Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 100-112)

MR DICK SAUNDERS, MR STEPHEN HADDRILL AND MS CHRISTINE FARNISH

25 APRIL 2006

  Q100  Angela Eagle: Christine, do you have a worry about the fund not even breaking even on an optimistic assumption until 2035? It is a huge potential reform of performance. It seems to be balanced on a knife-edge in terms of its desirability when you look at the size of fund and whether it breaks even.

  Ms Farnish: I think there is a very big question mark of uncertainty about how much it might cost, at the end of the day, to set up the sort of fund envisaged by the Pension Commission and to run it. The track record of doing very large national assistance of this sort is not a particularly happy one, which is why I think many of us on this side of the table would prefer this country's pension system to be a more evolutionary one and to build on more of what we already have. That has certainly been our starting point.

  Q101  Peter Viggers: You talked about employment patterns, which are important, and the change in employment patterns with people having half a dozen jobs during their careers and needing to be able to transfer their pension points easily and without undue expense. Would you very briefly explain how you would see a change of employment affecting pensioner rights and the costs in each case?

  Ms Farnish: Shall I start with our model? Under our model, as you know, we are suggesting a limited number of super trusts, into which employers could automatically enrol their employees, perhaps 10 of them across the country; those could be either national or sector-based. If someone moved from one employer to another, it may well be that they were a member of the same super trust, in which case the question you ask would not arise. If it was a different one, then there would be a simple transfer of the DC pot with the individual from the super trust where they were enrolled into the one where their new employer was enrolled. That costs around 30 pence per account currently between large DC schemes, so it is not a particularly expensive process.

  Mr Saunders: This is a very important point because the target market for this is those employers that have empty stakeholder schemes, and those are essentially small/medium enterprises. It is in that sector of the economy that you see the highest rates of employee turnover and also the highest rates of company mortality. I have seen figures suggesting that every year one in eight employees in firms below a certain size—I cannot remember now whether it 20 or 50 employees—sees their employer go out of business during the course of the year. That is a very high turnover of employers. It is absolutely central to this that this has to work seamlessly. That is the great advantage of a centralised national pension savings scheme because it gives you that single point of contact for all employers, so there is a single account for any individual, no matter who their employer is.

  Q102  Peter Viggers: So no change, no effect?

  Mr Haddrill: I think you would want to have complete portability of the pension pot within the NPSS. That is very important. As we were saying earlier, it can be done within the system and must be done within the system that we are proposing. There is a problem with transfers from outside of the NPSS into it. That is partly because it increases the risk of employers in effect coming down to the NPSS level. Also, I think it is not that straightforward to convert a DB existing scheme into a DC NPSS scheme. There are problems with transfers in and out but portability within is very important.

  Q103  Peter Viggers: Do you see any difficulties transferring in and out with bulk transfers?

  Ms Farnish: We are talking here about DC bulk transfers, not DB, for the reasons Stephen has given. Certainly for many years to come, it is going to be very difficult for there to be an acceptable mechanism to convert DB benefits into DC benefits in a bulk way, maybe sadly because it could solve some of our legacy problems, but there you go. DC bulk transfers would be possible for super trusts, and indeed if it is generally the view in policy terms that low charges are very important for consumers saving in DC pension arrangements, which I think most of us would now accept, there is a very strong case to allow and permit and design a system to allow the existing defined contribution pension accruals to be transferred into whatever new system finally materialised that is well run, well governed, low charge and in the interests of consumers. If we were to have such a system, then you could envisage those sorts of transfers. One of the advantages possibly with having more than one institution, a number of super trusts rather than a single NPSS, is that you do not have to cap the amount of money in it because there would not be the risk of market distortion in the way you might have with a single institution.

  Mr Saunders: I would be quite cautious about bulk transfers in because if they began to take place on any scale, then there would at least be a risk of over-concentration and implication for competition in the existing retail financial services market. That would need to be looked at very carefully before one were to allow that in any way. As to bulk transfers out, which you could perhaps conceive of if an employer decided to set up a scheme of its own, I see less problem with that as a principle, although it would tend to increase administration costs, so again that would need to be factored into any decision.

  Mr Haddrill: I agree.

  Q104  Peter Viggers: Taking up one point, reference to bulk transfers and defined benefit schemes, the Pensions Regulator has insisted on a transfer level which has shaken some people who have commented on this view. Do you see perhaps defined benefits schemes as it were withering on the vine rather than being subject to bulk transfer?

  Ms Farnish: Many company sponsors that have large legacy defined benefit schemes are facing a huge challenge as they project forward as to exactly how much that scheme is going to cost them and the risks involved in it. Many of them are looking for alternative ways to get those risks and costs managed that can take it away from their own company in-house, obviously. As you say, the regulatory regime currently makes that an incredibly expensive task. We need to have a further debate about how the existing liabilities in defined benefit schemes can best be managed for the future. I do not think we have reached the end of the story on this. The regime changed very dramatically three years ago when the rules changed on solvent wind-ups. I am pretty certain that those rules will need to be re-visited at some point in the future if we are to sustain many employers and create jobs in this country without undue costs on their shoulders for perhaps a minority of consumers.

