Work and Pensions Committee - Minutes of EvidenceHC 768

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Oral Evidence

Taken before the Work and Pensions Select Committee

on Monday 19 November 2012

Members present:

Dame Anne Begg (Chair)

Mr Aidan Burley

Jane Ellison

Graham Evans

Sheila Gilmore

Teresa Pearce


Examination of Witnesses

Witnesses: David PittWatson, Leader, RSA Tomorrow’s Investor project, and Michael Johnson, Research Fellow, Centre for Policy Studies, gave evidence.

Q1 Chair: Can I welcome you both to this first oral session of our inquiry into the governance of pensions? Unfortunately, Baroness Jeannie Drake is ill today and so cannot be with us, and I am sure she would have added a lot to the session. I take this opportunity to send her, on behalf of the Committee, our best wishes and hope that she is feeling better soon. In front of us, we maybe do not have the quantity but we certainly have the quality. Gentlemen, could you introduce yourselves formally for the record?

David PittWatson: I am David PittWatson and by background I am a fund manager, but for the last few years I have been running a project for the Royal Society of Arts called Tomorrow’s Investor, which has been investigating the British pensions system and how it compares with other pensions systems around the world.

Michael Johnson: Good afternoon, everybody. My name is Michael Johnson. I am a research fellow at the Centre for Policy Studies, unsalaried. I am an exCity worker for whom pensions is a pastime.

Q2 Mr Burley: There is clearly a very complicated pensions landscape out there at the moment, with people not saving enough for their retirement, generally low confidence in pension saving amongst the public, and what some people refer to as an apartheid between public sector and private sector pension provision. Could each of you start by perhaps outlining what you think are the three key issues that need to be addressed in order to improve governance and best practice in workplace pension provision?

Michael Johnson: I would start by distinguishing between regulation and governance, and I would think about what it is that regulation is doing, based on the observation that, whatever it is doing, it does not appear to be doing it very well. At the moment, we have a framework where regulators essentially impose regulation upon the industry, and I think that is in the hope it will engender some trust between the industry and consumers, and it patently does not. So I would like to see the relationship between the regulators and the consumers fundamentally changed, so that instead of having the regulators sitting above the industry and the consumers below, I would like to see the regulators coming underneath the consumer, adopting the eyesight and experience of the consumer, and being much more assertive on the quality of governance in the interests of the consumer and more or less stop formal regulatory actions against the industry, because it patently does not work. So it is a complete change of perspective. That would be my starting point.

The second concern is patently we want to catalyse a savings culture in this country, and for the consumer that means engaging with an industry that is widely distrusted. Much effort has gone in the last months and years to thinking about how we can enhance the quality of the trust relationship. I think of this as not being the fundamental problem. In some senses I trust John Lewis and I trust the toasters that they make; it is just that I don’t happen to want to buy a toaster. It is the lack of demand for pensions that is the problem in my mind at the top of the tree. Yes, the trust relationship or the lack of trust between the consumer and the industry is very important, but I do not think it is at the apex of the issues that we need to address. Again, I suggest that the Government’s framework adopt that as an observation and start from there.

You asked for three thoughts; the third I will introduce is, I guess, the old question of public sector pensions. I would like the Government to set an example as to how workplace pensions could work better in this country, and I would like it to restructure wholeheartedly the Local Government Pension Scheme. Currently, we have 101 disparate, suboptimal, subscale funds, with a few exceptions. Their performance is pretty woeful, and I would like us to end up with maybe half a dozen funds with, let us say, £30 billion of assets in each, so that the Local Government Pension Scheme behaves and acts as the principal it is really supposed to be and exerts real influence on the industry. So, the third point is to suggest that the Government sets an example with its own house and starts with the LGPS.

David PittWatson: For my three headings, one would be costs, the second would be individual versus collective pensions, and then the third would be the regulatory structure. Costs are very important to pensions, because a pension lasts a very long time. A 1% charge on a pension from the age of 25 through to, say, a life expectancy of 85 will take 25% of your possible pension in charges. A 2% charge would take 50%. So costs are extremely important, and people do not understand what the costs of pensions are. In part, that is just because they find percentages difficult and they find it difficult to work this out. In part, also, it is because they are not told the full cost of pensions. They simply are not told the full cost of pensions. So, transparency and pressure on costs would be something that would dramatically improve things even without any change in the structure of pensions.

The second thing, though, is the difference between an individual savings account pension and the collective pension. An individual savings account, what we would call an individual DC pension in the UK, just looks like an individual savings account that becomes an annuity when you retire, and that is quite a costly and inefficient way for people to be saving. The best pension systems, as you would find in Holland or perhaps Denmark or in bits of the United States-CREF, for example-are ones where people invest collectively and so they share the risk. They share the risk on their life expectancy and they share the risk on the returns that they are getting. Now, collective pensions are a little bit difficult to set up, and you need to think about the governance of them and various other things, but all the studies we have looked at conclude that collective pensions give better results for less risk. And the better result is substantial: anything between 25% better up to, in some cases, 100% better, but if you were thinking seriously about the upside from collectivity, it is 30% to 40% upside in pension relative to saving individually.

So costs, collectivity, and then the third thing I think I would be absolutely with Michael on, which is if you think about the regulatory structure, think about how the regulatory structure creates the best behaviours from the industry in providing and for the saver in being able to make savings. We know and everybody accepts that people need and have to make savings in this country, because we hold our state pension very low compared with most of the developing world. How do we get them to do that, and how do we get them to do that into a system that is trustworthy, that does what it says on the tin-not just trusted but trustworthy? Those would be my three.

Q3 Chair: Interestingly, you both mentioned the regulatory structure and, Michael, you said there was a lack of demand in the pensions system or the pensions arena, but auto-enrolment is coming in and that will create more demand. You have been very critical so far, but perhaps I can tease out a wee bit more on exactly what is wrong with the regulatory structure as it is. Is it fit for purpose in terms of auto-enrolment and what kind of regulatory framework would you prefer over the one we have? I assume from what you have both said that you would prefer something different.

Michael Johnson: The short answer to the question of whether it is fit for purpose is no. As I mentioned earlier, I am keen to empower the governance side and have the regulator driving a much more empowered trustee framework, but this creates a conundrum because professional trustees are conflicted. This resonates with some of the things David has just been talking about, but one of the things that we need irrespective of the private sector or public sector is massive scaling up to harness the economies of scale and attack costs. But the professional trustees, who are really the lynchpin for change in my model of the pensions arena, are conflicted, because the fewer pension schemes that there are, the less trustee business there is.

