HC1494 Work & Pensions CommitteeWritten evidence submitted by Friends Life

Friends Life are a major provider of corporate pension schemes in the UK with over 20,000 corporate clients providing pension benefits to over one million employees. We have been involved in consultations with tPR and DWP throughout the period over which welfare reform has been developed and we are keen to be involved by providing input into this inquiry.

Our responses to the specific questions raised are as follows:

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

A key element of DWP communication should be around communication of the generic benefits to both employees and employers of saving for retirement. Communication should not be limited to auto enrolment in isolation, nor should it promote NEST ahead of existing provider provision. Engagement of both stakeholders in the value of pensions is essential, ahead of anything specifically aimed at auto enrolment.

We will be providing help to our clients but for those employers without access to an adviser, or for whom pension provision is something new, they will be reliant upon government sponsored support.

It is impossible to underestimate the level of support some employers will require, particularly the small and micro employers.

Educational communication to employers and employees should be differentiated based upon the size of the employer and timely in relation to their staging dates ie the communication to employers in advance of early staging dates should be different from that provided later, when smaller employers will be meeting their obligations.

Employee communication should be similarly targeted at those groups who have not engaged with pension saving to date. This should be clear and not rely upon the traditional financial messages which have failed to engage employees to date. We would encourage an approach which is aimed at eliciting an emotional response to pension saving which can be easily understood by the target audience.

Communication should not end with enrolment, ongoing communication with employers and employees will be necessary to ensure continued compliance and engagement with retirement saving.

Arrangements for phasing and staging the introduction of auto-enrolment

These seem sensible, offer sufficient flexibility and sufficient preparation time for smaller employers. They also spread the load for providers and the regulator.

The proposed delaying of staging dates for micro employers so that they are not impacted by legislation prior to April 2014 is also welcomed.

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

Most large businesses already see the value in offering a pension scheme as part of a wider benefit package designed to attract and retain to employees. The impact on all businesses in terms of increased costs will be dependent upon:

The remuneration structure and demographic of the company, ie how many workers will be auto enrolled.

The current take up levels of any existing scheme.

The proportion of workers who maintain membership post enrolment.

From the work we have done with employers it is clear that some sectors (eg retail and catering) will be affected more than others. These sectors experience low levels of engagement from a workforce that is transient, particularly in the first year or so of employment, and as such typically have low levels of take up. The opt-out rates for these companies will largely dictate the impact auto enrolment will have on their businesses.

Small and micro employers will need substantial and focussed educative support and assistance to fully meet the new requirements as it is clear that despite some good communication from tPR many employers, even medium sized employers, have little appreciation of what the new legislation will mean for them and their businesses.

Continued support will be required around the administration of the auto enrolment process, and the communication to employees of their rights and options. We see the payroll providers as having a crucial role in this area, to ensure that their systems reflect the new requirements and that small employers remain compliant with legislation.

Our research to date has revealed little evidence that payroll providers are engaging with employers to ensure they are meeting their needs, which is very concerning.

For employers who already sponsor workplace saving for retirement this support may well be provided, at least in part, by their pension scheme provider.

Role of The Pensions Regulator, including in certification of schemes

The regulatory role of tPR is essential to the success of the automatic enrolment, however, the size of the task should not be underestimated.

We see registration as a first and essential step in regulating compliance with legislation and we are happy that this provides the regulator with sufficient information, while not over burdening employers in terms of the volume of data required, nor the timescale in which it should be provided.

The success of tPRs role will be depended to a large extent upon the resource that is made available to follow up on those employers who intentionally or unwittingly fail to comply and/or register with tPR, and those employers who adopt practices that are designed to induce opt-out. It is this element that should be the key focus of the tPR rather than focussing on checking that employers have completed every item correctly within all the required documentation.

Communication will again be key in reducing the number of employers who do not comply, this should aimed at smaller employers in particular along with their professional advisers, such as accountants who could play a key role in promoting compliance to their clients.

