by Ben Infield
It seems like a long time ago now, but way back in November, The Chancellor stood up at the Autumn Statement and said that he would consult on giving savers a legal right to require a new employer to pay pension contributions into their existing pension pot if they choose to do so, meaning that people can move to having one pension pot for life.
Soon after the Chancellor sat down, a call for evidence was published entitled Looking to the future: greater member security and rebalancing risk. Somewhat unexpectedly, the radical proposal that would overhaul the workplace pension system as we have known it since Automatic Enrolment was introduced, came out of the government response to the consultation on solving the problem of small pots.
To further add to the confusion, one of the central themes of the call for evidence was how a hypothetical lifetime provider could help grow the Collective Defined Contribution (CDC) market, despite one not yet existing. However, for my money, this significant departure from the policy consensus was never about providing a solution to small pots (one is already in train) or trying to push a new CDC proposition. Instead it has always been about furthering the government consolidation agenda to deliver the much-vaunted investment in productive finance.
After all, the Chancellor was quick to point out that the proposed reforms could unlock an extra £75 billion of financing for high-growth companies by 2030 and provide an extra £1,000 a year in retirement for an average earner saving from 18. Perhaps the government is forgetting that we are still waiting on Automatic Enrolment being extended to 18-year-olds, after the relevant Bill gained Royal Assent at the end of last Summer.
At the Association of British Insurers (ABI), we were keenly aware of what a major change both member choice and a pot for life approach would mean for our industry but also for employers and savers alike. So, alongside our response to the call for evidence in January, we contracted WPI Economics to produce authoritative research looking at the impact on the market dynamics of workplace pensions, as well as employer and saver behaviour.
In the meantime, the Spring Budget brought a much less committal approach with the Chancellor this time only saying that government will continue to explore how savers could be allowed to take their pension pots with them when they change job. This could not have been more welcome news, for the proposed reforms truly present an upheaval in pensions policy and one that needs to be properly discussed, examined and thought through before any further steps are taken to make it a reality. So it would seem that Ministers and officials are now in listening mode, a perfect opportunity then to deliver the findings of the research we commissioned.
Cross subsidisation
One of the key findings of this work was that the current cross-subsidy that underpins the success of Automatic Enrolment could be lost under the change to a member choice or pot for life model. Under Automatic Enrolment, charges mainly take the form of a very small percentage of the value of the pension pot. Because it is a percentage, this means that people with smaller pension pots benefit from lower charges than those with larger pots. Firms recoup the lower charges for small pots by charging more for larger pots – this is known as cross-subsidisation. While to some, this might sound strange at first, this principle has been likened to the Pareto principle and is a fundamental rule in how systems such as income tax work. While very far away from Corbynomics, you could say that Automatic Enrolment has always been to some degree about ensuring the interests of the many rather than the few.
Under a system that prioritises member choice people would be encouraged to switch providers and firms – creating a retail or individualised pricing model, similar to banks. Within this model, it would be rational for pension firms to seek to attract savers with bigger pots out of workplace pension schemes, leaving smaller pension pots behind.nder a system that prioritises member choice people would be encouraged to switch providers and firms – creating a retail or individualised pricing model, similar to banks. Within this model, it would be rational for pension firms to seek to attract savers with bigger pots out of workplace pension schemes, leaving smaller pension pots behind.
Furthermore, the WPI Economics report analysis of international and UK markets, found that those with lower savings could end up with lower performing defaults, while also potentially being hit with increased charges as they would lose the cross-subsidies from larger pots. This could cause existing inequalities in pensions to deepen further, as it’s more likely to impact those who are younger, on lower incomes, women, and people from ethnic minority backgrounds.
The research reinforces the ABI’s message in our call for evidence that both member choice and pot for life proposals would be significant departures from the current Automatic Enrolment system where employers play a central role in the pension arrangements for their staff.
Outcomes for savers
In a survey of over a thousand employers, WPI Economics found that 65% said it would be more difficult to assess the quality and value of a pension scheme for employees under the proposed reforms. And over half (57%) said they would take less interest in the quality of the scheme that they would choose for the employees who remain with their workplace provider.
For those who do decide to act, insights from WPI’s employer poll reveal concerns about the outcomes for savers. Over half of employers (59%) said that they would worry that their staff would make bad pensions decisions if they had to choose for themselves. Likewise, 62% of employers expressed concerns that the reforms would lead to their employees getting worse pension outcomes compared to just 10% who disagreed that there would be a negative impact.
Admin burden for employers
Results from the poll also revealed that the reforms are likely to create a significant admin burden on employers. 63% of employers said that they’re worried the proposed reforms will increase their payroll provider costs, while 28% estimate that the reforms will require an additional five hours of staff time per month. Modelling based on the findings suggests that this admin burden could cost £550 million per year across the economy.
With this research now published, hopefully, policymakers can gain a greater understanding of the challenges and risks involved in going ahead with the major market intervention presented by moving to a member choice and pot for life system.
Whatever comes out of the government response to the call for evidence, there is certainly no prospect of pensions policy practitioners being able to rest on their laurels. Within the current Automatic Enrolment paradigm there is still much detailed work to be done on fixing the issue of small pots, building a fair and comparable Value for Money framework and implementing pensions dashboards. That is before we begin to mention the more fundamental need to increase minimum pension contributions for most people to 12%, allowing for the necessary flexibility to make sure everyone is advantaged. This process should start, as the Chancellor eluded to, by getting people saving for retirement from age 18, and from the first pound earned.