House of Commons - Treasury - Written Evidence

Select Committee on Treasury Written Evidence

Memorandum submitted by the National Association of Pension Funds (NAPF)

EXECUTIVE SUMMARY

1. The Pensions Commission's two reports have shown that the current system for funded pensions in the UK will not be adequate for the future: millions of people are not saving in a pension even where one is available to them, do not have access to an employer contribution, or find that their savings are eroded by charges. The Treasury Select Committee have themselves identified the need for a future pensions system in which working people have trust and can save with confidence.

2. Reform is therefore needed. The National Association of Pension Funds (NAPF) fully supports the Government's objectives of achieving higher levels of pensions saving at lower cost.

3. The shift from a largely defined benefit pensions system to one based on defined contributions is profound, and not all the implications have been thought through. In particular, a key issue is risk to the end consumer and how it is managed. In our view this is as important as cost and must be taken account of in the design of the new pensions system. The challenge is how best to get a fair deal for consumers—not just one that seems fair at the start, but one that can be sustained over time.

4. NAPF supports the principle of auto-enrolment into good value pensions saving available to all. A new system built on Super Trusts would achieve the same low cost and coverage as the proposed National Pensions Saving Scheme (NPSS) but without the disadvantages of posing significant risk to Government and presenting consumers with difficult (and unwanted) investment decisions.

5. Super Trusts have been designed around the needs of the potential consumer base—millions of people on low or moderate incomes who are wholly unfamiliar with making complex financial decisions such as fund choice and who have low levels of trust in the financial services industry.

6. Super Trusts would be large scale, not-for-profit, multi-employer DC pension schemes. Employers would be required to designate a Super Trust (or run a suitable alternative) and employees would be auto-enrolled into the scheme and given their own personal Super Trust Account. These features, combined with the fact that there would be a limited number of Super Trusts operating in the market (we suggest 10-20) would ensure that scale was built quickly and costs were low. Our modelling suggests Super Trusts could operate at around 40 bps, providing good value for money for scheme members.

7. Super Trusts would be run by experts with a legal duty of care to scheme members. They would operate on the "buy side" of the market, purchasing scheme administration and fund management services on the basis of cost and quality. The strong governance framework underpinning Super Trusts, combined with their buying power, would ensure that the costs to members remained low over time. For this reason, Super Trusts would not require any imposed system of price regulation.

8. Super Trusts would adopt a pooled investment approach that would mitigate many of the investment risks inherent in the NPSS and other alternatives. Asset allocation decisions would be taken by investment experts within the Super Trust who would pool risks across their member populations and invest the pooled fund in different classes of assets, taking account of the need to optimise overall returns for members whilst managing investment risk. This should give a better risk/return outcome for individual consumers.

9. Super Trusts could be set up on a regional, sectoral or national basis. They could be provided by a range of institutions that met statutory selection criteria (overseen by the regulator) which would include independent governance, not-for-profit status, a requirement to act in the interest of members, and competence to provide low cost, high quality DC pensions. Existing multi-employer schemes which are today providing low cost pensions to millions of working people could act as hubs for new Super Trusts.

10. Super Trusts could be regulated by either the FSA or the Pensions Regulator. Our preference at this stage is for the latter as we would prefer to keep the interests of the consumer or the "buy side" of the market separate from those providing the underlying services (regulated, as now, by FSA).

11. Super Trusts would deliver a fair deal for millions of future DC pension savers and sustain it for the future. Super Trusts would deliver a lasting model that could work with, and adapt to, changing market forces.

INTRODUCTION

1. The National Pension Savings Scheme (NPSS) or its alternatives could benefit millions of people, many first time savers, so it is essential that consumers have confidence in the new arrangements. If people do not, large numbers will opt out and the UK's problem of chronic under saving, highlighted in the Treasury Select Committee's (TSC's) inquiry into Restoring Confidence in Long-Term Savings, will continue. This raises very important questions about:

— the design of the new system;

— the delivery mechanism;

— the regulatory environment; and

— its interaction with the state pension system.

2. The TSC's inquiry is therefore a timely and important intervention. The National Association of Pension Funds (NAPF) welcomes the opportunity to submit written evidence.

3. Section 1 sets out in summary form the NAPF's preferred alternative to the NPSS—Super Trusts. Further details are supplied in Annexes B and C.

4. Section 2 deals with the issues of particular concern to the TSC surrounding the costs and regulation of NPSS and existing pensions products.

About the NAPF

5. The NAPF is the leading voice of workplace pensions in the UK. Our member schemes currently account for around 80% of private funded pension saving in this country, by size of assets and by number of customers benefiting. NAPF members manage around £790 billion pension fund assets.

SECTION 1: SUPER TRUSTS—AN ALTERNATIVE TO THE NATIONAL PENSION SAVINGS SCHEME

6. The NAPF supports the principles underpinning the NPSS:

Auto-enrolment

Large scale

Low cost

7. But whilst agreeing with the substance of the Pensions Commission's proposals, we believe there is a better solution to deliver the Government's objectives (shared by the NAPF) of low cost and wide coverage that builds on the existing pensions infrastructure, and which exposes the Government to less risk—Super Trusts.

8. The NAPF recognises that arguments around some important policy decisions relating to the extension of pensions coverage will be largely unaffected by the choice of infrastructure. Regardless of whether it establishes a NPSS or supports the creation of a series of Super Trusts, the Government will still have to decide who should be auto-enrolled, what the minimum level of contributions should be, in what circumstances employer contributions should be compulsory, and which employers should be allowed to administer their own schemes. These are important issues that will need to be addressed in the White Paper expected in the Spring and on which Government will need to consult widely.

9. Super Trusts meet the objectives for reform set by the Government and Pensions Commission: mass coverage; low cost; consumer protection and scheme governance; simplicity; and high persistency. They have been designed around the potential consumer base—millions of first-time savers on low and moderate incomes, likely to have low levels of financial literacy, low levels of trust in the financial services industry, and unused to making complex financial decisions.

10. Super Trusts would be new financial institutions occupying the space between retail pensions and occupational pension schemes as they exist today. Super Trusts would be based on the principles of mutuality, operating on a not-for-profit (or rather profit-for-members) basis with the interests of members, and not commercial pension providers, paramount.

SUPER TRUSTS—KEY FEATURES

— Large scale achieved by requiring employers to join a Super Trust (or run a superior alternative) and automatic enrolment for employees, to:

— ensure scale is achieved quickly;

— keep costs low and give value for money to workers; and

— provide enough diversity to achieve good value for consumers without wasteful marketing costs.

— Trust-based—so members' needs are put first.

— Collective investment, to give:

— the potential for higher returns; and

— investment decisions to expert trustees, rather than inexpert individual savers.

— Individual Super Trust Accounts for each member to provide a "lifetime pot" for consumers.

11. Super Trusts would be multi-employer pension arrangements which could be set up on a regional, sectoral or national basis and authorised by either the Pensions Regulator or the FSA. There would be a limited number of Super Trusts - probably no more than 20. NAPF analysis indicates that Super Trusts could operate at around 40bps. Each Super Trust would be governed and run by a board of expert trustees, who would have a legal duty of care towards the Super Trust's members. Trustees would be ultimately responsible for administration, investment, governance and member communications.