Secondly-and I am coming round to answer your question-you must remember that pensions are utterly different from any other consumer good. When we buy something, normally one has immediate utility of it, and of course when it comes to a pension it is quite likely that one does not discover until 30 or 40 years later whether what one has bought works. Pensions are clearly sold, they are not demanded, as I mentioned earlier, and here’s the key point: the consequences of an undersaving nation fall upon the taxpayer, and I think that legitimises a much more assertive role for the regulator-and I would rather not use the word "regulator" in the context of what I am thinking about-so that the regulator can enforce tough standards for governance. We can get sidetracked for a second on the debate between trust and contractbased governance, but fundamentally what really matters is maximising the pensions pots. I think that is what the regulator should be thinking about: how do I maximise the scale of someone’s pension pot at retirement by putting in governance? You could call them guidelines or you could call them something a bit more assertive. You could move away from nudging to shoving, and demanding, for example, that pension schemes scale up in the way that is now happening in Holland and has happened in Australia. So the whole flow of the thinking of the regulator is, as I mentioned earlier, through the eyes of the consumer and harnessing some of the things that David talked about, including collectivisation and socialisation of risk. Of course bear in mind that the industry, the provider side of the industry, absolutely does not want collectivisation or scaling up; it is not in its interests, and therefore perhaps I, as one voice, will be opposing the industry on almost anything it says on this score.

David PittWatson: I am not an expert on the regulatory structure, but I would note that you have two regulators for pensions and not one. I would note that their remit is not one that is to try to make sure that Britain has the best possible pension system, which you might have wanted it to be, and I would note that even if it was, their powers are too often ex post rather than ex ante. Rather than setting up a structure so that it delivers this, it waits for something to go wrong and then shuts the barn door.

But, Chair, you started with something-while I have my criticisms of the British pension system-that has been a big advance in terms of the way that we are thinking about pensions, which is auto-enrolment. Of course, if we are trying to address your question, which is how you have a good system where you get people to save for their pensions, auto-enrolment and those sorts of nudges are exactly the sort of thing that you want to do. People nudged through auto-enrolment will get a good deal; 95% or 99% of the time, it is a good thing for them to be doing. But there are two caveats that I would add to this, which are regulatory, and one is about not having a regulation and one is about having a regulation that should not be there.

The first is about not having a regulation. Up until the introduction of auto-enrolment, occupational pensions were all ones that were done as stakeholder pensions, where there were requirements on the provider not to charge too much and also to be careful about the way they invested other people’s money. As we have moved to auto-enrolment, there is now no cap on the fees that can be charged for your pension, which has been bought for you by your employer and which you may hold on to for the next 30, 40 years before you retire. We would be very, very concerned that that is an invitation to people to sell bad pensions, and of course if they do, that will discourage other people from investing in good pensions.

The second thing, though, is a regulation that is there that we do not understand, because one thing that we ought to be able to say is, "Look, if you have a concern about who your pension provider is, why do you not go to NEST? This is something that the Government has set up and that the taxpayer has funded through a loan to make sure everyone can get at least a decent pension." Unfortunately, restrictions have been placed on what it is that NEST can do, so NEST cannot take more than £4,200 from any individual in any given year, which means that as a provider to a large employer it does not make sense to go to NEST, because you would need two pension providers. You cannot take money in and out of NEST as you can from other pension providers, so it means that NEST is hobbled in that way. If people are only in the scheme for three months, then the three months has to stay there instead of being taken out again when they leave, and so on and so forth.

So auto-enrolment, Chair, is a very good policy, but to make it work we need something that caps fees at something that is reasonable, so that nobody is mis-sold and buys a bad pension, and we need to make sure that NEST can thrive.

Q4 Chair: There was something you said, Michael, that got my colleagues excited, so I am going to bring Graham in first and then Sheila.

Michael Johnson: If I can quickly come back on that comment about regulations for a second, the Thornton Report back in 2007 looked at institutional structures to do with pensions and regulation, and what became apparent was that The Pensions Regulator (TPR) looking at workplace pensions is essentially dealing with a voluntary relationship between employers and employees, whereas the FSA-soon to be the FCA1-is looking at the personal pension side, which is a contractual commercial relationship between those who are saving and the industry. I think therefore that there is good cause to have two regulators who are dealing with different types of relationships, but one must question why DB and DC regulation is comingled between the two regulators. I would like to see all DB regulation concentrated into a merged TPR with the PPF2, because the PPF has the modelling skills and so on, which is essentially dealing with DB types of problems. I am loath to advocate structural changes, but that is one I would suggest makes sense, leaving all the DC regulation in the FCA, so we have some clarity about the natures of the risks that are being regulated and acceptance that the relationships between the industry and the savers within those two regulatory frameworks are different.

Q5 Graham Evans: Michael, very interesting; you too, David. You said something about the industry and transparency and costs. When I had a proper job, I worked in the manufacturing industry, and through the 1980s and 1990s you had something called "lean manufacturing". The manufacturing industry has changed in the last 20 years. In my experience, when I was involved in turning around companies and industries, you would look at the process and you would strip out costs. You would strip it and strip it and strip it, and quality was a given; you had to maintain quality and, in fact, enhance quality, but what you got rid of was inefficiency and waste. You still had the performance, because that is the whole point of the business. You strip out that cost. The transparency aspect is that when your customers would say, "Right, let us have a look at your books. I am going to get this contract, but I want to see your books, mate. Where are the costs?" and the customers knew what the costs were. They knew the raw material costs; they knew the labour costs and so on and so forth. Do you think that could be applicable to the City and that could be applicable to the pensions industry? Because what has happened in the manufacturing industry is the competitiveness of it. The quality has gone up, the costs have come down and it is a winwin: the businesses are profitable; the customer gets a good deal. That is the reverse of what has happened in the pensions industry. What caught my ear, Michael, is that you have a feeling for this, having been in it; is there any chance that we could have an industry that would be attractive and therefore create that demand?

Michael Johnson: First of all, a clarification: I have not been in it. I have not worked in the pensions industry at all. I have worked in financial services in the looser sense.

I think the starting point is communication. There is nothing better than pensions for obfuscation and bamboozlement, and I think that is where we are starting from. Secondly-and I have written about this at length in a paper3-I do not believe competition works in the financial services industry, because we have these extraordinary lengths of chains of intermediaries, which makes it extremely difficult to really work out what is going on. Such is my concern about the seriousness of the lack of a savings culture here-and we have been waiting too long for the industry to change its behaviour-I think that it is entirely legitimate now for the Government to be much, much more assertive and to demand some of the sorts of things that David was talking about in terms of transparency of costs and so on, but also the traditional mechanisms that, for example, fund managers use when they talk about the Total Expense Ratio. The Total Expense Ratio tells you at least and no less than half of what you really need to know. So there is a masking of key things that are really relevant to the investor, and let me give you a little example, if I may, and it comingles with some of the LGPS observations.

