HC1494 Work & Pensions CommitteeWritten evidence submitted by National Association of Pension Funds (NAPF)

About the NAPF

The NAPF is the leading voice of workplace pension provision in the UK. We represent some 1,200 pension schemes from all parts of the economy and 400 businesses providing essential services to the pensions industry. Ten million working people currently belong to NAPF member schemes, while around 5 million pensioners are receiving valuable retirement income from those schemes. NAPF member schemes hold assets of some £800 billion, and account for over one sixth of investment in the UK stock market. Our main objective is to ensure the security and sustainability of UK pensions.

Executive Summary

The NAPF is strongly supportive of the 2012 reforms, which are designed to tackle the UK’s pensions savings crisis by widening access to workplace pensions through auto-enrolment. The scale of the problem meant that consensus had to be reached with all the major stakeholders. Whilst it is right that the Work and Pensions Select Committee makes sure that the 2012 reforms are on track to succeed, it must make sure that this consensus remains and that the focus remains on implementation.

Last year, the Making Auto Enrolment Work (MAEW) Review made a series of recommendations to improve the 2012 regime, which the NAPF supported. We do believe there is still room to streamline the auto-enrolment process to make it less burdensome for employers to provide good quality pensions, but with the introduction of auto-enrolment scheduled for October 2012 there is little time to implement major changes to the 2012 regime. We would therefore urge the Government to consider carefully the case for streamlining the auto-enrolment process during the 2017 review. Changes made after the 2017 would be based on employers’ and employees’ real experiences of auto-enrolment and evidence may show that there is no need for the process of auto-enrolment to be as prescriptive going forward.

We see the introduction of auto-enrolment and NEST as the start of a journey – not the finishing point. More work needs to be done to encourage people to save more than the 8% statutory minimum, which is generally recognised as not enough to reach the Pensions Commission’s recommended replacement rates. Part of the solution will be in reinvigorating existing occupational pension schemes, as was promised in the Coalition Government. Initiatives such as the NAPF’s Pension Quality Mark (PQM) will also help recognise employers who provide good quality pensions.

Auto-Enrolment – Why is it Necessary?

1. The 2012 pension reforms have been designed in response to the UK’s pensions savings crisis. Without action a large proportion of today’s workers are facing poverty in retirement, with only means-tested benefits to support them. The Pensions Commission itself recommended widening access to workplace pensions through automatic enrolment - so that all employees have access to a pension with an employer contribution. Introducing NEST and auto-enrolment together means all employers will offer such a pension. The expectation is that auto-enrolment will harness the power of inertia meaning most people will take up the offer.

2. The scale of the problem and the long-term nature of the solution meant that a consensus had to be built including all the major stakeholders. Whilst it is right that the Committee makes sure that the reforms are on course to succeed, it must make sure this consensus remains.

3. Throughout the debate on the 2012 reforms, there have been concerns about employees on low incomes and the interaction with means tested benefits. The NAPF believes that the answer to this problem is to increase incentives to save for those on low incomes by further reforming state pensions and benefits.

4. We welcomed the Government’s Green Paper A State Pension System for the 21st Century and support the Single Tier option for reform – combining the Basic State Pension and State Second Pension (S2P) into a single, simple pension of £140 a week. We believe the Single Tier pension will complement auto-enrolment by improving individuals’ incentives to save and by making it easier for employers to make decisions about scheme benefits and contribution levels. The NAPF is leading the debate on reform of the state pension system with our Foundation Pension proposal and we look forward to working with the Government to develop this proposal in greater detail.

Making Auto-Enrolment Work

5. Last summer, the Making Auto Enrolment Work (MAEW) review team was asked to examine the scope of auto-enrolment and to determine whether there were any viable alternatives to NEST. The review team set out a series of recommendations, many of which are being put into law in the Pensions Bill 2011.

6. Overall, the NAPF believes the review team took a reasonable and common-sense approach to the reforms:

Earnings threshold. The review team recommended that the earnings level at which individuals become eligible for auto-enrolment should be increased from the current £5,035 level to the income tax threshold (currently £7,336 in 2010-11).

Age band. The review team did not recommend any changes to the age band. All employees between the ages of 22 and State Pension Age who earn above £7,500 should be eligible for auto-enrolment.

All employers. The review team concluded that all employers, including small employers, should be required to auto-enrol their employees. Other stakeholders argued that small employers should be exempt but the NAPF stressed that the reforms should aim to reach all employees, regardless of who they work for.