  Q105  Peter Viggers: I switch to another point. The assumption in the Turner Report is a non-persistency of some 2.5%. Do you think that is reasonable or what would the impact be if it is not in accordance with Turner's estimates?

  Mr Saunders: As I said earlier, we have not done any modelling on persistency, so I cannot really comment on Ned Cazalet's 10% versus Turner's 2.5%. Clearly, this is one of the important factors in doing the arithmetic, but only one of the factors. Admin costs are also an important part of the equation, and collection costs as well. Overall, I do not think that more pessimistic assumptions about persistency would torpedo the scheme at all. It might mean that the scheme needs to operate at a slightly higher cost than it otherwise would, but it is important in this not to start with a predetermined idea of what the costs are going to be. We all have a feel for what they are. We think they will be somewhere between 0.3% and 0.5 % but we should not select a number and try to work back from that. We have to allow competition in the provision of services to the scheme and then the costs will emerge from that process. It is difficult to start with a particular price cap of 0.3% or 0.5% or 0.8%, or whatever it is.

  Q106  Peter Viggers: The Swedish system has been much quoted because it is rather similar to that which is proposed. Have you looked at this and do you think it teaches us any lessons?

  Mr Saunders: Yes, indeed, we have looked at it very closely. An important difference between the Swedish scheme and what we are saying is that the Swedish scheme starts with a fund platform which has 700 funds on it. We are not suggesting that at all because we think that will just confuse people. We think it is much more important to focus on the default fund. In terms of cost, there are some very interesting and important pointers in the Swedish scheme. The default fund in the Swedish scheme is currently charging 15 basis points, that is 0.15%, for fund management. It is quite a small fund at the moment and that is likely to fall as the fund gets bigger. In terms of administration cost, the PPM, which is the central agency which runs it, is charging something over 20 basis points at the moment for admin. However, the important point about admin costs is that they decline in percentage terms as the assets under management increase. Admin costs are, broadly speaking, fixed in cash terms. It costs the same to manage an account that has £1,000 in it as it costs to manage an account with £10,000 in it, but as a percentage obviously in basis point terms that £10,000 account is one-tenth of the cost of the £1,000 account. As the scheme grows, the admin costs will decline automatically, in accordance with the laws of arithmetic. They are projecting that by 2020 the admin costs will decline to something like 5 basis points. That is the basis on which they are saying that for the default fund by 2020 they expect to see costs of less than 20 basis points.

  Q107  Mr Gauke: What do you see as the role of the FSA in your respective models?

  Mr Haddrill: We see a very important and continuing role for the FSA in making sure that the providers or the fund managers are properly solvent, and so on. That needs to continue. We believe that if you have a model, as proposed by Turner, where there is complete suitability of the pension product for everybody, or almost everybody, then what you do not need is the sort of conduct of business regulation. We do feel, and I think Lord Turner feels and everyone feels, that if you have to import that, then you will add unacceptably to the costs. You are certainly not going to achieve the kind of 0.3% to 0.5% figure that he has been talking about.

  Mr Saunders: In terms of a centralised NPSS, I would very much agree with what I understand the FSA to have said: that provided there is a straightforward, simple interaction between the state system and the means testing and NPSS, then the need for advice about whether or not you are in the scheme largely falls away because there is a clear benefit to joining the scheme. That benefit is the employer contribution that is made to you, which you would not otherwise be benefiting from. In a central NPSS, with that caveat, then I would see relatively little need or room for regulated advice. Having said that, I think one of the things you would want the NPSS to do would be to make available a very wide range of educational material and information for the members of the scheme, for the public.

  Ms Farnish: I have little to add. A lot does hang on the extent to which the state pension system can be reformed so as to reduce the extent of means testing. If we fail to do that, as part of this pension reform process, then any system into which the vast majority of working people are auto-enrolled is doomed to fail. It is absolutely crucial that the state pension system, which will underpin the funded pension system, becomes a simpler system and one which is more predictable for people to provide the basic bedrock on which they can then take that decision to save and auto-enrol. As long as that is done, then the FSA role is as has been described. Clearly, if we ended up with a system whereby commercial providers, whether they were insurers or anyone else, were designated as people into whom the funds were auto-enrolled, then we would need a much stricter regulatory regime than the sort of model perhaps that we have put forward, or the Turner model, whereby there is an institution acting on behalf of consumers that is a powerful institution in the market with a job to protect the consumer interest, that can really start to provide more of a balance of power in the retail market than we have had up until now.

  Q108  Mr Newmark: Can I ask perhaps the other side, and I do not know whether Stephen Haddrill wants to respond to that point, but perhaps in doing so both Richard Saunders and Stephen could answer the point that I think Christine has made that it is crucial that we simplify the means testing state pension in order to negate the need to have a suitability test. How important is this suitability test? Does it make it a complete non-runner if you have to have regulated advice in this area?