12. The Super Trust would "own" the scheme. It would operate on the buy side of the market and purchase services (including scheme administration and fund management) from wholesale providers on behalf of members. Contracts would be awarded on the basis of cost and quality of service. Trustees would re-negotiate and re-let contracts periodically to help drive improved performance and efficiency in the market to the benefit of consumers.

Simple for employers

13. Employers would be required to affiliate to a Super Trust. The joining process would be simple and low cost, with employers completing a simple application form. Employers who failed to select a Super Trust (and who did not have an adequate alternative) would be defaulted into a Super Trust by the regulator. Employers would be responsible for auto-enrolling employees and paying over contributions.

14. However, employers could opt out and run their own arrangements provided they met certain standards.

Better for working people

15. Employees would be automatically enrolled into the selected Super Trust. Unless they opted out, they would be required to make the minimum level of contributions set by the Government. Each Super Trust member would have their own personal Super Trust Account (STA) and would receive an annual statement setting out: the contributions paid into the scheme over the past 12 months; total contributions paid; current value of pension fund; and the income this could give in today's prices.

16. When moving to a new employer who was affiliated to a different Super Trust, the member would be required to transfer their Super Trust Account to the new Super Trust. This would give individual savers "lifetime pots" and reduce the proliferation of small accounts whose value is eroded by charges.

Investment strategy

17. Super Trusts would adopt a pooled investment approach that would mitigate many of the investment risks inherent in NPSS or other individual DC alternatives. Individuals, who generally take poor investment decisions or who find the prospect of making a choice so overwhelming they are deterred from saving, would not be required to take individual investment decisions. Instead, decisions would be taken by investment experts within the Super Trust. Trustees would set and publish an investment strategy, and select a number of managers to invest the fund. Super Trusts would pool risks across their member populations by investing in different classes of assets, taking account of the need to optimise overall returns for members whilst at the same time reducing individuals' exposure to market risk. Within these pooled arrangements, individuals would have their own individual "units" or Super Trust Accounts. This would help build a sense of ownership of the pension asset and encourage pension saving.

Controlled competition and managed choice

18. Given that Super Trusts would be very large-scale entities, it has been suggested that a logical end point would be to have a single Super Trust. However, we see significant disadvantages in a single entity, whether Super Trust or NPSS, as shown in the following table:

Table 1

ONE SCHEME vs MANY

One	Many
No competition	Managed choice for employers between a limited number of high quality providers
Monopolistic	Contestability and transparency between Super Trusts drives standards up and costs down
Distorts investment market—need to limit contributions	More investment diversity means there is less risk of market distortion and no need for limits on contributions
Needs new untested infrastructure	Builds on existing infrastructure (IT and institutional)
Political risk—one powerful body close to Government	Reduces risk of political interference

19. There is an important regulatory role in ensuring that Super Trusts work effectively. This role could be given to either the FSA or the Pensions Regulator. Our preference is for the latter as this would keep the interests of consumers on the "buy side" of the market separate from those providing the underlying services (which would remain regulated by the FSA).

Building consensus—public opinion

20. The new funded pensions system must have the confidence of the general public if it is to succeed and result in the "step change" in savings behaviour the Government rightly seeks. Yet a recent poll of representative sample of 2,000 adults conducted for the NAPF shows that the public would be far from confident in a state-run system. When asked how confident they would be if the new funded pensions system was run by Government, 51% of people in a Populus poll for the NAPF said they would not be confident that the system would record amounts saved accurately. And 54% were not confident that a state-run system would be glitch-free. [3]

21. Super Trust-type institutions are the public's clearly preferred option. Further polling for the NAPF sought consumers' views on who should run the new system. Respondents were asked:

Which of the following do you most agree with? The new scheme should be run by . . .

— A government body, as having one scheme would be the simplest and most efficient way of doing things.

— Insurance companies, as they already do a good job of looking after people's money.

— Not-for-profit companies with a legal duty to put savers' interests first?

— Overwhelmingly consumers support the not-for-profit option. 61% of people aged under 65 and in work favoured the Super Trust model. Only 20% thought the government should run the scheme. Fewer still—just 17%—said the insurance industry should be given the task.

Advantages of Super Trusts

22. Super Trusts have significant advantages over NPSS and Partnership Pensions:

Cost

Coverage

Consumer protection

Lower investment risk

Competition

23. A further note outlining some of the more detailed operational issues surrounding Super Trusts is attached as Annex B. This note, prepared for the Minister for Pensions Reform, clarifies some of the issues on the design of Super Trusts that arose in the discussions at the Ministerial Summit held on 28 February 2006. The NAPF's document Super Trusts—putting members first is attached at Annex C.

SECTION 2: ISSUES RAISED IN THE TSC'S INQUIRY

Costs of NPSS and Super Trusts

24. The NAPF completely agrees with the Pensions Commission's desire to drive down pensions costs to give better value for money to consumers and to ensure that more of workers' hard-earned savings are working to their advantage, rather than being siphoned off in charges to pension providers. As the Commission argues, people benefiting from low charges in occupational pension schemes can, for the same savings outlay, receive a pension nearly 30% higher than someone facing an annual management charge in line with the current stakeholder price cap. [4]In its previous reports, the TSC drew attention to evidence that individuals can pay "many thousands of pounds in commission over the lifetime of a long-term savings product, payments which can represent as much as 18% of the client's total contributions over 20 years".[5]

25. In developing our proposals for Super Trusts, the NAPF commissioned Delloite & Touche LLP to undertake some modelling work to assess the likely costs of Super Trusts. Whilst the assumptions underpinning these costs are clearly subject to a number of uncertainties (not least over the likely number of people who might opt out of the scheme), we have based our cost modelling on the actual experience of large occupational and multi-employer schemes. And we have stripped out unnecessary marketing and commission costs.

26. As the Pensions Commission identified in their first report (and as recent analysis from Watsons has shown) many occupational arrangements are already providing pensions to millions of working people at costs at or below 30bpts.

27. Our modelling indicates that Super Trusts could operate between 38 bps for 10 Super Trusts to 47 bps for 40 Super Trusts. These costs are considerably lower than those envisaged for other alternative proposals to NPSS, and lower than our remodelled costs for the Commission's NPSS. [6]

28. These costs for Super Trusts are built on the actual experience on large multi-employer schemes in operation today which are already providing valuable benefits at low cost to millions of working people in large and small companies. By contrast, the 30bpts target for NPSS is based on an untried and untested infrastructure and is therefore likely to be subject to much greater uncertainties than the projected costs for Super Trusts. The insurance industry has already demonstrated that it cannot provide pensions at low cost. And even with the benefits of auto-enrolment and compulsory contributions it is suggesting that the costs for its NPSS alternative—Partnership Pensions—would be around twice the cost of Super Trusts.

29. We have deliberately excluded some of the cost advantages that Super Trusts may enjoy (such as the further economies of scale that could arise if existing occupational DC provision—estimated to stand at £160 billion[7]—was consolidated into Super Trusts) in order to build a prudence margin around our work. We have built the following into our costs of Super Trusts:

— the costs of governance (including trusteeship and regulation);

— communications (including providing help and assistance to scheme members on whether or not to remain opted in, help with annuitisation etc);

— set up and administration costs; and

— fund management costs (including investment strategy and expertise).