What is crucial in terms of an investor’s ability to understand costs is the rate at which the portfolio is being turned over by the fund manager. Now, the Total Expense Ratio takes no account of transaction costs, be they implicit or explicit. So over a fiveyear period, some analysis was done looking at some 199 public authorities’pension funds between 2003 and 2007 inclusive, and costs came down a little bit over that period, which seems like a consumer triumph. But then the next stage of the analysis found out that turnover of the assets trebled in that fiveyear period, so the commissions doubled. That is as stark an illustration as I can give as to some of the behaviour within the industry that I think is completely unacceptable, but that information is not disclosed. Furthermore, it took the two researchers who were doing this work, Tim Jenkinson and Mark Abrahamson in Oxford (Saïd Business School), two years and 120odd freedom of information requests to get to the bottom of it. So this is part of the lack of transparency problem that makes it so much more difficult to identify-going back to your original question-where efficiencies can be made. Examining the extraordinary length of the chain of intermediaries begs some major questions about what most of these people are doing. Maybe I am going to jump the gun here, but I believe that we do not need 80% of the industry.

Q6 Graham Evans: Cutting out the middleman.

Michael Johnson: Cutting out dozens of middlemen, and let me be even more clear, if I may. Let us remind ourselves that very few people enter financial services with the express purpose of enriching others. 90% of the population of this country has very basic savings needs. We need a rainy day savings account and we need something that we currently describe as retirement saving or pension. So we have an enormous, bloated industry that is imposing upon the population products of immense complexity, of dubious performance at best, that serve no purpose for society, that cost everyone a lot of money, and they continue to get away with it. Excuse me, David; I will give you a chance in a second.

I would like to pick up on some of the comments to do with NEST. NEST’s hobbling through the inability to take transfers in and out and the contributions cap should be removed as soon as possible, along with a number of other hobbles that it has. I would like to see in extremis everyone in the workplace, be they public sector or private sector, participating in NEST or one of its competitors, so that we can harness all the economies of scale and the sorts of things that David has been talking about. I must reiterate the point. Whilst I believe in free markets and so on, this industry is unique, because the consequences of an undersaving nation hit the taxpayer.

Q7 Chair: Are you essentially saying that the industry themselves are unlikely to put their house in order and cut their costs because it is a nice wee earner for them? They are making lots of profit as they are at the moment, so why would they rock the boat?

Michael Johnson: Yes. I spent the last two years writing a paper called "Put the saver first".

Q8 Graham Evans: Might we have a look?

Michael Johnson: I have a copy here. There are only three in existence, by the way. I will take bids for it. The mindset for writing that paper was that my natural inclination is not to say the Government should be doing this, the Government should be doing that. That is my natural inclination, and so I couched it in terms of 104 proposals for the industry to put its own house in order, to demonstrate that it shares a common purpose with the consumer, which it patently does not do at the moment, but also to give it a fiveyear window of opportunity to do that. Five years is very deliberate, because in 2017 we review auto-enrolment and we review NEST. Do I believe the industry is going to do that? Not a chance, but let us give them that chance and prove me wrong.

David PittWatson: Graham, your first description of markets working well and your description of quality in UK manufacturing is exactly how markets ought to work: they should encourage people to do things for lower cost and at higher quality, and that is the pressure that is put on you. That is the efficiency argument for markets, and it is also, I think, a moral argument for markets: people who work hard and do the right thing prosper; people who do not, fall by the wayside. That is not happening in investment products. That does not mean that there is no room for markets, but it does mean we need to take a step back and think about how we construct markets so that people are getting low-cost, adequate pensions and that that is working. But we are some distance from that right now in the UK, and simple transparency would be a very, very good start.

Q9 Sheila Gilmore: In relation to the comments about this being a field where it is important for the taxpayer and everybody to get involved, surely regulation is only one part of it. Is there also a case, frankly, for compulsion, as with the setup for auto-enrolment? I don’t know if you would take that on board.

Michael Johnson: The C word, compulsion-perhaps the most difficult word in this lexicon and context. I am reluctant to stick my head up above the parapet, but given that I now have opportunity to do so, human nature and human foibles being what they are, I believe we have no choice. The reason we have to compel people to save for their retirement, and what gets me off the fence-and I have thought about this long and hard for about three or four years-is the principle of reversibility. If the savings and pensions crisis that we fear materialises in, let us say, 20 years’ time and we have not compelled people to save, it is too late to do anything about it; whereas if we do compel people to save and that crisis does not materialise in 20 years’ time, then we can lift compulsion. So, reluctantly, I am now in favour of it, whereas I think if one had taken a poll of opinions, as I did a few years ago in a working group for the now Prime Minister, most of us would have been against compulsion in that working group and, indeed, in the steering committee, and that mindset has changed. Virtually all of us now are in favour of compulsion.

David PittWatson: I think, however, Sheila, before you to move to compulsion you want to be sure that, if you were compelling people to save, they would be saving into a system that you knew was effective and trustworthy. To compel people into a system where you are not sure of that is something I think the Government ought to be very cautious about. So if one were asking where we need to look and urgently look, that goes back to your question of how we manage to get a system that we know is a quality-assured, low-cost system delivering the best possible pensions it can for the costs that it is incurring.

Michael Johnson: That is a very important point.

Q10 Chair: Just before we leave this stuff about regulation, both of you support larger schemes, collectives and the sharing of the risk, but there are a lot of small schemes still there and, in the short term, even if we are to go down the routes that you are both advocating, including major reform to the pension system, there are still going to be the small schemes. Have you got any advice on how particularly The Pensions Regulator can work much harder to improve the return on these small schemes?

Michael Johnson: Well, I would suggest that there are some lessons from the Australians and the Dutch and the Danish, particularly the Aussies. There, there is a framework moving pretty rapidly into place where the regulator is certainly setting some guidelines for what is good governance, and if schemes do not meet those criteria, they are forced to merge. The Dutch have already been through this exercise. They moved from 3,300 schemes down to a current count of 450odd. This is part of what I mean by the state’s role being legitimately much bigger in this industry than perhaps in any other. That does sound a bit top down and it sounds a bit desperate, and I am sorry, but I think it is realistic, because if one steps back and looks at this country’s forecast debt as a percentage of GDP, the central, 50year forecast from the OBR4 is about 82% national debt to GDP. Remember Maastricht and 40% and all that? That is long gone.

Secondly, if one looks at the consequences for savings ratios and an ageing population, as people age they tend to save less and start consuming more, which is great from a Treasury perspective, but from the DWP’s perspective it is not ideal. So we have the potential in the next 20 to 30 years of seeing huge uplift in the volume of debt we have as a proportion of our economy and a shrinking availability of domestic savings, and this phenomenon will be going on in other developed nations as well, leading to an international bun fight for capital. That is why it is absolutely crucial that we really kick-start aggressively, including the use of compulsion, an increase in the savings of the country. So that is the sort of macroeconomic picture, stepping backwards, and these are not Michael Johnson numbers. These are numbers that are coming out of the OBR.

David PittWatson: If you want to get low costs, you need to have big schemes.

