HC1494 Work & Pensions CommitteeWritten evidence submitted by the Trades Union Congress (TUC)
1. Introduction
1.1 The TUC strongly supports auto-enrolment, contingent employer contributions and the creation of NEST as a low-cost pension scheme that remedies the failure of the market to properly serve the interests of low to median earners. We welcome this opportunity to set out our views on the progress of this policy, and have concentrated in this evidence on those parts of the terms of reference where we have views or experience to contribute.
1.2 The decline in employer support for pensions has been dramatic. By 2010 only 39% of male employees and 2% of female employees belonged to an employer-sponsored pension scheme in the private sector, compared with 52% and 37% respectively in 1997, with pension coverage concentrated on those with higher earnings.1
1.3 While the TUC has long backed compulsion, we recognised that auto-enrolment and the other recommendations of Lord Turner’s Pensions Commission created the opportunity to create a very wide consensus around a comprehensive reform programme. We have therefore backed the 2012 reform programme as important steps in the right direction, but also believe that the 2017 review will need to ask hard questions about the success of auto-enrolment and the adequacy of contribution levels.
1.4 While we recognise that major reforms will need to wait for the 2017 review we think there is a strong case for creating a more level playing field for NEST before then by lifting the contribution cap and by ending the ban on transfers in and out of NEST. These changes are justified by the development of differential pricing for deferred and active members of pensions, and the need to deal with the problem of multiple small pots, highlighted by the Government’s review of the regulatory arbitrage2 planned by some pension companies planning to exploit the loophole that would allow employers to reclaim contributions from trust-based schemes. These changes are in line with those recommendations made by the Making Auto-Enrolment Work (MAEW) review3 set up by the Government that have not been included in the subsequent Pensions Bill.
1.5 While the MAEW review held to the basic principles of auto-enrolment by resisting calls to end universal auto-enrolment we were disappointed by the introduction of the optional waiting period and the higher earnings threshold for auto-enrolment, subsequently included in the Pensions Bill.
2. Transfers in and out of NEST and the small pot issue
2.1 We are disappointed that the Government has not taken forward the recommendation in the MAEW review to allow transfers in and out of NEST.
2.2 The review indicated that people could easily retire with multiple small pension pots. These will be difficult for individuals to deal with and multiple small pots may well face higher deferred member charges from pension providers. If the Government’s review of short-service refunds concludes that they should end (as we have argued) it is likely that the number of small pots will increase. There will also be a need to find a home for pension contributions paid into DB pensions, if the review accepts that expecting employers to deal with small defined benefits (DB) scheme pots built up during a short job tenure would be unreasonable but still expects contributions to be retained as pensions savings.
2.3 We understand that there was a wish to protect pension companies from the competition offered by the low cost and simple default fund structure offered by NEST in order to maintain consensus around the recommendations of the Pensions Commission. But we have consistently argued that there is no justification for this special treatment, especially as these reforms deal with what is widely recognised as a market failure.
2.4 Since the original discussions that led to the ban on transfers the argument for change has grown stronger. Firstly the size of the small-pot problem has become more apparent. Indeed it is unlikely that pensions companies are keen to maintain numerous unprofitable small pots. Using NEST as a default home for small to medium pot transfers – and indeed any transfers – makes sense for savers and employers. Secondly the introduction of active member discounts/deferred member penalties underlines the advantages for consumers of NEST given that it does not differentiate between active and deferred members.
2.5 The ban on transfers out of NEST should also be lifted. We have consistently pointed to the likelihood of migrant workers only in the UK for a short period of time building up a small NEST pot which they will not be able to access until many years after they may have left the country. It is also highly likely that many young people will build up a small NEST pot before working for an employer with a quality pension scheme where they may wish to transfer their NEST pot.
3. NEST Contribution Cap
3.1 We are disappointed that the Government has not acted on MAEW’s recommendation to legislate at an early stage to remove in 2017 the NEST contribution cap of £3,600 (2005-06 terms).
3.2 As with the transfer ban, the cap was introduced to protect the pensions industry from competition from NEST’s low cost scheme, and to ensure that NEST concentrated on its target membership of low to median earners. However we have always argued that this was an unfair restriction that hinders both consumers and employers.
3.3 It is wrong to think that members of NEST’s target market will never wish to save more than the cap. They may receive some additional non-earned income such as a legacy that they may wish to put towards their pension. They may be at a stage in their life when they wish to give some priority to building up their pension and be prepared to reduce consumption to do so. The pensions system should not discourage this.
3.4 The strongest argument for lifting the cap is that it imposes unnecessary burdens on employers. NEST has won wide praise for developing an extremely simple product that businesses will find easy to operate. Employers can be confident that they are making a pensions choice that will be good for their staff and easy for them to use. However, the cap means that it may well not be suitable for all the staff of an organisation as it will not prevent better paid staff making the level of contributions needed for a reasonable target replacement income. While some employers will wish to have different pension arrangements for staff in different circumstances, it is absurd that the law forbids them from choosing NEST for all their staff.