Impact of design features on the costs of NPSS and its alternatives

30. Government decisions regarding some key design features will impact on the regulation (and therefore costs) of NPSS or any alternatives. Of most significance are:

— whether or not NPSS/ Super Trusts run alongside any of the alternative arrangements on offer;

— the extent of investment choice; and

— the interaction between the state pensions and NPSS/Super Trusts.

31. Each of these issues are dealt with below.

Impact on costs of a multiple model solution

32. An important issue that will have implications for the costs to consumers of the new savings system is whether or not a single or multiple model structure is adopted.

33. It has been suggested that Super Trusts could exist in the market place alongside the NPSS or Partnership Pensions. There is no reason why this could not happen in theory. But we think a dual system would be suboptimal for consumers, increasing costs and adding complexity.

— Were Super Trusts to run alongside Partnership Pensions, insurers would be likely to engage in expensive marketing campaigns in an effort to buy business and build scale. This would not be in consumers' interests, and would perpetuate the damaging behavior the Pensions Commission identified in its First Report in regard to the retail pensions market. In the face of this, it is unlikely that low cost, not-for-profit Super Trusts would get off the ground.

— Were Super Trusts to run alongside NPSS, the Government would have to build a costly infrastructure to run the NPSS that might not be required. Consumer confusion might increase opt-outs.

Impact on costs and regulation of fund choice

34. Super Trusts are based on the premise that all members will be entered into a single, pooled, fund. As explained above, this will obviate the need for scheme members to choose individual funds—a choice that most savers do not seem to want. Polling conducted for the NAPF by Populus indicated that just 15% of respondents would feel confident about choosing how to invest their pension fund, with 41% preferring to leave complex investment decisions to experts, such as the people who would be responsible for running Super Trusts. [8]

35. By contrast, under the NPSS (and the alternatives suggested by the ABI and IMA) consumers would have to make a fund choice based, in the Commission's words, on their own risk-return preference. This has implications for both the costs and regulation of NPSS.

36. As the Commission itself recognises the "freedom to choose between alternative funds will also add cost".[9] These additional costs arise due to the additional administrative complexities, additional communications requirements to explain to consumers the choices available, and the administrative costs associated with fund switching. These costs do not arise under Super Trusts. In this context, it is worth noting that the Chilean government was forced to remove fund choice options as consumers were switching funds to frequently.

37. But as the Pensions Commission also points out "The trade-off facing individuals between risk and return is therefore inherent, and the consequences of poor decisions and poor timing very large|there is, moreover, extensive evidence that a significant proportion of the population is both ill equipped, and recognises itself as ill equipped, to make informed choices between different risk-return combinations." 10[10] Recent FSA research into the financial capability of the UK population bears out these risks. For example, it showed that 40% of people with equity ISAs were unaware that its value would fluctuate with stock market performance. 11[11]

38. This has significant implications for the regulation of the NPSS and associated fund choice, particularly as the Commission's costings for the NPSS do not allow for any advice costs associated with investment choice. The Commission advance that just as the Government would be able to say: "well we didn't make you join [NPSS]—you could have opted out", it could also say "well, we didn't make you invest in that fund, you could have chosen a different fund". However, we do not believe this is how the politics of large numbers of disgruntled pensioners would play out. And the argument sits uncomfortably with the Commission's conclusion that state intervention in pension provision is needed because individuals lack the information to make informed decisions and do not always act rationally on the basis of the information they do have. If the default fund performed badly, those who remained in it would be as likely to blame the Government as if they had no choice. Therefore, were investment choice to be permitted, it would need to be accompanied by additional regulation by the FSA to ensure consumers did not "mis-buy". This would inevitably feed through to higher consumer costs. In addition, the design of the default fund would be a critical issue with the NPSS. There would be a high probability that the single NPSS default scheme would be a low risk—low return fund. It is generally recognised that such funds are not appropriate for long-term investments such as pensions.

NPSS/Super Trusts and state pension reform

39. We agree with the Secretary of State's comments that the state and private pensions reform aspects of the Pensions Commission's proposals are a package. Failure to take them forward in tandem has implications for both the costs of the new system and its regulation:

Regulation:

Costs:

40. Government has a pivotal role in taking forward state pension reform that achieves the goal of a higher state pension and less means testing. Without such reform, NPSS or any of the alternatives will fail.

Impact on the operational costs of existing schemes of the NPSS

41. The existence of a NPSS, and indeed any of the alternatives being proposed, will increase the operating costs of existing occupational pension schemes. This is due to the requirement on employers to automatically enrol all employees aged 21 and over into their existing pension arrangement. According to the 2005 NAPF Annual Survey, 62% of employers do not currently use auto-enrolment, and where this is the case scheme take up stands at around 42% (compared to 89% where auto-enrolment does exist). Typically sponsors of occupational scheme sponsors contribute in excess of the legal 3% employer minimum proposed for NPSS or its alternatives.

42. If employers who currently offer good pension schemes on an opt-in basis simply entered all staff into these schemes, their pension costs would rise considerably. For example, eight NAPF members, including a number of large retailers, have recently estimated that auto-enrolment would increase their scheme costs by more than 40%. The General Household Survey 2004 estimated that 20% of employees work for organisations which provide pension schemes but are not members of those schemes. Rather than accept an increase in overall remuneration costs, some employers may decide that they have a fixed amount of money to spend on pensions and that auto-enrolment will mean spreading these resources more thinly. This could mean mking pension arrangements less generous—in the case of DC schemes reducing contributions and in the case of DB schemes switching to DC (or the NPSS) for future and perhaps existing staff.

43. However, under a Super Trusts regime, we can see other areas of the pensions market where costs would fall. For example, employers with defined contribution occupational pension arrangements could decide to transfer those arrangements into a Super Trust. This would have benefits for the employer, who would not have the administrative complexities of running a scheme themselves, and would also benefit employees due to the lower costs of Super Trusts pensions. Accrued GPPs and stakeholder pensions could also be transferred in to Super Trusts. This design feature is unique to Super Trusts. Partnership Pensions would place limits on the amount that could be transferred into a Partnership Pension, with the result that consumers could be locked into existing high charging pensions products.

The role of the Regulator in keeping charges low—price caps

44. Because of the legal duty on Super Trusts to operate in the interests of scheme members on a not-for-profit basis, and because of the buying power of trustees, the costs to members in Super Trusts would not only start low but stay low. One of the strengths of a plurality of Super Trusts is the ability to benchmark schemes and compare performance across a range of functions, including investment performance, costs and charges and quality of administration.

45. NAPF has designed an important role for the Pensions Regulator in relation to costs and charges for Super Trusts. However, we do not believe that this should require a cap on the charges levied by Super Trusts (just as it has not been necessary to cap the charges of existing multi-employer schemes). We propose that each year Super Trusts would be required to report to the Pensions Regulator, in a specified format, on all costs and charges, investment performance, service standards and scheme membership. Such reports would be in the public domain. Any Super Trust that had costs significantly above the benchmark would be subject to further regulatory intervention. The presence of the Regulator, therefore, would be sufficient to keep the performance of Super Trusts "sharp".