Q11 Chair: The NAO5 was very critical of the outcomes for people in small schemes. I suppose this fits in with your general narrative.

David PittWatson: Yes. To be honest, in an individual DC you can have a small employer who ought to be able to get quite low costs by getting a large contractor. I think it is a little bit more difficult in trusteebased schemes for DB, but again not impossible, and allowing that sort of flexibility for merger would, I think, be something that you would want to do. It is not without difficulties though.

Michael Johnson: None of this is without difficulties. If we talk a little bit more about collectivisation, which is part of the scaling up equation, I would like to remind people of the work that the DWP did in three reports in 2008 and 2009. The December 2009 report concluded that "as a result of this further work, the Department has concluded that Government shall take no further action on CDC6 schemes". So a fairly severe line was drawn three years ago that essentially said no to CDC schemes. The question I would ponder here is what has changed over the last three years, because clearly there is a lot more investigation going on into the CDC world.

This is perhaps where I differ a little bit from David. I think what has fundamentally changed is that the actuarial profession has gone into lobbying overdrive on the virtues of CDC, not least to consider replacing sources of income with the demise of DB. That is not consumerled. Furthermore, one of the actuarial consultancies conducted some research on employer interest in CDCs in July this year and found that more than 60% of employers were not going to touch it. So we must be a little bit careful about all the intellectualist excitement that is around CDC and bear in mind what is the perspective of, in terms of workplace pensions, the employer sponsor. What we cannot get away from is pensions are the way that we manifest intergenerational injustice in this country, and CDC is another way of doing it, because the next generation runs the risk of there being a lack of assets. Let us not kid ourselves: CDC is otherwise known as withprofits, and we have learned some lessons from Equitable and so on, but let us not lose sight of that. This intergenerational inequality is becoming a bigger and bigger issue, and that is the danger, in my mind, with CDC; and that is why-we have not talked about this yet-again picking up lessons from the Dutch, cost-control levers are so important, and that takes us to governance.

Q12 Chair: We have a whole section on CDC schemes coming up, so you have probably already answered some of the questions.

Michael Johnson: Oh goody.

Chair: Our next section is around charges and communication, but you have also answered quite a lot of those questions as well, so I hope my colleagues will be able to go through and pick out the things that we want to explore in a bit more detail.

Q13 Jane Ellison: Yes, indeed; you have touched on quite a bit of it. The next question is really about the charges, the complexity of charges, how some of the current reforms might affect them, and looking at the way those charges are communicated. In particular, Michael, you mentioned the long chain-all the different people in the chain-and I think you said that potentially 80% of that chain could be effectively removed. So I suppose the thrust of this question is where are all those charges coming from and how can they be addressed? In particular, how do we get schemes that communicate their charges more transparently, assuming no overnight revolution in the levels of financial literacy among average members of the population?

Michael Johnson: I am not going to be very popular with the industry here, and that is fine. Passive versus active fund management I think is perhaps the area where the biggest savings are available. I have looked at many sources of evidence as to the effectiveness of the value-added of active management given the costs, and I cannot find it. Therefore, if I had to make one proposal, it would be that those who are acting as trustees in the best interests of their beneficiaries should be focusing and concentrating solely on passive management of assets. That is where the largest reduction in costs comes from.

The second sort of observation is that you would expect a 4.5% higher yield for running equities versus Government bonds, but roughly twothirds of that disappears in costs. That is a shockingly high number, and that is aggregating all workplace pension funds in this country and just looking at the data. So again that takes us back to the question of whether fund managers are being a little bit greedy, and I would suggest they probably need to reduce their charges by a factor of four.

Q14 Jane Ellison: David, you gave some examples of charges.

David PittWatson: Yes. I think we probably sent you a copy of this7, which is about charges.

Jane Ellison: Yes. There are some eyeraising examples.

David PittWatson: Two things. First of all, it appears charges are really quite high. The difference between a 0.5% charge and a 2% charge is utterly dramatic in terms of the pension you are going to end up with, and people don’t understand what these charges are. Further, when they ask what the charges are, they are told about some of the charges as percentages, which they find difficult to work out the significance of, but they are not told about all of them. In particular, they are not told about the costs of buying and selling securities and buying and selling shares, which is what fund managers typically do, or the stock lending or other charges that are not required for them to show the spreads between the buy and sell of a share or a security that they are buying. But the thing that we found extraordinary in this RSA work was that we phoned 23 pension providers, asked them what their charges were and they told us what the Annual Management Charge (AMC) was. We said, "Are you sure that is the only charge?" and they said yes. We said, "Are you sure that includes the cost of buying and selling securities?" They said yes. And we asked them a third time and they confirmed it, so three times. 21 of them out of 23 said that that was the only charge. Only two of them said they would get back to us, and they did not get back to us.

For this Committee, last week Hari Mann, who did this research, went back to 10 of the providers to see whether there had been any change, because there was a statement from the industry saying that they recognised that this was a very big problem and it needed to change. So we phoned 10 providers of whom the last time round eight had told us there were no further charges and two had said they would get back to us. This time, nine of them told us that there were no further charges. So we are not seeing a change in the industry despite the fact that this was on the front page of the newspapers and on the Today programme. So there is a big, simple thing that we could do initially, which is just to allow people to know what the charges are. If you did do that, I would personally recommend that you use the Danish system, which is one that gives you a bank statement so that you can see in pounds, shillings and pence, but there could be a debate about that: whether it is the Danish system of pounds, shillings and pence or whether it is percentages that people receive. But what I cannot see is any reason whatsoever why people should not know what the full charge upon their pension that they are paying for is, and I do find it dispiriting that we have had this industry debating this now for years and we have not yet had that problem solved.

Q15 Jane Ellison: Just on the point about the current reforms, it sounds like you don’t think they are likely to address the problems, but there is the Retail Distribution Review and there are codes of conduct, I think, being developed by the National Association of Pension Funds and the Association of British Insurers. Are they in any way addressing the transparency issue?

David PittWatson: These things are really helpful, and in all of this for policymakers I would say just make sure that we are encouraging the good as well as saying what is not so good. Savings and pensions is, I think, going to be a market and there should be a market choice, and when people are offering transparency there needs to be advantage. There needs to be incentives for people who, as in your manufacturing example, do the right thing and disincentives for people who do not do the right thing. The Association of British Insurers (ABI) has said that there is going to be absolutely full transparency on everything by 2013. That is great. It is really important that somebody makes sure that that does happen. Certainly in the three months between our first study, that promise from the ABI and today, no one has told the call centres that when somebody says, "Is that all the charges?" that you are to say, "No, it is not all the charges; there will be some other ones," and I think that is a pity.

Q16 Chair: How is Joe Public going to find out? If you cannot find out, what chance has any of the rest of us?

