The Government's pension reform

Written evidence submitted by NAPF

About the NAPF

The NAPF is the leading voice of workplace pension provision in the UK. We represent 1,200 pension schemes from all parts of the economy and 400 businesses providing essential services to the pensions industry. Our members provide pensions for 15m people and collectively hold assets of £800bn, accounting for a sixth of investment in the UK stock market. Our main objective is to ensure there is a secure and sustainable pensions system in the UK.

Questions for the Minister

We have outlined our main areas of interest below and have proposed some questions that we suggest the Committee may wish to ask the Minister. The questions cover:

· State pensions reform

· Auto-enrolment and NEST

· Reinvigorating occupational pensions

· Better regulation

· Contracted out rebates

· Early access to pension saving

· State pension age

State pension reform

The UK’s state pension system is the bedrock on which people save for their retirement. Or it should be. While the state system has and will continue to have an important role to play in providing an adequate floor of benefits for people – safeguarding them against poverty and providing a starting point for their own saving – successive changes have left the UK state pension system as one of the most complicated and least generous in the world.

The state system fails to meet its most basic objectives:

· Today 58% pensioners need some form of income-related benefit in old age. Even after the latest round of reforms, that number will fall only slightly to 53% – still unacceptably high [1] .

· It is one of the lowest state pensions in the developed world. OECD figures show the gross replacement rate for a median earner in the UK in 2009 was just 30.8%, compared to an OECD average of 59%.

· The system is complex and poorly understood.

· While men and women will begin to experience similar outcomes from the state pension system, it will take decades for the difference to equalise – even by 2030 the difference could be as great as £17 a week.

The current state pension system is too complicated. People do not understand how much they will receive from their state pension, which makes planning for the future difficult. Add to it the complex interaction between state pensions and means tested benefits and people lose the incentive to save for their own retirement. Many simply will not know if it "pays to save".

That is why the NAPF has been arguing for a new and more radical approach – the Foundation Pension. The Foundation Pension would combine the current basic and State Second Pension into a single flat rate benefit. It would be paid at a level above means tested benefits and uprated by earnings.

The Foundation Pension is key to getting Britain saving again. Importantly, those in work and saving in workplace pensions will have a much clearer understanding of the income they can expect when they reach state pension age. They will know it will "pay to save" and that what they save through their workplace scheme will not be lost through means testing in later years. This should act as an additional incentive to save.

Reinvigorating occupational pensions

Pensions work best when they are provided through the workplace. That is why the NAPF believes that all working people should be entitled to a decent pension that comes with their job. But workplace pensions are under significant pressure because of rising operational costs and increasing employer sensitivity to the scale of pension scheme liabilities:

· Over the last few decades there has been a significant decline in defined benefit pensions, in favour of defined contribution pensions. Today less than a quarter of defined benefit schemes in the private sector remain open to new members.

· At the same time, DC based pension coverage ha grown from 10% of the workforce in 1997 to 16% in 2009.

The reasons for this change are many: regulatory costs, increasing employer contributions and rising administration costs, changing investment conditions, increasing longevity and change in the accounting rules.

Unless further action is taken to arrest this decline, private sector pension provision will wane and individuals will not achieve the income they need or deserve in retirement. That is why the NAPF supports the coalition Government’s commitment to "reinvigorate occupational pensions".

The NAPF has recently launched an independent Workplace Retirement income Commission chaired by Lord McFall of Alcluith. The Commission has been tasked with analysing workplace saving and coming up with a roadmap for reform. The Commission will report in October 2011.

Auto-enrolment and NEST

The NAPF supports auto-enrolment, mandatory employer contributions, and the introduction of the new National Employment Savings Trust. We believe these reforms are an important step in kick-starting the retirement savings culture in the UK and getting millions of people to save into a workplace pension for the first time. However, the NAPF believes that the introduction of auto-enrolment and NEST is just the beginning of the story. More needs to be done through the Government’s commitment to "reinvigorate occupational pensions", to increase saving to the levels needed to give individuals an adequate income in retirement.

The NAPF is pleased that the Comprehensive Spending Review has given the green light to auto-enrolment and NEST following an independent review headed by Paul Johnson. This review recommended a number of changes to the scope of auto-enrolment that the NAPF has welcomed. These changes will reduce burdens on employers and help employers to use existing good quality pension schemes. The changes being taken forward as part of the Pensions Bill include:

· Earnings "trigger". The Bill introduces a new earnings trigger of £7,475. Once a jobholder reaches this amount, they will become eligible for auto-enrolment. However, the earnings band remains in place. Employers and employees will have to pay contributions on earnings between approximately £5,000 and £33,000 (in 2006 earnings terms).

· Postponement of auto-enrolment. All employers will have the option to delay auto-enrolment by 3 months. The Bill allows employers to base the delay on 3 dates: from the employer staging date, from the first day of an employee’s employment, or from the day an employee turns 22 or reaches the earnings trigger. Employees can opt-in during the waiting period.