46. By contrast, having a single NPSS, with no contestability over the functions exercised by the NPSS, runs the risk that those running the NPSS become complacent, with the result that costs did not fall as assets under management grew and no pressure for dynamic improvement in service standards.

47. Given the lack of governance in the retail-based Partnership Pensions model to keep charges low, it will be essential to regulate prices if the Government decides to opt for Partnership Pensions in favour of lower cost Super Trusts. Experience has shown that without imposed price control, expensive and unnecessary marketing and commission costs will creep back into the system to the detriment of consumers. Equally, the Government should be explicit about what will happen if the set up and on-going costs of the NPSS are higher than predicted and, as a result, costs to consumers rise.

Regulation of NPSS and Super Trusts

48. Super Trusts could be regulated by either the FSA or the Pensions Regulator. Our preference at this stage is for the latter as we would prefer to keep the interests of the consumer or the "buy side" of the market separate from those providing the underlying services (regulated, as now, by FSA). The remit of the Regulator's proposed powers and responsibilities in relation to Super Trusts is set out in Annex A.

49. Whilst the Pensions Regulator would be responsible for regulating the Super Trust itself, the FSA would also have an important regulatory role. Trustees of Super Trusts would select and award mandates to asset managers, and third party administrators (which could include insurance companies) and possibly annuity providers who would provide important services to Super Trusts. The FSA would, as now, be responsible for regulating these institutions.

Lessons from stakeholder pensions for the NPSS - lessons for regulation and charge caps

50. Extending much needed pensions opportunities to millions of working people by building on the stakeholder model will fail. Experience has shown that commercial providers would be likely to build costs back into the system, principally though marketing and advice costs, but also product complexity (eg a very large number of fund choices). Stakeholder pensions started with a 1% price cap, but following industry pressure, costs have risen to 1.5%. Yet the numbers of people (particularly those in the target market) are now buying/ being sold stakeholder pensions has not increased significantly. Hence a retail-based solution will require a higher degree of regulation and oversight by HMT and FSA to ensure that government objectives are being met and that costs are not increasing.

March 2006

Annex A

51. The Pensions Regulator would be responsible for authorising Super Trusts. We envisage no more than 20 Super Trusts would be authorised. Super Trusts could be established by a range of entities and in order to ensure that Super Trusts were established by organisations that had the potential to run successful schemes the Pensions Regulator would need to set the eligibility criteria for organisations that could establish Super Trusts.

CRITERIA FOR ORGANISATIONS FOUNDING A SUPER TRUST

— The Regulator must be satisfied that the founding organisation:

— had a robust business plan;

— was able to meet Super Trust start-up costs; and

— could reach a specified minimum scale to operate at low costs.

— Could demonstrate that trustees and senior management had the necessary expertise, competence, probity and integrity to operate a Super Trust.

— The Regulator would also take account of:

— the total number of Super Trusts; and

— other schemes operating in the same sector or region.

52. The Regulator would operate a filtered authorisation process which could work as follows:

— the Pensions Regulator would invite expressions of interest from those interested in establishing Super Trusts;

— applications which did not meet the Regulator's criteria would be filtered out at this early stage; and

— remaining applicants would be invited to submit full business plans.

53. The Regulator would then select the final Super Trusts based on the strength of their business plans and the quality of the proposed Super Trust personnel.

54. The Pensions Regulator would also approve the appointment of individual Super Trust trustees put forward by the Super Trust. In doing so, the Regulator will have regard to the fitness, competence and expertise of the trustees. The Regulator would also keep a register of approved trustees.

55. Ultimately, the Pensions Regulator would have the power to de-authorise Super Trusts that did not operate in the interests of scheme members, for example by failing to provide an adequate level of service to scheme members or failing to keep costs low.

56. In advance of closing a Super Trust down, the Regulator could impose new management (much as the Regulator can do with failing schemes currently). This would provide scheme members with continuity of membership, whilst at the same time ensuring that there was a governing body in place that would act in the members' best interests. The Pensions Regulator would be responsible for moving the members of a de-authorised scheme to a new Super Trust.

57. The Regulator would receive, once a year and in a specified format, annual reports from each Super Trust. This would report on all costs and charges, investment performance, service standards and scheme membership. In turn the Regulator would publish an annual report assessing the performance of each Super Trusts and comparing their performance. This would be a beneficial competitive pressure on Super Trusts to maintain high standards in the interests of scheme members and to adopt best industry practices.

Annex B

SUPER TRUSTS—A BETTER ALTERNATIVE TO NPSS A NOTE FOR STEPHEN TIMMS

INTRODUCTION

1. Following the Minister for Pensions Reform's invitation, this note responds to the points raised about Super Trusts in the discussion that took place at the Cabinet War Rooms on 28 February. In particular it corrects some of the misunderstandings regarding the operation of Super Trusts deals with some of their perceived weaknesses.

CHOICE

2. Much was made at the Cabinet War Rooms event on the degree of choice that should be available in the new system and by whom that choice should be exercised.

3. Whichever system is eventually selected, there will be choices to be made. In the NPSS, individuals will be required to select an investment option. Under Partnership Pensions, employers will have to select a provider whilst individuals will have to decide whether to remain in the scheme selected by their employer or make their own arrangement and then select an investment option; under Super Trusts, employers would be required to select a scheme from the limited number available. In all the models individuals will need to decide whether or not to remain auto-enrolled.

4. In designing alternatives to the NPSS, it is important to take account of our starting point and immediate goal: turning millions of non-savers into regular pension savers. Many of these people will never have saved in a pension before and most will have poor levels of financial literacy. It is important, therefore, that the new system is designed around the needs of the majority of savers' rather than the more sophisticated savings tastes of policymakers and commentators.

5. Many participants on 28 February acknowledged that amongst the strengths of Super Trusts were the relatively simple choices arising from the limited number of Super Trusts that would operate in the market. This managed choice would help ensure transparency and efficiency. However, others suggested that a drawback of Super Trusts lay in the fact that:

— employers and not individuals would be required to choose the Super Trust into which contributions would be made, as a result of which individuals could not independently switch between or select funds; and

— individuals would be placed in a single, pooled, investment fund and would not be offered an investment choice.

EMPLOYER CHOICE

6. As described in paragraph 3, it is important that choice is exercised by those best placed to do so. In terms of choice of Super Trust, we believe this means employers. However, a number of participants at the 28 February event questioned whether this was the case.

7. Yet employers—even small employers—make complex decisions and address complicated issues on a regular basis by virtue of the fact that they are employers. For example, they must comply with detailed employment and health and safety legislation and the National Minimum Wage. And employers, including small employers, are already required to select financial services products to comply with the law, for example stakeholder pensions and employers' liability insurance.

8. A limited choice of, say, 10-20 Super Trusts should not prove onerous as many participants at the 28 February event recognised. Moreover, employers that could not (or would not) designate a Super Trust would be defaulted into a Super Trust via HMRC and Pensions Regulator.