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

Our research to date has revealed great variance in expected opt-out rates between sectors and also between different employers within the same sector. Possible explanations for these variations will be the demographic of the employees and the socio economic situation that applies at the staging date, both at a macro and micro level eg at a micro level we would expect employees automatically enrolled in January to opt-out in higher numbers as they are more focussed on maximising take home pay or short-term debt reduction following the expense of Christmas.

What we have heard from a variety of clients in sectors with low take up at the moment is that they are struggling to predict opt-out rates and the resultant impact upon their business.

What is not fully understood is the power of inertia, when applied to employees on low levels of income. Automatic enrolment is used by pension schemes today but this has only been adopted by paternalistic employers who are committed to long-term pension saving. In these schemes opt-out rates of 10% or lower are quite usual. In an environment where employer commitment to pension saving may not always be so strong (eg one employer we spoke to expressed a view that they “want as many people to opt-out, while remaining on the right side of the law.”) past experience may be no guide to likely future opt-out rates.

If numbers automatically enrolled are significantly lower than predicted it is clear that the aims of auto enrolment, to promote pension saving across the UK working population and improve incomes in retirement will not be met. There will also be an impact upon NEST as funds under management and initial charges will not provide the income they expect to receive. There will be a delay in paying back loans through the 1.8 % initial charge, and the term over which this applies will be extended.

As we are not privy to the business model of NEST we are unable to comment about other break even points or the effect severe under achievement of target enrolment rate could have upon NEST’s viability.

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

We do not expect NEST to take a significant share of our current market. Our existing customer research has shown that our employer customers are not looking to use NEST as their core pension provider and that many are averse to using NEST for any pension provision.

Some are looking to adopt NEST as an ancillary scheme in which to auto enrol those members who do not join their pension scheme now. These tend to be low paid and more mobile workers for whom NEST has some advantages (eg a single pot for life).

We intend to work collaboratively with NEST to ensure we can provide mutually beneficial arrangements for employers and their employees as well as ourselves and NEST.

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

Automatic enrolment has already spurred interest in Master Trust activity, in part driven by the attraction of short service refunds. While there are benefits to be achieved by this model, once short service refunds are removed, we do not feel that the remaining benefits in terms of economies of scale will add significant benefit for either employees or employers over a contract based solution with good provider governance in place.

NEST, and the reduced margins which will come with including lower paid and more mobile workers within pension schemes, will drive a move to a more e commerce based model. Fewer providers will communicate with employees via paper, as is the norm now. The internet and email will take over as the major ways in which providers communicate with employees and the way in which employees and employers interface with those providers. We do need to ensure however that those employees who are not enabled are not left behind.

Auto enrolment may also bring about changes to:

The language and communication styles that providers use as they address a new group of investors.

The provision of financial education to the new wider demographic.

The default funds that are used across the industry.

At this stage we do not expect new providers to launch mainstream pension products as market penetration may be difficult to achieve. What we may see are some niche players move in to provide products such as roll over plans, to allow the accumulation of transfer values in a single pot.

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

The restrictions on NEST mean that they are likely to be forced to concentrate on their target market of middle and lower paid sectors. Employers with a large proportion of higher paid employees are likely to have an existing scheme and are unlikely to use NEST as they will need to run another scheme for those who contribute more than NEST limits Although, it is unlikely that the NEST product would provide the customer experience and return on investment for employers, in terms of attraction and retention of staff, that these employers are looking for from their core pension scheme.

With regard to transferring assets we see no reason why NEST could not accept small transfers in order to facilitate the amalgamation of small posts.

It is essential that the process of transferring small pots is simplified (both from a regulatory perspective and also from a systems perspective). This is critical to minimise the financial costs for providers of administering small pots, as well as allowing individuals to reduce the number of pensions pots that they are holding. This simplification should apply for transfers into NEST and also into other employer sponsored pension schemes.

For larger transfers we feel that the 2017 limit is sensible. Fund performance is likely to be a factor in deciding whether a transfer is right for a member with a larger transfer. Low charges could prove immaterial if transferred to a fund range that significantly under performs. A period of time before larger transfers are allowed and over which performance can be judged seems sensible.