4. NEST investment strategy
4.1 We support the investment strategy developed by NEST. This has been based on an impressive amount of high-quality research into the attitudes and behaviour of the target group of low to median earners who have not been properly served by other pension providers. It is perhaps surprising that work of this depth and calibre has not been undertaken – at least to our knowledge – before.
4.2 We are aware that some have criticised NEST for some aspects of their investment strategy, particularly the low risk foundation stage. But this is clearly based on good research into the risk appetite of likely savers, and given the small amount that will be built up by most NEST savers over their first few years of membership will make little difference to their eventual pension pot. As the research shows that investment volatility could well lead to people deciding to opt-out of pensions saving, we think that the foundation stage is a welcome innovation in pensions design. The issue for us is not why is NEST’s offer somewhat novel, but why are other default options not built on the same assumptions and research.
5. NEST market share and viability
5.1 NEST is clearly confident that its projections for take-up will allow it to become financially viable within the planned timetable. We see no reasons to doubt these. Of course levels of opt-out may be much higher than research or international experience suggests, but if this occurs then the whole policy of auto-enrolment will have failed. This will not just be a problem for NEST and other pension providers, but for the public policy objectives behind the 2012 reforms, and will require serious consideration of compulsion.
5.2 It has to be said that current economic circumstances are not those that anyone would choose for the introduction of auto-enrolment. The living standards of the target group for auto-enrolment did not grow in line with the wider economy in the years before the 2008 crash. Now they are falling as wages fail to keep up with inflation. The market turbulence of recent weeks may well further deter those with no previous experience of investing from doing so. Although experience in other countries suggests that inertia will deliver many millions into making their first pension contributions, no-one can predict with certainty what opt-out rates will be, although we are cautiously optimistic that the policy will go a long way to meet the ambitions set by the Pensions Commission.
5.3 Whatever the eventual opt-out rate, for NEST to be able to offer the lowest possible charges to its members it needs to not just cater for employers and scheme members in which no other pension provider would be interested but achieve a reasonable share of the wider workforce. Given its low charges and its concentration of lower earners it is clearly a suitable choice for many employees.
5.4 We are concerned however that there are a number of obstacles faced by NEST that mean that it may not reach its proper potential. NEST already faces the additional costs associated with its public service obligation to accept any employer. This is met to some extent by the terms of the “soft loan” to cover NEST’s set up costs. Further restrictions simply result in an unfair advantage to existing providers, who have failed this market in the past. We have already described the problems caused by making it the only pension scheme with a ban on transfers and the only pension scheme with a cap on contributions.
5.5 But we are also concerned with the potential for mis-selling scandals in the provisions of pensions to meet the employer auto-enrolment duty. The sale of financial services to consumers is now rightly heavily regulated, but the employer duty requires every employer to “buy” a pension scheme for their staff, and this market is unregulated.
5.6 Employers will tend to seek advice from Employee Benefit Consultants (EBCs) or IFAs, but there is a danger that they may not give unbiased advice regarding NEST.
NEST does not offer commissions – the main driving force for IFA business.
EBCs may recommend products in which they have a wider commercial interest through providing administrative or continuing paid-for advice with the pensions options they recommend.
5.7 We are very worried that the pensions industry - who lobbied hard against requiring trust-based governance for auto-enrolled pensions - are now developing trust-based arrangements to exploit the loophole that allows trust-based schemes to make short-service refunds of employer and employee refunds. This drives a stake through the heart of auto-enrolment as one of its main purposes is to allow workers in sectors with short tenure and high churn rates to build up a pension. We welcome the Government’s intention to close this loophole, but are concerned that they have not used the current Pensions Bill to do so. We understand some of the technical difficulties, but believe that an interim solution of paying all short-service refunds to the employee would remove at a stroke the incentives to exploit this loophole, and could be achieved by a relatively simple amendment.
5.8 NEST is not therefore operating on a level-playing field, but faces obstacles that hurt the consumer, mostly burden employers and seem mainly designed to help an industry that has failed to serve the target market in the past. The MAEW review exhaustively considered whether auto-enrolment could work without NEST. It concluded that it could not. As NEST is therefore a vital part of the new pensions landscape, it does not make sense to hobble it.
6. Phasing, staging and the impact on business
6.1 We understand why the implementation of auto-enrolment has been staged, and why contributions are being phased, even if we are disappointed that the combined effect means that it will not be until 2017 that auto-enrolment at full contribution levels will be universal. But this will undeniably minimise the cost of the reforms on business.
6.2 Understandably many people have used the shorthand of talking about an 8% minimum contribution rate for auto-enrolment. But this is misleading as the 8% is only payable on a band of earnings. Those who earn a salary exactly at the top of the earnings band will be putting 6.8% of their pay into their pension, as no proportion of their pay below the bottom of the earnings band generates a contribution. Anyone earning more or less than this will be getting less. Employers are liable for 3/8th of this so the maximum employer contribution will be 2.55%. Few employees earn exactly this amount so the total extra payroll cost for most employers will be significantly less.