Consumer switching

9. One objection raised against Super Trusts is that consumers would not themselves be able to choose which Super Trust they belonged to. This is of course also true of the NPSS, though for a different reason.

10. The advantage of the Super Trust approach, with an employer selecting a single Super Trust into which his or her employees would be automatically enrolled, is that it simplifies scheme administration for employers who would only have to send pension contributions to one provider. By contrast, if individuals were able to select their own providers, employers would be faced with sending contributions to a number of providers, most likely through a new and untried "BACS-plus" system which would not only add to the costs of the new pensions system but possibly also delay the introduction of auto-enrolment.

11. It is perhaps worth noting that consumer choice can create systemic imbalances. The Chilean government halted consumer choice because consumers were switching funds too frequently.

12. However, our proposal makes clear that we see scope for choice to be transferred to individuals over time: "as members' funds grew and as Super Trusts became familiar and trusted organisations, it would be possible to allow members to select their own Super Trust from the range available. Australia has adopted a very similar approach, moving from a situation in which workers were compelled to join their `Award Super' fund to permitting choice of funds (introduced on 1 July 2005)." [12]

Investment (fund) choice

13. It was suggested at the Cabinet War Rooms event that the Super Trust model is flawed because it does not offer individuals any investment choice as participants would be placed in the Super Trust's single pooled fund that would be overseen by expert trustees.

14. We believe this pooled approach has considerable strengths compared to both the NPSS and Partnership Pensions where individuals would be required to select investment funds. As the Commission itself comments "The trade-off facing individuals between risk and return is therefore inherent, and the consequences of poor decisions and poor timing very large|there is, moreover, extensive evidence that a significant proportion of the population is both ill equipped, and recognises itself as ill equipped, to make informed choices between different risk-return combinations." [13]The Commission also acknowledge that the "freedom to choose between alternative funds will also add cost".[14] In our central recommendation, we suggest that this cost should be stripped out and that all members should invest through the Super Trust's pooled fund.

A false choice for most

15. International experience suggests that where people are offered choice in defined contribution schemes, most prefer not to exercise that choice. In the UK, NAPF members who offer default lifestyle funds report that, on average, 83% of scheme members remain in the default fund. [15]In Sweden, 91% of individuals now invest in the default fund. [16]Of these, it is estimated that three times as many passively accepted the default fund as actively selected it. It is therefore reasonable to expect that, for the vast majority of people auto-enrolled into the new pension system, fund choice will in any case be a theoretical possibility rather than something that they will take advantage of.

A choice people do not want

16. Nor is there any evidence that people want choice. In a Populus poll commissioned by the NAPF, people were told that if they joined the new scheme, they could be asked to choose how their money was invested. Few felt confident about taking the decision themselves without incurring the advice costs which the Pensions Commission is rightly keen to strip out of the system.

— Just 15% said: "I would be confident in choosing how to invest the money in my pension fund by myself with no professional advice."

— 42% said: "I would be happy to decide how to invest the money in my pension fund but I would pay an independent financial adviser to help me."

— 41% said: "I would prefer to rely on the expertise of the people managing my pension fund to decide how best to invest my money".

Those in social class DE and aged under 65 were most likely to say they would be confident in taking the decision themselves without advice (21%).

A damaging choice for a minority

17. Even if only 10%-20% of the people saving in the new pension system chose to make active fund choices, there could still be around one million people doing so. Before committing to making fund choice available, the Government should look at the choices these people are likely to make. The target market for the new savings system is also skewed towards those who are less likely to understand the differences between asset classes. 49% of male full-time manual workers and 60% of female full-time manual workers have no current pension provision. [17]

18. Research commissioned by the NAPF suggests that significant numbers could make unsuitable investment choices. While some may shoulder too much investment risk, the more common mistake is likely involve excessive caution. [18]55% of people say they would want the largest proportion of their savings to be invested in "accounts paying a low rate of interest but where you are guaranteed not to lose your money" rather than in either "shares in British and foreign companies" or "the property market". This figure rises to 61% amongst people aged 18-34—the age group for whom low-risk, low-return investments are most unsuitable.

19. The Child Trust Fund (CTF) provides additional evidence that significant numbers of people will choose inappropriate investment options. By January 2006, 310,000 cash CTF accounts had been opened. [19]This represents more than one-fifth of all CTF accounts. [20]Few experts would regard cash as a suitable instrument for an 18-year investment.

20. Lord Turner has advanced two arguments for fund choice. [21]His first argument is that, even within the target group for the NPSS or any alternative system, people will have different risk-return preferences. Higher earners within this target group or those expecting to inherit significant assets may be prepared to take greater risks with their pension savings than others. Likewise, riskier approaches to investment are more suitable for those who would be comparatively relaxed about having to postpone their retirement if the gamble didn't pay off. The NAPF accepts that this is a genuine advantage of fund choice, but believes it needs to be balanced against the risk, acknowledged by Lord Turner, that "people exercise that choice in a way that harms them".[22]

21. His second argument is much less convincing. This concerns the potential come-back on the Government in the unlikely event that it turns out that someone would either be better off if they had not saved at all, or their final pension fell below expectations due either to poor investment returns or a poor fund choice. Lord Turner likens the Commission's preference for fund choice to its preference for auto-enrolment above compulsion. The Commission advance that just as the Government would be able to say: "well we didn't make you join—you could have opted out", it could say "well, we didn't make you invest in that fund, you could have chosen a different fund".

22. We do not believe this is how the politics of large numbers of disgruntled pensioners would play out. And the argument sits uncomfortably with the Commission's conclusion that state intervention in pension provision is needed because individuals lack the information to make informed decisions and do not always act rationally on the basis of the information they do have. If the default fund performed badly, those who remained in it would be as likely to blame the Government as if they had no choice. We do not believe that creating a situation where the investments of significant numbers of people are certain to perform badly is a price worth paying to avoid the hypothetical possibility that everyone's fund performs badly (and replace it with the possibility that this is true for just 90% of people).

Adding fund choice to Super Trusts

23. If Government insisted that investment choice was an essential design feature of the new pensions system it would be quite possible to offer fund choice within Super Trusts—just as it would be possible for the Government to establish a National Pension Savings Scheme that did not offer a choice of funds to individuals. The Government can separate its decision about whether to offer fund choice from its decision about who should run the new system. If it is determined to offer fund choice, this should not be seen as a showstopper for the Super Trusts model.

24. If the Government did want to incorporate choice into the Super Trusts model, it would be relatively simple to offer individuals a choice of the underlying funds within the Super Trust's pooled fund. If the Government wanted an even wider range of fund choices to be available, Super Trusts could facilitate access to more specialist funds due to the strength of their buying power and investment expertise.

Personal responsibility and choice

25. It has been suggested that the absence of consumer choice—whether fund choice or provider choice—means that there is little chance of individuals building a sense of personal responsibility for their own retirement futures under Super Trusts. We do not agree.

26. International experience as well as that of NAPF members shows that individuals build personal responsibility for pensions by saving regularly and seeing their pension funds grow, not through the ability to make fund choices.

Taking account of members' interests

27. Super Trusts would be closer to scheme members - the people who really matter—than a single national scheme. However, to generate scale, Super Trusts would, by definition need to be large, perhaps with as many as 500,000 members depending on the eventual number of Super Trusts.