Certification. The review team argued in favour of a simple system of self-certification that employers can use to ensure their defined contribution scheme meets the contribution requirement. The NAPF worked closely with the DWP to develop a simple certification process and the review team’s conclusions echoed the approach the NAPF has been pushing for. An easy-to-use certification system will ensure that existing schemes can keep their current definitions of pensionable pay, which are typically more generous than the auto-enrolment definition of qualifying earnings. We are pleased the Pensions Bill 2011 will allow the DWP to implement this important measure.

Waiting period. The review team recommended that there should be an optional three month waiting period before employees are automatically enrolled. This is a significant easement and we are pleased that the Pensions Bill 2011 will put this recommendation into law. The three month waiting period means employers will no longer be forced to enrol employees who stay for very short periods or who are likely to opt-out anyway, thus avoiding the substantial cost of setting up scheme membership and refunding contributions. Employees are still protected because they can choose to join the scheme during the waiting period. The three month waiting period is essential in managing the costs and complexity of auto-enrolment.

NEST. NEST should go ahead as planned as it is key to the successful implementation of auto-enrolment. The NAPF has been supportive of NEST from the beginning. However, it is important that NEST complements, not competes with, existing pension provision.

Early auto-enrolment. Large firms who would have originally had to start auto-enrolment in October 2012 should be allowed to auto-enrol their employees early in July 2012, giving them some much needed breathing room to avoid busy periods around the New Year.

7. Of course there is still more room to make auto-enrolment less costly and bureaucratic for employers. There is a risk that some employers will reduce their contributions down to the minimum to contain their increasing costs. A key part of the success of the reforms will be in increasing access to good quality existing schemes. The average contributions going into an existing DC scheme run by NAPF members is 12% while the average contribution into an existing DB scheme run by NAPF members is 21.8%.1 The NAPF’s Pension Quality Mark (PQM) leads the way in recognising employers who provide good quality pensions by setting minimum standards around contributions, governance (including charges) and communications. To date, 114 schemes now have the PQM covering almost 200,000 pension savers.

8. However, we accept that, with the introduction of auto-enrolment scheduled for October 2012, there is little time for major legislative overhaul. We would therefore urge the Government to consider carefully the case for streamlining the auto-enrolment process during the 2017 review. Changes made after 2017 would be based on employers’ and employees’ real experiences of auto-enrolment and evidence may show there is no need for the process of auto-enrolment to be as prescriptive going forward.

Answers to Specific Queries

DWP’s communication strategy for introducing auto-enrolment and provision of advice and support to employers and employees

9. The introduction of auto-enrolment from 2012 presents us with a major opportunity to change the way the nation thinks about saving for retirement. But to ensure the success of the 2012 reforms, the DWP needs to lead a comprehensive and coordinated communications campaign in conjunction with the Pensions Regulator, consumer groups, unions, and other stakeholders.

10. The DWP is currently developing its communications strategy for individuals which, on paper, appears to be thorough and will probably be effective once implemented. However, we would have liked to see more progress to date. In our view, the key to a successful communications campaign will be reaching the individuals least likely to be currently saving.

11. This is where joined-up communications with employers is crucial. Our survey data shows that many people trust their employer the most when it comes to information about saving for retirement.2 But too often employers are hesitant to talk about pensions, for fear of straying into the realm of financial advice. Employers must be given support and guidance to talk with confidence about pensions to their employees. The Pensions Regulator had already launched a number of tools for employers, but it could also produce other guides for employers about communicating with their employees about pensions. The final report of the Workplace Retirement Income Commission (WRIC) recommended that employers who provide good quality financial education and guidance should be given “safe harbour” where they can be free of concerns of regulatory or legal comeback.

Arrangements for phasing and staging the introduction of auto-enrolment

12. Auto-enrolment will be costly and administratively burdensome for employers. As part of the consensus reached around the Pensions Commission’s recommendations, the Government agreed to stage the introduction of auto-enrolment over a number of years to give employers time to prepare. Employer contributions are also gradually increasing from 1% to 3% to help employers adjust to the cost of auto-enrolment. We have argued for more flexibility for employers when choosing their staging date as many employers use a variety of payroll cycles. However, staging and phasing remain important elements of the auto-enrolment consensus.

13. Staging the introduction of auto-enrolment over several years will also ensure that the Pensions Regulator is able to cope with its new responsibility for enforcing the employer auto-enrolment duties as millions of employers register with the Regulator.

