:

“Independent guidance is clearly better than that provided by company sales teams, but half an hour of the best possible advice will not equip people for what could be thirty years of managing their pension pot… Expecting the market to deliver retirement income solutions that work for the great majority is unrealistic. The annuities market was broken, but what we need is the same careful consideration of policy, consumer preference and evidence that led to pensions auto-enrolment.”

It is clear that a number of very complex factors will play against each other, with some inherent tensions that were noted by Members on both sides of the House in their speeches. It is important that we stress test the measures properly in Committee.

The Bill introduces a number of measures that we support, and as I have highlighted, there are some issues on which we think that the Bill could be strengthened. We look forward to picking up those issues with the Minister in Committee.