28. Despite their size, it would be important to ensure that Super Trusts took account of the views of scheme members and participating employers. In our 10 February submission (paragraph 3.13) we proposed that to ensure Super Trusts continued to improve service standards to scheme members and participating employers, Super Trusts could establish advisory or consumer panels to sit beneath the main Trust board and to provider consumer feedback to it. This would help to ensure that the trustees of the Super Trust were providing a valuable and valued service.

Super Trusts and Investment discretion

29. We have been asked about the extent to which Super Trusts would have discretion over their investment decisions. We do not envisage Super Trusts as being homogenous. Investment (and investment performance) could be one of the factors which differentiate one Super Trust from another. Super Trusts must have enough discretion to reflect the different characteristics of their members, just as occupational pension schemes do today.

30. It would of course be possible for the Government to set legal parameters concerning the investment decisions which trustees must take. However, the danger with a prescriptive approach is that it could leave trustees unable to respond flexibly to changing market circumstances to the benefit of consumers. A Super Trust with appropriate governance and expertise could take advantage of such opportunities. It could also construct baskets of assets and investment managers to reduce risks for the members (both the risk of volatile performance and the risk of selecting an unsuccessful manager). The risk of selecting an unsuccessful manager is mitigated within a group's portfolio because a number of different managers are used and there is a review process which regularly refreshes the manager list. These features are much harder for an individual to achieve.

One provider or many?

31. Much of the discussion at the Cabinet War Rooms therefore centred on the relative merits of a single-provider versus a multi-provider solution.

32. A plurality of Super Trusts:

— means contestability between Super Trusts which will drive up scheme quality and drive down costs on a continuing basis for the benefit of consumers;

— provides choice for employers who will be able to select the most appropriate Super Trust for their workforce, rather than workers being offered a "one-size-fits-all" arrangement;

— reduces the risk of political interference, for example on investment related matters;

— does not require an artificial cap on contributions to prevent market distortions; and

— unlike a single provider solution, does not require the building of a new (and therefore untested) infrastructure to run the new system.

33. By contrast, two main arguments for a single-provider solution were advanced. It was claimed that costs would be lower and that there would be no risk of individuals becoming aggrieved because one provider had performed better than another. We believe that both of these supposed advantages are much less clear cut than advocates of the NPSS have maintained.

Costs and performance

34. All participants in the debate acknowledge that their cost modeling is subject to a number of uncertainties. However, Lord Turner has argued that, whatever errors there are in the Commission's estimate of absolute cost levels in the NPSS, the NPSS is likely to be the lowest cost model available. Both Lord Turner and Richard Saunders of the IMA likened their vision of the NPSS to the single Super Trust model referred to in the NAPF's original submission which indicated that one Super Trust could operate at a lower Annual Management Charge than a number of Super Trusts. Advocates of the NPSS have taken this to mean that the NPSS has the "lowest AMC of any of the proposed models".[23]

35. Such a conclusion would only be reliable if the static cost models which we and others have used perfectly replicated the real world. In practice, the world is a dynamic place. Ensuring that the incentives are there for costs to stay low is therefore every bit as important as getting costs down in the first place—especially when the White Paper is intended to herald a long-term solution to the problem of inadequate pension savings.

36. Where a number of providers exist, there will be scope for innovation and diversity, for benchmarking performance against what others are doing and for spreading best practice. This insight is central to the Government's reform agenda in other policy areas. People serving on Super Trust boards would be conscious that their Trust's performance was being compared with others and, mindful of their professional reputation, would be anxious not to lag behind. We are pleased that you listed this scope for "benchmarking" as an advantage of the Super Trust model when summing up the day's discussions.

37. By contrast, it is unclear what would stop a monopoly provider from resting on its laurels. There would be no means of benchmarking how good a job this provider was doing, and not even a theoretical possibility that employers could transfer to another provider (unless they wanted to assume responsibility for managing their own scheme). A pluralist solution would be likely to drive standards up and costs down over time. Establishing a monopoly provider could have the opposite effect.

38. Proponents of a single-provider solution have raised two specific charges in relation to the costs of Super Trusts. They argue that non-persistency would be higher in a multi-provider solution and that marketing costs could push up the AMC.

Transfer Costs

39. Some participants at the 28 February event suggested that Super Trusts would face additional costs due to transfers between schemes. Whilst some workers would be required to transfer between schemes on changing jobs (if their new employer was not in the same Super Trust as their previous employer) such criticisms fail to take account of the scale of Super Trusts and their proposed sectoral and regional structure. These factors mean that there would be far fewer transfers than if each employer ran their own scheme. Furthermore, the experience of occupational schemes also suggests that administrative costs associated with transfers are very low. As outlined in our submission to you on 10 February, we have taken account of the costs of transfers between Super Trusts.

40. Moreover, we believe that this tells only part of the story regarding transfers. It would be wrong to look at the number of transfers between different providers within the new pensions system while ignoring transfers between the new pension system and alternative pension arrangements.

41. The Super Trust model is the only one which would enable consolidation of the existing DC market. The Commission is concerned about a single NPSS becoming too large, while the ABI is concerned about the "impact on existing business" is savers move from pensions with high charges to those with lower charges, so both place limitations on the ability of employers and individuals to transfer existing DC pensions into the new arrangements. If companies chose to transfer their legacy DC pensions into a Super Trust, individuals would not need to leave the Super Trust system when taking up employment with these companies. The Super Trust model is also the only one that does not require a cap on contributions (see paras 66-69)—meaning that individuals need not transfer out once their earnings and desired contributions exceeded a certain level. So while there would be transfers between different Super Trust providers that would not occur within a single NPSS, there would be fewer transfers between the new pensions system and alternative provision.

Marketing Costs

42. It was suggested that Super Trusts would replicate the excessive marketing costs that currently exist in the retail financial services market. Concerns about marketing costs are legitimate in the context of the ABI's proposals where Lord Turner has rightly identified the tendency of insurers to compete on the basis of brand rather than cost or service quality as a market failure in financial services.

43. However, this need not be a concern with Super Trusts which would be set up on a not-for-profit basis and which would all have sufficient scale to operate at low cost. They would not, at least during the first phase, be appealing directly to individuals but would be selected by employers. If Super Trusts were established on a sectoral or regional basis, employers would be able to base their initial selection on something other than brand. By contrast, the ABI model would allow individuals to override their employer's decision from the start. When an individual moved employer or when an employer changed their default provider, the individual would need to decide whether to remain with their existing provider or switch to the new default provider. The danger is that insurers would spend significant sums on marketing materials aimed at individuals in these circumstances, and that this would lead to higher charges for savers.

Coverage, governance and freedom from political interference

44. In a pluralist solution, there will be greater distance between the Government and people's savings than in a single-scheme solution.

45. The IMA has attempted to position its version of the NPSS as being "close to the NAPF"[24] in terms of governance arrangements. However, we believe it is unlikely that a single provider could either be truly independent from Government or (just as important) be seen to be independent.

46. There are two dangers in having an arrangement that is not completely separate from Government. One relates to coverage and the other to the potential for dragging investment decisions into the realm of politics.