· Certification. The DWP, in conjunction with the NAPF and others, has been developing a new system of self-certification for schemes who use alternative definitions of pensionable pay to ensure they meet the auto-enrolment quality requirements. The Bill gives the Secretary of State the power to implement this new certification system through regulation.

Better regulation

The NAPF believes that confidence in pensions is best secured through having well-run pension schemes supported by the right regulatory framework that ensures appropriate safeguards are in place so that savers are not exposed to excessive risk. Such a framework needs to be simple to operate for trustees; understandable for sponsors, trustees and members; and have the ability to be flexible to changing conditions. Above all, the NAPF believes that the regulatory environment should encourage good workplace provision rather than discourage it as now.

A genuinely, risk-based regime needs to be supported by the right regulatory infrastructure. There is currently a multiplicity of regulatory and quasi regulatory bodies whose existence is confusing to practitioners, but above all to pension scheme members. This is especially the case with the Financial Services Authority (FSA) and the Pensions Regulator (TPR), both of which have responsibility for aspects of Group Personal Pensions (GPPs) and Stakeholder Pensions.

The NAPF believes there should be a single regulator for pensions. However, the single regulator must also be the right regulator. At present, the Pensions Regulator is charged with three statutory objectives:

· to protect the benefits of members of work-based pension schemes;

· to promote good administration of work-based pension schemes; and

· to reduce the risk of situations arising that might lead to claims for compensation from the Pension Protection Fund.

In practice it is the last of these objectives that dominates the Regulator’s activities with the result that it is overly focused on the defined benefit "run off" and insufficiently focused on the continuation of good quality workplace pensions. The Regulator’s activities should be reoriented to make its primary focus on ensuring the longevity and health of workplace pension schemes. To give it this required focus, the NAPF believes that the Regulator should have a new statutory objective: to promote good pension provision and to ensure their health and longevity.

As well as ensuring that we have the right regulatory architecture and objectives for the system of pension regulation, the Government must also take full account of the costs and benefits of policies when legislating. BIS has introduced a "One-in, One-out" rule, intended to ensure that no new legislation which imposes costs on business or civil society can be introduced without identifying existing regulations with an equivalent value that can be removed. (Regulations required to implement EU obligations and the public sector are excluded.) It is not clear what progress has been made on the ‘Out’ side of this policy since it was introduced in September 2010.

Contracted out rebates

The Government recently announced that it will be reducing the contracted out rebate for defined benefit (DB) schemes from 2012 to 2017 from 5.3% to 4.8%.  Employers with DB schemes that contract out of the State Second Pension (S2P) pay reduced-rate national insurance contributions for those employees who join their schemes. To create the new 4.8% rate, employer rebates will fall from 3.7% to 3.4% and employee rebates from 1.6% to 1.4%.

Pension schemes that contract out of S2P take on considerable costs and risk by providing benefits in place of the State Second Pension.  The NAPF believes that the value of the contracted out rebate should properly reflect the risk taken on by the employer and the increased liabilities schemes will incur as a result of contracting out.  The reduction in the value of the rebate will raise the operating costs of final salary schemes, and is likely to spur more employers to close these pensions to staff.

Early access to pension saving

The NAPF supports the Government’s efforts to foster a culture of saving in the UK and agrees with its aims to encourage people to take responsibility for their own pension provision. Given the limited amount of research and evidence available to us, we have concluded that early access would only harm overall levels of retirement saving in the UK and that it should not be considered as a policy going forward. Our specific concerns include:

· Early access would reduce people’s overall levels of savings. Evidence from the United States demonstrates that early access reduces people’s overall levels of savings at retirement. The NAPF believes that early access has the potential to undermine the principles behind the introduction of automatic enrolment in 2012.

· The long-term effects of early access would be difficult to communicate to scheme members. The UK pensions system is already one of the most complicated in the world, making it difficult for people to predict with confidence what they will receive in the future and for schemes to communicate the benefits of pension saving. The NAPF is concerned that pension scheme members may not fully understand the long term effects early access could have on their final retirement income.

· Early access would be difficult for schemes to deliver. Early access in all its forms would be complex and expensive for schemes to administer. Schemes should not be required to offer early access to scheme members.

State pension age

The current Pensions Bill amends the timetable for the increasing state pension age (SPA) from 65 to 66. Women’s SPA is currently rising from 60 to 65 and this process is currently scheduled to be completed by 2020. The change brought forward in the current Bill speeds up the equalisation so it occurs by November 2018. Both men and women’s SPA will then increase to 66 between December 2018 and April 2020. The NAPF acknowledges that raising the State Pension Age is necessary to reflect the fact that people are living longer. However, we are concerned about the short amount of time individuals have been given to revaluate their retirement plans. 4.9 million people will see their SPA increase and 330,000 women will see their SPA increase by more than 18 months. In particular, 30,000 women born between 6th March and 5th April 1954 will have their SPA increased by two years. We are particularly interested in the Government’s plans for further changes to the state pension ages.

February 2011