David PittWatson: Absolutely. We have had a number of people who are members of the RSA-this takes up my weekends now-who keep sending me scans of letters that they have received from their pension provider, saying "What does this mean? I don’t understand." There is one I have with me just now that claims that all the transparency that we have laid out in this report is something that they do automatically. That I think is absolutely not true. There are others, withprofits, for example, where it has not worked and people are having letters coming back saying, "We simply cannot tell you what the costs are." None of them are being told what the trading costs, stock lending costs and such things are.

Michael Johnson: We need to be very clear that codes of conduct are essentially voluntary rather than mandatory, and therefore, in my mind, it raises the question as to whether the trade bodies are simply trying to buy time. They seem to invite some sort of compromise that a code of conduct is just enough to keep the show on the road.

Q17 Jane Ellison: Is that because of the Government’s reserve powers protection-they want at all costs to stave that off?

Michael Johnson: Every time one thinks about what the role of the state is here, I go back to the observation that we are facing an enormous savings crisis. We do not have time to wait for codes of conduct to essentially be arbitraged and ignored and politely put to one side. We need to get on with it.

Q18 Chair: But you are also asking the industry to do something that is going to be alien to them. You are asking them to be passive instead of active. Both of you are nodding there, but it is what they do. They meddle. They reinvest, they try to get better deals, and all of that has costs and charges.

David PittWatson: I think, Chair, what I would say is this: I think it is very difficult for the industry, because they are not incentivised to provide the lowest cost and best service. But not to try to change the system so that it works that way, if I can borrow your example, is a little bit like the British car industry in the 1960s, who said, "Oh, whatever you do, don’t have us make this lean manufacturing, high-quality stuff, because we won’t employ so many people," and so on so forth. What will happen is somebody will come in and compete with you. Ultimately, someone will come in and compete with you, and they will do it properly and you will be out of business. The best thing for the industry to do right now is to accept that there really is a significant gap between what we are providing in Britain and what the prospect is for what we are going to be providing in Britain, and what best practice would be, if you look around the world, and to try to fill that gap. In this, the regulator and the rulemakers should be the industry’s friend in trying to ensure that the incentives are set so that people who do a good job prosper, and people who do a poor job fall by the wayside. That is how markets ought to work, and right now that is not the way they are working in the pensions industry. There are some good bits, but that is not the way they are working in the pensions or investment industry.

Q19 Jane Ellison: A very, very quick word just on active member discounts. I suspect I know what you think about them, but do you just want to put a quick comment on the record about the problem or not with them?

David PittWatson: It is a really good example of incentives that go wrong. So, look, if I am an employer, it is a good idea to get the employer to set up the pension fund, because they can focus on it and they can buy something that is right for their staff. If you leave that employer, they have no incentive to make sure that you are getting a good pension any longer. So there is this famous thing called the active member discount. The retired member surcharge would be the other way of putting it, where the fees on your pension fund go up when you leave the employer, and so you are charged more. Of course there is an incentive for the person who is providing the pension or any investment to do that, because they get greater fees. It looks as if the charges they have for active people are lower, but they know they are going to get them when everybody leaves, and there is little incentive for the employer to make sure that the fees are kept down. So they are a really bad idea-a really bad idea-because they are incentives to encourage people to do the wrong thing rather than to encourage people to do the right thing.

Michael Johnson: I agree with David, but I would make the observation that if we adopt pot follows member, that would probably address that, but that takes us into a whole new, separate arena.

Chair, if you don’t mind, may I just put a slightly different perspective in here for a second, which is going back to communication? We have talked a lot about the foibles of the industry, but I think there is a lot that the Government could be doing that would be very simple. But unfortunately there is tension here between the Treasury, which wants people to go out and consume, so it can collect lots of VAT, and the DWP, who would prefer people to do some saving. I shall just give you a little illustration about communication. Imagine I were to say to you all, "Congratulations, you have hit 65 and you have a pot here of £100,000." That is four times bigger than the average in this country, and I would imagine you would be feeling fairly cheerful. Alternatively, I could say to you, "Congratulations, you have hit 65 and here is your pension." This is based on pricing from last week. "The best annuity you can have is £56 a week." Now, those two offers are exactly the same, but from a communications perspective they are utterly different, and what I would like to suggest to the Government is two things in terms of what it says to the people on this subject.

First of all, one simple goal of retirement should be to be a debtfree homeowner. That is your goal; nothing else. Just aim to be a debtfree homeowner. There is a sort of part B to this, which concerns consumer debt, and what the Government could do more than anything else to invigorate savings outside of the regulatory and governance framework is to say to people, "Pay down your consumer debt." We have £230 billion of consumer debt in this country at the moment, which is about £8,000 per household. The APR8 on credit cards, as you probably all know, is about 18%. So the average household is paying in interest £2,300 a year on consumer credit. How can we legitimately be encouraging 80% to 90% of this population to be saving when, for most people, saving means cash, not investments; it means cash earning next to nothing. On the other hand, we have a substantial part of the population servicing credit cards out of posttax income at 18% per annum. Now, surely the message from Government to the people is "The best risk-return move you can make is to reduce your consumer debt." That is equivalent, if you are a 20% taxpayer, to earning 22% per annum riskfree.

So I would encourage you or ask you when you are thinking about this subject to bear that in mind: £8,000 per household, and that excludes mortgages, of course. If you add mortgages, you add an average of £56,000 per household. So whilst on the one hand one can see the advantages of thinking about saving and what we can do to encourage a savings culture, I would also like to suggest negative debt as an approach, which for most people in this country is far and away the most fruitful way to save for the future.

Chair: So the aim is to be debtfree and have a pension. That is the secret of it.

Q20 Graham Evans: That is very interesting, because in the olden days that was thrift, wasn’t it? You did not spend what you did not have. Credit cards came up in the 1960s and it has really gone downhill from there. I agree with a lot of what Michael was saying. What criteria do you two think the Government should use in deciding whether to use its reserve powers to cap pension scheme charges, and what might be an appropriate level to set the pension schemes at?

David PittWatson: This has become a little bit more complicated, because, as you know, some people are taking upfront charges and then an annual management charge, and you might want to include trading charges and so on. But it would seem to me that you do not want to cap it too low. You want a market to be able to be there. That is perfectly sensible, but it would seem to me that the industry is running around and saying, "Well, we can do this for 1% a year." Well, how about we do what the stakeholder deal was: the first 10 years 1.5%, and after that 1%, if you say you can do it for 1%. This is not going to hurt any legitimate provider of pensions. What it will do is stop any illegitimate provider of pensions, and that is what that capping should be there for. In the meantime you should be encouraging people who can offer really good deals, of which NEST is one and there are some other providers around who are offering really quite reasonable costs and charges. But the regulation should be there to make sure that this system is not abused, because if you get abuse in this new auto-enrolment system, we really, really have a problem persuading people that they ought to save, and there are people out there who will take advantage.