  Mr Haddrill: It is not a non-runner but it is a non-runner at the kind of costs that people are trying to achieve. A suitability test is absolutely fundamental. If it is suitable for everybody, then I do not think you need regulated advice, as Christine was suggesting. Yes, certainly for people probably up to about the sort of £15,000 a year level, it would not be suitable without some progressive reduction in means testing over a fairly rapid period. Yes, you are absolutely right.

  Mr Saunders: If means testing persisted by the time this scheme was up and running, then it would be a non-runner. I would not introduce this scheme if there was substantial means testing in the state pension system. Having said that though, there is time to sort this out. Assuming that legislation goes ahead to implement this, we are probably looking at five years before NPSS even starts, then another five or 10 years with people building up substantial pots and coming up to retirement. That gives quite a long window in which to sort out the state pension scheme. To return to the question that was Mr Cousins asked Mick McAteer, whether that means the Turner package or something else, I do not know. I do not have a view on that; Christine might. There ought to be a clear objective that by about 10 or 15 years down the track we want to see the extent of means testing within the state pension scheme to be at a minimal level.

  Mr Haddrill: I do not agree on the point about time because people are not saving enough now for their retirement and the longer that goes on, the less they will have in retirement. From the point of view of the individual, I think there is a concern. The other concern, which is one for individuals but also for the industry, is that the longer this debate goes on, then potentially it overhangs the existing savings market. It could damage the savings market with people not sure whether they want to buy an existing product or they want to wait for this to come along.

  Q109  Jim Cousins: Could I put a slightly different form of my question to Mr McAteer to you, particularly in the light of what you have just now said? If the Government cherry-picked Turner in the sense that it committed itself to an auto-enrolled national pensions scheme, but had not committed itself to Turner's proposals for the basic rate of state pension, would you be prepared to operate your scheme under those circumstances?

  Mr Haddrill: Probably not because what we would look for the Government to do is to take some decisions on the reduction of means testing before we would operate the NPSS or before we would think it should be operated. It is very hard for the Government to take decisions on means testing without having decided what to do on the basic state pension. I think those two must go together.

  Mr Saunders: If I may answer a slightly different question, I think in terms—

  Q110  Jim Cousins: The purpose of parliamentary scrutiny is that you bring yourself to answer the questions that are actually put to you. I have asked you: would you be prepared to operate your scheme that you have advocated this morning if the Government had committed itself to the second bit of Turner, the National Pension Savings Scheme, but not to the first bit of it—had not committed itself to the first bit of Turner, which is a major increase in the basic rate of state pensions? It is very simple. Would you be prepared to operate your scheme under those circumstances?

  Mr Saunders: If you come along to a fund manager and say, "We have £10 billion of assets here. Will you manage these for us, please" the manager will say yes, obviously, but would that be a good idea from a public policy perspective? I think the answer is unequivocally no.

  Ms Farnish: My answer is no.

  Q111  Chairman: Assuming the NPSS or something based on it is introduced over the next five years, what impact do you expect that to have on the current pensions and indeed savings market?

  Ms Farnish: That depends on how it is done, Mr McFall. Provided it can be done in a way that consumers believe is going to give them a fair deal and the system is one which they feel they can trust and have confidence in and it is not going to change and get fiddled with over time, then I think we will end up with a far better system than the one we are heading to. It is going to be very different from where we have come from but I think we could still make a success of defined contribution pension savings in this country with sufficient thought and planning. It is critical that we do because, as I said at the beginning, we are seeing a very seismic shift here between the sort of way in which the risks in the pension system are going to be falling from where we have come from to where we are going.

  Mr Saunders: I would agree with that. The impact of the NPSS in economic terms on the current long-term savings pensions market will be modest because the numbers involved are quite modest. Even after 10 years, the NPSS might have something like £100 billion funds under management. That will be about 3% of what IMA members currently look after on behalf of their clients. The flows into the NPSS are estimated by Turner to be about £8 billion a year. We published figures yesterday showing that there were net flows into UK retail mutual funds of £4 billion in the first quarter alone last year. So the numbers in NPSS are not large. The impact of NPSS will not be large, given the almost seismic forces which are now driving change in the occupational pensions market which Christine has talked about.

  Mr Haddrill: It can be very beneficial if it draws people who are currently entirely focused on credit and debt into saving and gets them started because it a simple product that serves their basic needs. That could lead into people saving more in other ways. The risk is that it becomes seen as a kind of Government blessed standard for occupational pensions and that employers then reduce their contributions down to that kind of level, and that would be very damaging. That is why some separation of the two markets is necessary.

  Q112  Chairman: Lastly, do you agree with the view that the more choice, the greater the propensity for regulation. The question underlying that is: what can you do to keep the FSA out of it?

  Ms Farnish: I think I will give you that.

  Mr Saunders: I would agree with that, Chairman.

  Mr Haddrill: We feel there is a role for an economic regulator and he will make sure that there is a balance in choice.

  Chairman: May I thank you for your appearance this morning. It was not as lively as the first session but just as revealing and highly civilized.





 
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