Coverage

47. The Government has rightly said that the number of people who choose not to opt out will be a key determinant of the scheme's success. The NAPF has argued that if the Government wants to avoid a high opt-out rate, it must ensure that first-time savers feel able to trust the people and institutions looking after their money. This requires that the new pensions system is independent (and seen to be independent) of both Government and commercial interests.

48. Some advocates of the NPSS have echoed this view. [25]They part company from the NAPF in their confidence that no-one will fear that a single national scheme (even one set up as a non-departmental public body) is too closely associated with Government to be trustworthy. To justify this stance, they argue that the Bank of England provides an example of how a single public sector body can be independent from Government. There are two reasons why this is not a good analogy. First, an independent Bank of England was not (like the NPSS) created from scratch. Rather, the Bank already existed and its Monetary Policy Committee was handed powers that Ministers had previously chosen to exercise themselves. Secondly, making Bank of England independence a success depended in large part on convincing the financial markets that the Government would not interfere. For the NPSS to be a success, millions of individuals need to be convinced of this.

49. It is partly because of this impression of independence that a clear majority of people polled by Populus on behalf of the NAPF said they would prefer their savings to be looked after by not-for-profit companies rather than a Government agency or commercial providers.

50. Another reason for believing that coverage would be higher under the Super Trust model than under the NPSS is that Super Trusts would not require people to put their faith in a new public sector IT project. Further polling commissioned by the NAPF showed that only 16% of people were confident that such a system would record the amounts they had saved without errors, while only 25% were confident that it would ensure they were paid what they were entitled to. People would not have to take this leap of faith before saving in a Super Trust Account. Of course, errors in occupational schemes are not unheard of, but if they occurred on anything like the scale that people fear for the NPSS, this phenomenon would undoubtedly have been documented in a publication as thorough as the Pensions Commission's First Report.

51. Finally, many employees will be more likely to participate in a scheme if their employer (who they see as being used to taking financial decisions) has selected that scheme. Research published by the ABI last year showed that people were more likely to trust their employer not to let them down when it came to pensions than they were to trust either the Government or pension providers. [26]

Keeping politics out of investment (and investment out of politics)

52. Some people in the City have already expressed concern about the scope for political interference under the NPSS. Peter Butler, the Chief Executive of Governance for Owners says: "Once politicians wake up to the power they could have it would be like nationalisation by the back door." [27]

53. Some of these concerns might be misplaced: provided it is clear that funds are the legal property of individuals rather than the NPSS, it should be possible to avoid a situation where the Government is deciding how to exercise the voting rights that attach to shareholdings. The more probable danger is that the Government would come under pressure from interest groups to redefine the NPSS default fund (or even the full range of funds) in order to exclude shares in particular companies.

Differential outcomes and employer liability

54. Many commentators at the 28 February event acknowledged that a strength of Super Trusts is that they offer employers a simple choice of pension provider which in turn would lead to greater transparency and lower cost. However others suggested that multiple Super Trusts would lead to differential outcomes and that employers would be "scared" of selecting a scheme when they could be held liable by employees for any differential performance.

55. It is of course possible to ensure that no-one experiences a relative benefit arising from performance differentials—but only at the price of removing the scope for innovation that is likely to drive up standards for everyone. And even the NPSS would result in differential outcomes as scheme members will select different funds with different returns. In this context we find it strange that those who have worried about differences in performance between different Super Trusts usually say that individuals should be asked to choose how their money is invested. Any differences between the performance of different providers will be tiny compared with the likely difference between investing in equities and investing in guaranteed bond fund over a 40-year period.

56. In a pluralist environment, one Super Trust can experiment with a slightly different way of doing things. If this proves successful, others will follow. If it doesn't, the innovative Super Trust can return to the status quo ante. The Regulator would also be able to monitor what different Trusts were doing and enforce minimum standards. So whilst the possibility of some differences in performance is essential if we want to raise standards for all, any significant differences are likely to be short-lived. By limiting the overall number of Super Trusts, the Government can ensure that all have the potential to realise economies of scale.

57. The experience with defined contribution schemes to date and employer designated stakeholder pensions in particular, albeit limited, has not resulted in employers coming under fire from employees because the charges and returns in their schemes compare unfavourably with those administered by alternative insurers.

58. Under the present stakeholder legislation, employers with five or more staff are required to designate a stakeholder scheme but are not held liable for their decision to designate any particular scheme. As our submission makes clear, this feature of the law would transfer to Super Trusts.

59. For many employers, Super Trusts would represent an opportunity to free themselves of the burden of administering their own schemes without compromising on governance arrangements. Selecting a scheme does not look like an onerous requirement by comparison and involving employers could have a beneficial impact on take-up (see paragraph 51).

60. The wishes of those employers who don't want to choose a scheme should also be balanced against those of employers who do want to choose a scheme, but who might to want to run a scheme themselves (or to accept the management charges and lack of governance that comes with contract-based schemes). A recent survey of larger employers found that only 5% believed they were not at all responsible for providing financial security in retirement for their employees. [28]

Different costs for different Super Trusts

61. There was some confusion at the event on 28 February about how the client base of different Super Trusts might lead their costs to vary. Under our proposals, Super Trusts would not be able to refuse a particular employer designation (unlike stakeholder pensions currently). Employers would be free to join any Super Trust (not just the Super Trust for their sector or region) and Super Trusts could not "cherry pick" employers whose employees tended to earn most and have the most stable careers.

62. It was also suggested that costs would vary between different Super Trusts. To some extent, this is a feature of any pluralist solution and needs to be weighed against the benefits of the improvements in standards across the board that may come about through innovation. We do not believe that criticisms along the lines of "what if one Super Trust is really badly run?" carry much force. Besides the numerous safeguards outlined in our submission, the obvious answer is that the risk of provider error is diversified: in a single-provider solution, the same eventuality would affect millions of people.

63. One driver of differential costs highlighted at the Cabinet War Rooms was the possibility that some Super Trusts, because of their sectoral affiliations, would attract members capable of paying higher contributions and of remaining in the scheme for longer. It was suggested that Super Trusts serving industries where a large proportion of the workforce is transient and poorly paid (eg, hospitality) would have higher costs than those serving industries such as the financial services sector. It was also suggested that, once cost differences emerge, these could become self-perpetuating.

64. We suspect that such fears are overstated. For example, the Building & Civil Engineering (B&CE) scheme which services a low paid workforce with high labour turnover, already operates at a cost of around 85 basis points, despite receiving an average joint contribution of just £20 per month. However, B&CE have privately indicated to us that auto-enrolment and the introduction of mandatory employer contributions could be expected to push this cost down significantly to within the costs envisaged for Super Trusts.

65. However, we accept that the Government and Regulator may want to keep these issues under review if Super Trust model is implemented. If large cost disparities did arise as a result of differences in the sort of employers affiliating to different Super Trusts, measures could be taken to reduce these disparities. For example, the default arrangement for allocating employers that did not designate a scheme could be amended so that "less desirable" employers (ie, those whose workforce could be expected to have low contributions and high opt-out rates) who did not select a scheme were allocated to the Super Trusts with the biggest natural advantages in order to even things up. As our submission makes clear, at the extreme, a Super Trust with an unalterably high cost base could be wound up by the Regulator and its members distributed between other Super Trusts.