Michael Johnson: I am pretty reluctant to advocate capping, cost capping or charge capping, because one of the consequences is it will deter investment within the industry. I know Steve Webb, the Minister, has been pondering this. I view it as a last resort, and there are many other things I think that the Government, or the state, could to do to encourage the industry to change its behaviour before it goes to capping charges.

David PittWatson: You can see I agree with the broad thrust of most of what the Government is doing in pension policy. There is this point where the Pensions Minister is saying, "We are keeping an eye on this, and in the event that there is any abuse, we will close the stable door." I worry about that, first of all, because if you know what abuse is, then why do you not set the regulations so that the abuse does not happen? The second thing is I have been working on this for years now and I don’t know what pension charges are, because they are so opaque. I don’t believe there is anyone at the DWP who is able to tell us exactly what pension charges are and, under those circumstances, if it was me, I would be better safe than sorry. Even if it is at a high level-whatever level at which you would say, "If it is above this, it is really not a deal that people ought to be accepting"-set it at that level, but make sure that this auto-enrolment does not go wrong.

Q21 Graham Evans: When one looks at a lifetime of saving, from your 20s, your 30s, your 40s, your 50s, you have been working hard, and you or your employer have been putting the money in and you don’t have a clue what the charges are. When you eventually come to the end, you are going to draw your pension and you end up with an annuity, and annuities in the last 10 years have dropped significantly. So you have worked hard, done the right things, and even right at the end they have got you, one way or another, and it is not going to benefit you, the retiree, having done it for 40 years. What do you think the pensions industry can do to get a greater uptake on the Open Market Option (OMO) for annuities, because there is a tendency for them to say, "Well, we have had it all these years; stick with us Mr Customer." Why would anybody want to do that, but what more could be done?

David PittWatson: I think they have to offer you the best deal. One of the things that I thought was really interesting in the RSA work was that we started doing this with some citizen juries, which are sort of like expert focus groups, if you will; they were experts there. It was about the financial system: "How would you like all this to be managed, and would you like to influence the companies that you own shares in?" and so on and so forth. 90% of the people came back and said, "I do not want any of that stuff. I want to be able to give my money away to somebody that I can trust will look after it in the best possible way for me. I want somebody who is on my side, a fiduciary." In the same way as your doctor would be your fiduciary for health, so your pension fund provider would do that. Annuity rates will have fallen, pensions will be lower, because people are living longer. That seems to me to be okay. What is not okay is the level to which annuity rates have fallen without anyone having any notice and the level of charges that have fallen out of people’s pension pots without them ever knowing that it was going to happen, because that is not being on your side. It is clearly not being on someone’s side if you don’t offer the very best annuity that is available at the time that somebody retires. You don’t need a degree in economics to work that out. You just give people the best annuity, end of story.

Michael Johnson: I think the OMO has patently failed, the Open Market Option for annuities, and really this represents an opportunity for Government to demonstrate some degree of common purpose with its consumers. A third of the over-55s had never heard of an OMO-onethird. 70% do not fully understand what an annuity is, and I suspect 70% is a bit low, and the take-up rate for OMO is between 35% and 40%. I wrote a paper earlier this year about my vision for what we should do with annuities, and that was that we-and "we" could mean the state, but I suggested the industry be given two years to do this itself first-should set up a clearing house, or essentially a market place where it is mandatory that all pension pots, three months ahead of annuitisation, go into the clearing house, and that the provider or the industry that wishes to play the annuity market be required to bid on a daily or weekly basis for packages of annuities that are prepackaged within the clearing house, so you get some scaling up. So you really introduce a formalised, mandatory use of OMO through a market mechanism. Needless to say I have not heard many encouraging words from the industry, but it would be way of introducing some pricing tension and transparency.

Q22 Graham Evans: Just a quick one on the charges and the transparency. For example, say I gave you £100. Now, you are the pension man who is going to make me £150, as it were, but where do the charges come out of? You have your capital, which is £100, but my understanding is that some organisations take charges off the capital. In other words, you give them the £100 and that is my money, so all of a sudden it is £80 and they are working with £80, and then a middle man says, "Well, that is £80; I have £70," so essentially your capital is reduced even before you make your investment. Yet some people will take their fees off the returns. How do you monitor that? How do you get to know that there is the management fee, but it is not just that?

David PittWatson: As a consumer in the UK, you cannot find out the answer to these numbers unless you are willing to turn almost all your attention to doing it, and even then it is extraordinarily difficult to do. If you were in Denmark, you would receive a statement every year that would explain it to you.

Graham Evans: This is an outrage, Chair.

Chair: Money Box had a very interesting item on just that on Saturday.

Q23 Graham Evans: That is the level of my trying to understand this as a layperson who is new to this Committee. I have always had a private sector pension, but as an MP I now have a public sector pension, and it is a Defined Benefit pension, which is a totally new game. Your point is exactly right: the private sector pensions industry is a time bomb, which will eventually cost the taxpayer and the country. You mentioned before pot follows member, but what difference do you think that could make to private sector pension provision? As a new investor, say in your 20s, you say, "I work for this company. It is a good company, but there is no guarantee I am going to stay with it. Therefore, if I do invest in it, I know that pot will come with me wherever I go to," and it removes a lot of what we were talking about before, about vacant or passive pensions, inactive pensions, which get charges put on to them. What sort of difference do you think that could make?

Michael Johnson: The broad theme is Steve Webb’s Operation Big Fat Pot: the idea that one wants to consolidate and bring together all the disparate small pots that most people have. This is in consultation at the moment, and there are two suggested models as to how to do this, one of which is pot follows member and the other is an aggregator or more than one aggregator. This theme has become a proxy war ground or battleground between the vested interests of two disparate parts of the industry. On the one hand, we have the ABI community, who are very much in favour of the pot follows member framework. On the other hand, we have the NAPF9 with its super-trust agenda in favour of an aggregator or multiple aggregators. Whichever route we take, there will be some safeguards required, but the general direction of travel is absolutely right, and pulling together into one these disparate small pots is going to help cut costs dramatically. Needless to say the industry is not that keen on it, because it brings to the surface things like the disparity of charges between active and passive, former and past members and so on.

David PittWatson: So pot follows member and aggregation would be a good idea. The difficulty with pot follows member is encouraging somebody out of a well managed pension pot into a poorly managed pension pot, so you would need to have some sorts of standards that were minimums, otherwise you could imagine somebody might start with a very good pension, go into a bad one where there is no regulation on charges, etc, etc, etc, and the pension disappears.

Chair: I am really conscious that we are over the time. We said we would just have an hour with you, and we still have a couple of questions on the collective DC scheme.

Q24 Sheila Gilmore: Having read both of your papers in preparation for this, on one level it seemed almost overwhelmingly obvious that some sort of risksharing scheme or Collective Defined Contribution scheme was better than what we have at the moment. What are the potential benefits of that, if you can maybe go through that fairly briefly, and then what are the risks and why has it not happened?