6.3 While we would argue that this shows that the minimum contribution rates have been set too low, and that they mean that the low-paid could get very small contributions, it is undoubtedly the case that they ease the introduction of auto-enrolment for business. Staging and phasing (with small employers coming last in the queue) mean that these costs should be relatively easy to absorb for most employers.
7. Certification process
7.1 As a result of the MAEW review the current Pensions Bill will introduce a new test that simplifies the way that employers can certify that their defined contributions (DC) scheme meets the necessary quality test for auto-enrolment. We recognise that this is an issue for employers but we also want to ensure that employees do not lose out, and that no loopholes are introduced.
7.2 We note that amendments were passed in the House of Lords to strengthen the tests so that at least 90% of workers where certification is used receive no less than the statutory minimum. Plus, starting in 2017 the Secretary of State will periodically review the certification test at least every three years and has the power to strengthen or repeal the test.
7.3 We are disappointed that the guidance4 says that no respective calculation of shortfalls in contributions is required regarding the certification of money purchase schemes. Although we note that if the Pensions Regulator determines schemes have mis-certified schemes may be required to make retrospective payments of contributions. We would also question why this is guidance rather than regulations.
8 Charges
8.1 We are pleased the Pensions Regulator has recently said they will gather further information on charges and consider refinements on disclosures. While they said schemes should offer value for money they did not set a benchmark.5
8.2 Low charges are essential. NEST will set a new low charging standard for workplace pensions. Any default option that is higher than this should be able to demonstrate why it is more than the NEST default option for its scheme members.
8.3 David Pitt-Watson has highlighted the impact of charges as part of the Tomorrow’s Investor project at the Royal Society of Arts. He showed that current charges of 1.5% per annum amount to around 40% of total pension over the lifetime of a DC investment.
8.4 There is also a need to further consider active member discounts, or what the TUC and consumer groups term “deferred member penalties”, where members are charged more on leaving an employer. We are also aware of some employers requiring leavers to transfer out of their pension.
8.5 The new guidance for offering options for DC enrolment pension schemes, which covers both contract-based and occupational schemes, states that that “the default option should be appropriately and competitively priced for active and deferred members and charges should not be excessive in relation to the prices being provided”.6 However, the TUC wanted to see regulation which ensures that all savers can be reassured that they will not face charges significantly higher than the benchmark established by NEST and that deferred member penalties are forbidden.
9. Communication
9.1 It is vital that the Pensions Regulator, DWP and NEST have well-resourced, well-designed and targeted communications and advice for both employers and (potential) members so that both parties are aware of their respective responsibilities and their right to save. Unions stand ready to play their part in communicating the benefits of auto-enrolment and pensions savings, and we are working closely with the DWP and NEST.
9.2 Members need to be aware of the compliance regime and how they can whistle-blow if they are aware of a non-compliant employer.
10. Improving DC
10.1 In conclusion we think it is worth the Committee considering a wider inquiry into DC pensions. The decline of DB and the growth of auto-enrolment will mean a rapid growth in DC pensions, but many of these are unlikely to deliver pensions that members will think are adequate. With members bearing all the risks (other than those shared through annuitisation) it is right to ask whether they can be improved. We would suggest the following questions need to be tackled:
Are the minimum contributions adequate?
Are charges in some schemes too high, and can they be got lower?
Can we improve governance by adopting trust-based or other governance that puts member interests first?
Are there ways of sharing risk between members and with employers that can overcome some of the problems of volatility and penalties of individual life-styling?
References
1 ONS (2011) Pension Trends, Chapter 7 http://www.statistics.gov.uk/pdfdir/pt0611.pdf
2 DWP (2011) Preparing for automatic enrolment – response to the call for evidence: regulatory differences between occupational and workplace personal pensions
http://www.dwp.gov.uk/docs/personal-pensions-consultation-response.pdf
3 October (2010) Making automatic enrolment work: A review for the Department for Work and Pensions, Paul Johnson, Frontier Economics and Institute for Fiscal Studies David Yeandle, Engineering Employers’ Federation Adrian Boulding, Legal & General,
http://www.dwp.gov.uk/docs/cp-oct10-full-document.pdf
4 DWP (2011) Guidance on certifying money purchase pension schemes and the money purchase element of certain hybrid pension schemes
http://www.dwp.gov.uk/docs/money-purchase-schemes-guidance.pdf
5 Pensions Regulator (2011) Enabling good member outcomes in work-based pension provision, Discussion paper response July 2011
http://www.thepensionsregulator.gov.uk/docs/dc-discussion-paper-response-2011.pdf
6 DWP (2011) Guidance for offering a default option for defined contribution automatic enrolment pension schemes http://www.dwp.gov.uk/docs/def-opt-guid.pdf
26 August 2011