Should there be a cap on contributions?

66. One issue not discussed at the Cabinet War Rooms, but over which there remains some debate, was the question of whether contributions to the new savings scheme or transfers into it should be subject to a cap over and above the general limits on contributions attracting tax relief.

67. In its Second Report, the Pensions Commission stresses the importance of encouraging people to contribute more than the minimum. However, it believes that allowing individuals to contribute without limit could "raise concerns about the proportion of total national investment flowing through the NPSS".[29] It therefore recommends limiting the annual contributions to NPSS. While accepting that this cap "may be considered too restrictive in relation to people above average earnings",[30] the Commission defends an approach which "would mean that lower earners would effectively be free of any cap (since they would be unlikely to be able to use the full freedom) while limiting the extent to which higher earners could use the NPSS as a low-cost alternative for pension saving that is already in many cases occurring".[31]

68. The Commission is right to be concerned about the possibility that the volume of funds flowing through a single national scheme could be sufficient to distort the investment market. However, the dispersal of assets amongst multiple providers in either the NAPF or ABI models reduces the force of this argument. Nonetheless, the ABI follows the Commission in proposing a cap on contributions and would effectively lock individuals into higher charging products.

69. Any requirement to exclude higher earners should be regarded as a disadvantage in any scheme. There are four reasons for this:

— First, the relationship between the value of assets in an individual's account and the cost of administering that account will not be linear. Charging the same AMC (expressed as a percentage of fund value) to all savers will therefore introduce a degree of cross-subsidy. Those who save the most (typically higher earners) will be subsidising those who save the least (typically lower earners). Enabling people outside the target market to participate in the scheme will therefore bring down costs for those in the target market. These savings have not been factored into the costs of Super Trusts.

— Secondly, higher earners would themselves benefit from being given this opportunity to cross-subside lower earners. They would welcome the chance to save at, say, 30-50 basis points rather than 100 basis points. If a cap is imposed, the Government will have to explain why it is making these savers pay higher charges than they need to.

— Finally, any arrangement which encourages the separation of pension schemes serving company executives from those serving the majority of employees is unlikely to work to the advantage of the latter. Since directors are much more likely to appreciate the value of pensions than their staff, we may expect employer contributions to staff pensions to be higher when they are linked to the rate of employer contributions to directors' pensions.

Impact on existing schemes

70. Most of the discussion around a new system of pension saving assumes that the NPSS or any alternative will only cover those employers who do not already run their own pension schemes. We believe this is naive. In practice, significant numbers of employers are likely to gravitate towards arrangements which offer the opportunity to provide pensions that involve low charges for scheme members and few administrative burdens for employers. When these decisions are taken in the boardroom, surveys of human resources managers who believe this will not be the case offer only very limited reassurance. It is important to recognise that this leveling down impact primarily flows from the presence of auto-enrolment and mandatory contributions rather than the design of the NPSS or its alternatives.

71. Two issues need to be separated here. No one wants to see employers reduce the generosity of their pension arrangements, and the NAPF would happily work with the Government to look at how this can best be averted in an environment where auto-enrolment will raise some employers' pension costs. But there is an entirely separate question about whether employers will want to continue running their own defined contribution schemes when a low cost alternative is on offer. Rather than seeing the prospect that they will not as a threat and advocating arbitrary caps and other restrictions to slow the process down, the new environment could provide an opportunity to consolidate existing defined contribution provision, thereby generating a significant regulatory dividend.

72. We would be concerned if employers moved away from trust-based occupational schemes towards alternatives without adequate governance arrangements. Uniquely, Super Trusts would allow employers to move away from running schemes themselves without compromising on consumer protection. For some employers, this would be an important factor: 39% of NAPF members with occupational DC schemes say they selected this scheme type because they prefer trustees to look after members' interests. [33]

Super Trusts and third tier (employer-sponsored provision)

73. Just as the Pensions Commission envisages for the NPSS, Super Trusts would sit on top of a solid first tier of state pension provision. Along with occupational pension schemes, Super Trusts would form the backbone of second tier pension provision. But we acknowledge that employers may want to do more than the statutory minimum if it fits their business model, as may individuals. We therefore see significant scope for a vibrant third tier retirement savings market comprising retail pensions products (including stakeholder and group personal pensions) and other non-pensions products.

Legal Position of Super Trusts

74. We have been asked whether there are any barriers in European law to Super Trusts being regulated as occupational pension schemes. Our initial legal advice suggests that Super Trusts would fall within the definition of an occupational pension scheme as set out in European Directive 2003/41 on the Activities and Supervision of Institutions for Occupational Retirement Provision (IORPs). We would be happy to discuss this matter further with your officials.

Super Trusts and Partnership Pensions in tandem

75. It has been suggested that Super Trusts could exist in the market place alongside Partnership Pensions. There is no reason in theory why this could not happen. However, the dual system would present Government with some stark choices most notably around scheme costs and charges:

— All of the arrangements under discussion on 28 February (including NPSS) rely on economies of scale to build efficiencies and deliver low cost. Designing a system in which different models ran alongside each other would mean that scale was not achieved with the result that costs to consumers would increase.

— One reason why costs to consumers would increase is that providers of Partnership Pensions would be likely to engage in extensive marketing campaigns in an effort to buy business and build scale. This would not be in consumers' interests, would perpetuate the damaging behavior the Pensions Commission identified in its First Report, and would put not-for-profit Super Trusts at a relative disadvantage.

— In its first report, the Pensions Commission described the UK's pensions system as the most complex in the world. The current pensions reform exercise should therefore be an opportunity to simplify the pensions architecture. A multiplicity of pension arrangements would add to complexity and present additional choices for employers and employees who would be forced to choose their preferred type of pension arrangement (Super Trust or Partnership Pension etc).

76. So whilst Super Trusts could run alongside other NPSS variants, we do not believe this is the optimal outcome for consumers.

3 Populus polled 1002 adults by telephone. Polling was conducted between 17 and 19 February 2006. Results cited are for adults aged under 65. Back

4 Pensions Commission's Second Report, November 2005. Back

5 Restoring Confidence in Long-Term Savings, Eighth Report of Session 2003-04. Back

6 Combining the Commission's input data with our modelling assumptions increases the AMC for the NPSS from 31 bps to 46 bps. One reason for this is that the Commission assumes that an annual contributions is received at the start of Year One and that administration costs arise from the start of Year Two. When remodelling the cost of the NPSS, Deloitte replaced this assumption with one that was consistent with the NAPF model and with market experience. Back

7 Pension Fund Indicators- UBS Global Asset Managers, May 2005 (figure to end 2005). Back

8 Populus polled 1002 adults by telephone. Polling was conducted between 17 and 19 February 2006. Results cited are for adults aged under 65. Back

9 Second Report, p396. Back

10 Second Report, p195. Back

11 11 Establishing a baseline, FSA, March 2006. Back

12 Super Trusts: Putting Members First, p31. Back

13 Second Report, p195. Back