David PittWatson: Everyone thinks you get a better pension with collective savings, and you are right: if you think about a pension and how you would do it, you would do it collectively and share all the risks. But let us just be aware of some of things that you are going to have to deal with here. One would be the governance. So whoever is the undertaker or the entrepreneur behind one of these schemes cannot themselves profit on the basis of that scheme, because otherwise they can take money out and at the worst it becomes Ponzilike. Now, that is exactly what went wrong with the withprofits that Michael mentioned. The withprofits were set up by insurance companies, and then the insurance companies took whatever the fees were that they decided were going to be required in order to manage them. During good times, everybody saw the pots going up, and during the bad times they discovered that they had all the problems that withprofits had. So whoever starts this needs to be a cooperative, a mutual, an employer together with their employees, just like the big DB schemes that you would see in the private sector still today. Most of them are now closed, but just like those big schemes. That is number one.

Number two, you need to be really good on the communication of this. So, in Holland they have hit exactly the same sorts of problems that we have, with pots being underfunded and pensions having to be reduced. You mentioned the drop in annuity rates, for example. Annuity rates have dropped by 55% or 60% over last 10 years, so even if you had saved your £100,000 or £200,000, you will get only 40% of what it is that you would have expected 10 years before you retire. Holland has had that same problem, and they have had to reduce their pensions by as much as 10%.

Michael Johnson: Just to make a clarification, which I think is really important here: when you say they have reduced their pensions by 10%, do you mean pensions in payment?

David PittWatson: Expected pensions and pensions in payment, so pensions in payment have not gone up with inflation and will not go up with inflation. Most annuities of course are not real annuities.

Michael Johnson: That is a landscape that we have not contemplated in this country.

David PittWatson: The 60% relative to 10% I think is a good comparison, to give you a sense of the difference. But they have had problems communicating this, because everybody thought that they had a pension and they thought it was a guaranteed pension, and that is because for the last 50 years they did have a guaranteed pension. So you need to be sure that you have really good communications in all of this, and you need as well to understand that if life expectancy suddenly shoots up for people in retirement, relative to people who are young, a judgment is going to have to be made about whether there should be what they would call an intergenerational transfer. Are you going to say, "Okay, look, I am sorry, you are 65, but you are going to live until you are 95, so we are not going to cover you for inflation for the next 30 years; you will have to take some of that pain," or are you going to say it is the young people who are going to have to take this burden? There is an intergenerational transfer. All of those issues need to be decided by a group that you can really trust, the trustees, and they need to be selfless in the way that they make those decisions, so they cannot profit from having made one decision rather than another decision. They have to make it as though they were you-as though you were the community.

It is not straightforward to set these up, but we have done this in the past with every big private DB system that we set up in the 1950s, which, by the way, were set up with a degree of flexibility, just like the Dutch system. As we explained during the 1990s, when people took pension fund holidays, the trustees then insisted that the promise became a hard promise. It then became impossible to meet the hard promise, because longevity moved out and returns moved down, and we closed down our DB schemes. We have had schemes in the past, in the golden age of private pensions in the UK, that look pretty like the Dutch schemes now, but they do need to have all those characteristics. The regulations make them things that employers would be quite nervous about adopting right now, because they would be afraid that in a collective scheme they might end up with a hard promise that they were unable to keep.

Michael Johnson: I would echo everything that David said on that, but would reinforce the point that strong governance is absolutely crucial. If we look at what is going on in Holland at the moment, the two biggest CDC schemes there are both public sector schemes. They have a controlee that looks at assets versus liabilities, and if that ratio drops below 105%, things get pulled and things start being cut in terms of accrual rates or even pensions in payment. One lesson that the Dutch I think point in our direction, though, is that the decisionmaking process as to what gets cut has to be prescriptive rather than: "We will get in a room with all the various stakeholders and we will chat about it," because that is what happened in Holland until fairly recently and, lo and behold, none of the hard decisions have been made. So we are going to have to contemplate in this country cutting pensioners’ incomes, their actual pensions, in a way that we have never done before, with one minor exception, which was in 1973-74, when indexation, I think, on pensions was frozen. That was a oneoff.

Q25 Chair: But there would be a political price to that.

Michael Johnson: That is for you.

Q26 Sheila Gilmore: Are there changes in the law that would be necessary to move towards, say, collective savings?

David PittWatson: Realistically, Sheila, I think there probably would be. People in the pensions industry are extremely nervous about some of the interpretations that there have been in the law over the past 20 years that have hardened promises that they thought might have been soft promises. I can give you examples of that, but I know you don’t have too much time here. Our view would be that it would be possible to set up a collective DC scheme in this country; you could even set it up in Holland and use European law and, say, put British people into a Dutch scheme. That would seem not a terribly clever way of proceeding. What I think one would rather have would be a clarification of the law that said, "Look, it is possible for people to do this collectively." The governance of those schemes needs to live up to the highest standards of governance and take good advice and all the rest of it and communication and so on, but this should be something that employers with employees are able to do, because the price is really high. I mean, we put 6.5% of our GDP every year into private pensions. Right now, we are closing down our collective pensions and moving to individual pensions despite the fact that there is a 30% to 40% productivity increase available to us. That is 2% or 3% of our GDP that we could have in productivity in pensions by adopting a collective system.

I was looking at the GDP number to see what 2% or 3% would equal to: North Sea oil and gas. This is the equivalent of North Sea oil and gas. I was brought up in Aberdeen. I remember how much effort it was to get the rigs and the pipelines and the divers and the people who died on Piper Alpha to be able to get that 2 to 3%. You could put 200 people in a room and we could have a framework that would allow collective pensions in the UK that would add as much, over time, as North Sea oil and gas is adding today. It is a really huge opportunity. It does have some complications. I am not pretending that you can do this easily and suddenly wave a magic wand, but boy, what a prize.

Q27 Graham Evans: Just on Sheila’s point there, I was about to mention that it sounds like a real opportunity for some very well respected companies; I am thinking of the Cooperative Bank, for example, who are unique in the retail sector, but I believe they have in terms of financial services an ethical stance, which to me is the right place at the right time. Is this not an opportunity for the cooperative movement? The other organisation I was thinking of is somebody like Richard Branson with the Virgin Money type brand? Has nobody thought of this? This is a fantastic opportunity to make the revolutionary changes that you were talking about earlier: strip out the cost, get rid of the 80% middle men, and do something similar to what you were talking about there.

David PittWatson: It would be a great idea, Graham. Some 10 years ago I was on a thing called The Cooperative Commission, which was to try to move the Coop towards thinking about its ownership as being an advantage. This would be exactly the sort of thing that its ownership would help it with, because if you are a cooperative, you do not have that same incentive to try to do something that might be to your advantage but is not to the advantage of your customers. If you think about those people on the citizens’ jury, they want to give this problem away. They want to give it away to somebody that they can trust. What would you want? You would like very big, low cost schemes. You would like them really well inspected. You would like the newspapers writing about them to make sure that their costs were low and that when things went wrong, it was small things that went wrong and got corrected, rather than where we have got to here, where we have big things going wrong that have yet to be corrected. But it would be a super opportunity for something like a cooperative to run.