Likely impact of auto-enrolment on business, especially small and micro-businesses

14. The MAEW Review estimated that all employers will be paying an additional £3,240 million in contributions once phasing has ended. Small and micro-businesses employing between zero to 19 employees will pay an additional £970 million in contributions. The MAEW Review also estimated that the administrative costs of preparing for and maintaining auto-enrolment will cost businesses £444 million in 2012 and £127 million in each year following.

15. The NAPF has consistently argued that, because the costs of auto-enrolment are so burdensome for businesses, the process of auto-enrolment needs to be as flexible as possible. There is a risk that, in the current economic climate, many businesses may choose to level down their pension provision to the statutory minimum in order to contain their costs. Our latest Annual Survey shows that 7% of our members are planning to level down in some way and 20% have not yet decided what they are going to do in the face of increasing costs.3

16. The measures included in the Pensions Bill 2011 will go some way to introduce much-needed flexibility into the auto-enrolment process. In particular, the introduction of the three month waiting period will help businesses manage the costs and complexities of auto-enrolment.

Role of the Pensions Regulator, including in certification of schemes

17. The Pensions Regulator will play a key role in ensuring the success of the 2012 reforms by ensuring that all eligible employees are auto-enrolled and that unscrupulous employers who fail to comply with the reforms are suitably reprimanded. Employers will be required to provide information to the Regulator on the number of employees they automatically enrolled.

18. We have expressed concern that the process for registering auto-enrolment information with the Regulator has been constructed in an inflexible way which does not reward employers who have a proven track record of compliance. Although the Regulator has not yet finished developing its compliance strategy, we would like to see it take a more risk-based approach to policing the 2012 regime so that its resources can be used to tackle avoidance rather than focusing on employers who are trying to do right by their employees.

Estimated opt-out rates, including the possible impact on NEST if the numbers auto-enrolled are significantly lower than predicted

19. Of the approximately 10 million people eligible for auto-enrolment, the DWP estimates that one to two million individuals will opt-out of NEST and one to two million people will opt-out of other qualifying schemes.4 Given the high levels of participation auto-enrolment achieves elsewhere in the world, we see no reason to dispute these figures.

20. Most schemes will not be affected if levels of opt-outs are lower than expected. However, in order for NEST to remain a low-cost alternative, it needs to reach the DWP’s estimate of two to five million scheme members relatively quickly. If this cannot be achieved, it will take longer for NEST to repay its Government loan and, as a result, NEST members will have to pay the 1.8% contribution charge for longer. Good communications around the reforms will be integral to ensuring levels of opt-outs are low.

NEST’s potential market share and the possible effects on other providers

21. The DWP estimates that, of the 10 million people being brought into pension saving through auto-enrolment, two to five million people will be auto-enrolled into NEST and eight million people will be auto-enrolled into other qualifying schemes. Although this represents a large share of the auto-enrolment market, it is likely that NEST will serve the needs of many small employers and those on low incomes who, to date, have been viewed by the industry as uneconomical to serve.

22. Following the publication of the Pensions Commission’s final report there was a long and thorough investigation into whether existing pension providers could deliver an alternative to NEST (then called NPSS or Personal Accounts). Since then, pension providers have been unable to develop a model for reaching smaller employers and those on lower incomes at a reasonable charge level because of NEST’s universal service obligation. It’s clear therefore that alternatives to NEST would not offer any benefit to scheme members and would hinder the Government’s objectives of tackling poverty and boosting savings. NEST will be a key role in ensuring the success of the reforms, but it must keep focus on its target market and not compete with existing provision.

Whether auto-enrolment is likely to attract new providers and encourage new models of provision

23. The NAPF has long argued for the creation of other large-scale, collective schemes or Super Trusts to operate alongside NEST. We believe that Super Trusts would provide some diversity and competition in the auto-enrolment marketplace. Super Trusts would also help ensure that the costs and services provided by NEST remain competitive and high quality.

24. The NAPF is aware of a number of providers that are interested in entering the auto-enrolment market on a large scale. For example, some large insurers who traditionally offer personal pensions or contract-based workplace pensions are setting up Master Trusts. The Danish pension scheme ATP is also in the process of setting up a UK scheme that could operate in competition with NEST.

Likely impact of the limitations placed on NEST, including the contributions cap and the ban on transfers

25. As part of the consensus reached around the Pensions Commissions report, political parties, employers, trade unions and the pensions industry reached a compromise which limited the level of contributions into NEST and banned transfers of existing pension pots into NEST. The purpose of this compromise was to keep NEST focused on its target market and to acknowledge good quality existing schemes.