We would like to see an examination of whether 8% of qualifying earnings is sufficient to meet most employees requirements in retirement. We would encourage this review to take place in 2017 with a view to encouraging members to pay higher contributions. This could potentially be through gradually increasing the employee/employer contribution by say 1% every two to three years (as is the case in Australia).

NEST’s investment strategy

We believe that providing a limited fund range is the correct approach for the target market for NEST, this will make choices easier for those that move out of the default.

NEST has adopted a more cautious strategy than is the norm in the pensions industry and we understand the reasons why this decision was made. The work that we have done in the area of behavioural finance supports the NEST view that individuals naturally feel a loss more acutely than a gain and that this can lead to disillusionment with saving or buy high, sell low, activity.

We are however disappointed that the natural behaviour of individuals who are disengaged with saving has influenced the investment choices and the make up of the default in particular. We would have liked to see the trustees looking to provide education around long-term saving to address issues caused by short-term losses. We would have also liked to see the adoption of a more paternalistic approach to the default, with a design based around employees’ capacity for risk, rather than their attitude to risk, to provide more optimum performance over the long-term.

While fund levels are relatively low the marginal effect of lower returns will be small, but if contribution limits are lifted and transfers are allowed we would like to see a re-examination of the investment strategy to reflect the different demographic that could result.

Possible measures to reduce the proliferation of small pension pots

NEST is an ideal product for the target market of mobile workers who can continue to pay into the same pot over their working life. The pensions industry is not built around that model with pension schemes set up with individual charging and investment options based around the demographic of that particular employer’s scheme.

Small pension pots have been accepted to date but with the advent of automatic enrolment we expect them to proliferate and individually reduce still further in size.

We would like to see a sensible relaxation of transfer regulation to allow pots below an agreed size to be transferred simply, without advice, either to NEST, a “roll over” product or another employer pension scheme, so long as certain criteria are met around charges.

We would also support any move to allow employees to amalgamate separate pots at retirement to allow them to access the best annuity rates through an open market option.

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

A large proportion of the people in these categories will not be saving for their pension in old age and as a result of their employment contracts or their working patterns they are not catered for under auto enrolment legislation. As a result they will not receive an employer contribution to help them save.

In the case of the self-employed, reasonably, we can only provide communication and education to convince this group that pension saving is something they should be doing. The only alternative if this fails is compulsion in some form.

For many of those who are employed on short-term temporary contracts the period of temporary employment does not constitute the whole of their working life. There will be periods where pension saving is not encouraged through automatic enrolment but this may not make up a significant percentage of the time during which they are earning a wage. The rules around waiting periods and the earnings thresholds have been accepted as being required to simplify the auto enrolment process and lessen the administrative and financial burden on employers.

We cannot see any option that will bring these workers into pension saving in line with other workers , other than removing the lower limit for contributions and insisting that all employees are auto enrolled (with the option to opt-out) from day one of their employment.

We are unsure as to what effect this will have on increasing pension provision for those currently excluded as we do not know what the opt-out rates in this group would be, we would suspect them to be very high however. Any change may therefore increase the burden on employers without any appreciable benefit to the target group. It would also significantly increase costs for providers and lead to a large increase in the number of very small pots which could lead to a reduction in overall support for automatic enrolment.

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

Inertia will without doubt increase the take up rates of workplace pension provision via automatic enrolment. What it will not do is increase to any great degree engagement with pension saving or exert a significant behavioural change so that employees actively take ownership of their pension saving.

There is a risk that communication and engagement that ends with enrolment will achieve the aim of moving people out of extreme poverty and reliance upon the state in retirement, but it will not deliver the aspirational retirement incomes of most employees. To achieve this greater aim, individuals will need to engage with pension saving, to contribute above the minima required by auto enrolment and/or accept greater risk in the early years when it comes to investment. Ongoing support in the form of education, guidance and good governance around all of these factors will be required if employees are to achieve their aim, of providing an income in retirement that allows them to participate fully in society.

26 August 2011