26. Since the consensus was reached, concerns have been raised about these limitations:

Some people feel transfers into NEST are needed so NEST to reach scale quickly and therefore to remain low-cost.

The MAEW review felt that restricting transfers into NEST would exacerbate the problem of small pots, particularly for those on low incomes or for people who change jobs frequently.

27. Both the contribution cap and restriction on transfers will be reconsidered when the Government reviews the entire structure of auto-enrolment in 2017. We are therefore of the view that, in order to maintain consensus around the 2012 reforms and to make changes based on evidence of auto-enrolment in action, these limitations should not yet be removed.

NEST’s investment strategy

28. As a trust-based scheme, NEST’s investment strategy has been set by a group of trustees after conducting extensive research data on the scheme’s target membership and with input from professional investment advisers. The trustees have developed an investment strategy which they believe will help members achieve good retirement outcomes.

29. Based on research of their target member group the NEST trustees produced a strategy with clear return objectives coupled with a robust approach to risk management. The investment objective will be targeted via a default retirement fund with Foundation, Growth and Consolidation phases across the member’s savings lifetime. Those members who require a specific level of risk (eg Higher risk fund) or whose investment decisions are driven by faith or beliefs (eg Shariah or ethical funds) will be accommodated through a focused choice of additional funds.

Possible measures to reduce the proliferation of small pension pots

30. The build-up of small pots is a perennial problem for NAPF members and is likely to become a bigger problem after the introduction of auto-enrolment. In many cases the cost of administering small pots can be larger than the value of the pots themselves. Current rules allow trust-based schemes to refund employee contributions for up to two years after members join the scheme. Research conducted by the NAPF shows that the average refund of employee contributions is around £750. According to DWP research,5 schemes use the retained employer contribution to help pay for the costs of scheme governance, advice, administration and communication – all of which benefit scheme members.

31. NAPF members accept that it would be better to encourage more employees to transfer small pension pot upon leaving a job rather than to refund them. However, the rules around transfers are extremely bureaucratic and off-putting.

32. The DWP itself estimates that auto-enrolment will create an additional 200,000 small pots worth less than £2,000 each year after 2017.6 In its response to its call for evidence, the DWP acknowledged that small pots would be burdensome for schemes and employers and is therefore not planning to act on the issue of refunds until a solution can be found to address the complexity and costliness of transfers. We are pleased that the DWP has recognised that addressing the issue of small pots and transfers is essential to the success of auto-enrolment.

How self-employed people, and part-time, temporary, casual and agency staff, will be treated under auto-enrolment; and the equality implications

33. Many NAPF members employ part-time and temporary workers during peak times in the year, particularly around Christmas. For these employers, auto-enrolling employees who will only stay for a short time (and therefore only accrue a very small pension pot) is uneconomic and could lead to further levelling down.

34. The NAPF welcomed the MAEW Review’s recommendation that all employers should be able to use a three month waiting period to delay auto-enrolment. Having to auto-enrol all eligible employees from day one forces employers to deal with the costs and complexities of setting up scheme membership and eventually refunding contributions when short-term or temporary workers opt-out.

The extent to which auto-enrolment is likely to achieve the desired behavioural change in terms of encouraging people to make provision for retirement.

35. Most of the research around the effects of auto-enrolment comes from the US where 42% of 401(k) plans use auto-enrolment to boost scheme membership.7

36. In 2009 the US Government Accountability Office (GAO) conducted a study of 401(k) plans and found that automatic enrolment is powerful behavioural tool to increase employee participation. Some 401(k) plans using automatic enrolment experience participation levels of 95%.8 Auto-enrolment is especially effective for low income and younger employees. The GAO reports that a 2007 Fidelity Investment survey found that 30% of employees aged 20 to 29 were members of 401(k) schemes without automatic enrolment. Plans that did use automatic enrolment saw participation levels of around 75% amongst 20 to 29 year old employees.

37. The effectiveness of auto-enrolment in increasing participation rates was one of the main reasons why the Pensions Commission recommended its introduction in its second report. According to the Pensions Commissions’ research, auto-enrolment can normally achieve participation rates of between 60-80%.9

38. From 2012, all UK pension scheme will be required to use automatic enrolment. This will be a huge step forward and will bring millions of people into pension saving. To make the behavioural impact of auto-enrolment more effective, the Government must engage in a comprehensive communications campaign aimed at individuals which would provide clear messages about the importance of saving for retirement.

23 August 2011