Q28 Sheila Gilmore: DWP, as I understand it, looked at this before in 2009 and decided, I think, that there was no employer appetite for this. Do we have to wait for there to be an employer appetite or an employee appetite, or is this one of the things where maybe decisions have to be made, because people will not come round? Subject to the safeguards being given, is this something where we cannot wait for people to come to a decision that it is a good thing?

Michael Johnson: I think, first of all, you need to be mindful that many employers have made the transition from the DB world to the DC world, and they really do not want to spend more time and effort going anywhere else. If we start talking about collective DC, then that is another lexicon.

Secondly, there is the point David was making: that employers who might even consider CDC are fearful of the creep of regulation that starts making things look a bit harder than a promise, and then we are just repeating all the mistakes that we made in the overreaction to Maxwell and the way that we essentially demolished workplace DB pensions in this country. So, for the state, the Government, step one is to establish absolute clarity and certainty in the minds of the employers that that is not a risk. Then I think more employers would take it more seriously.

David PittWatson: I think that is absolutely right. As to the lack of employer appetite, I was very surprised at that when I read the paper, so I went back to the questionnaire. One of the reasons that there might be no employer appetite is that in the questionnaire nobody explained to them that this would give them 25%plus better pensions. So what they were asked is "Would you be interested in a new system that is called ‘collective pensions’ that would have these complexities, but would give you another option?" and they said, "No, we don’t want another option for pensions; we are all right." Had they been asked, "We have come across this better system that seems to give you 25% to 40% upside; would you be interested?" I think it might have changed the questionnaire.

Q29 Graham Evans: It asked the wrong question.

David PittWatson: Exactly. So that was the first thing. The second thing in that paper was that the modelling included some situations where the pension fund could go bankrupt. Now, in a collective DC it is not possible to go bankrupt, because you do not ever make a hard promise in a collective DC. That is why it is so terribly important that you have fiduciary management. So somebody had put something into the modelling and that was another thing that moved it. I have spoken to the then Pensions Minister privately on this, but I am sure she would confirm it. This was at the end of 2009; it was at the end of a Government. It looked like a scheme that had some problems. It was not clear that there was any demand for it and nobody had explained that there was a huge upside, and, therefore, that was the accepted position and we moved on. I think it is understandable how we reached that position, but I think it was a mistake.

British people should have the same opportunity in their pensions that Dutch people have. It is wrong that if a British person and a Dutch person save the same amount for their pension with the same life expectancy and retire on the same day, the Dutch person gets 50% more in their pension than the British person does. It is a huge opportunity, but also it is wrong that that should be the case. One of the ways that we could move towards the Dutch system would be to allow collective investment. Another would be to try to encourage very great scale and very low cost in what we are doing. It is not that there will not be individual pensions. There can still be individual pensions that are slightly different and do slightly different things for you. But this opportunity for collective pensions is, I think, the thing that would be the natural way of investing for a very, very large percentage of the population.

Q30 Chair: I have one query that is not clear in my head. What happens to the annuity in your CDC scheme? Does it become like Michael’s clearing house but you still have an annuity, so because you have a large bulk of people buying an annuity together, you get a better deal?

Michael Johnson: The current framework is that when somebody gets to retirement an assessment is made of the affordability of an annuity, whatever that may be, and then that is what is paid out. So it is based on an assessment of the investment as it stands at that time, plus taking into account life expectancy and so on. That is a form of selfannuitisation within the fund, but another way of doing it would be to adopt the clearing house, which I would love to see across the country for everybody to participate in. Everybody could see what was going on.

David PittWatson: With a big collective scheme, you would not encourage people to annuitise, because it comes out of a pot.

Q31 Chair: Right, that has answered my question.

David PittWatson: But there is a little tweak on this, Anne, just to be careful. There are some people-Keith Ambachtsheer, for example, at Toronto University, whom I respect greatly-who would say that despite that, you would want to have two different pots, so that you have a greater level of security on the pension pot than you do on the savings pot. It does not mean that you would try to have absolutely 100% certainty on the pension pot, because of life expectancy and because it is daft just buying Government bonds when people are only 60 and are going to live for another 30 years. There is a two-pot solution as well, but in general you do not need this annuity market and you do not have this overpromised and extraordinarily expensive instrument that you have to buy when you retire.

Chair: Well, can I thank you very much? I think we could have gone on for some while longer than this, but unfortunately we do have another session to come. But can I thank you both very much for coming along this afternoon?

Examination of Witnesses

Witnesses: Niki Cleal, Director, and Chris Curry, Research Director, Pensions Policy Institute, gave evidence.

Q32 Chair: Welcome to our second set of panellists this afternoon. Sorry to keep you waiting, but thanks very much for being here. I know you are both from the Pensions Policy Institute, but perhaps you could introduce yourselves for the record.

Niki Cleal: I am Niki Cleal. I am the Director of the Pensions Policy Institute. For those of you who don’t know us, we are an independent research institute. We produce research and analysis on different aspects of pensions policy. The one thing I would say is we are not a lobbying organisation, so we don’t lobby Government for any particular policy. We are about trying to bring the evidence to bear to some of these policy questions.

Chris Curry: I am Chris Curry. I am Research Director at the Pensions Policy Institute.

Q33 Chair: Thank you very much for coming along this afternoon-or nearly evening, judging by the darkness outside. There is obviously a lot happening in the pensions sphere at the moment, but the biggest thing is auto-enrolment, and that is bound to have an impact on what is happening, what the current trends are, and how the landscape is going to change. How do you see the landscape in the coming years as a result of the introduction of auto-enrolment?

Niki Cleal: I think auto-enrolment is a huge change for the pensions landscape in the UK. The work that we have done suggests that we will continue to see a decline in defined benefit schemes in the private sector, and when we look forward, PPI’s projections are that by 2020 we might have around 15 million people in the UK saving in defined contribution schemes compared with less than one million saving in defined benefit schemes in the private sector. Nearly all of that increase in defined contribution savings is really as a result of automatic enrolment. So the changing of the default, so that people are going to be in a pension unless they do anything to the contrary, we think is going to lead to a massive increase in the numbers of people saving in pensions.

Q34 Chair: Obviously, the title of our inquiry is Governance and Best Practice in Workplace Pension Schemes. We have already heard from the panel previously that there is real confusion in terms of who the regulators are and, indeed, fiduciary duty, in terms of in whose interests they are acting. So what needs to change to make sure that the governance of pension schemes is good and also that the regulation is understandable and effective?

Niki Cleal: I think one of the things we need to take a step back on is just to think about what is important in pensions, and I think I would argue that we should be concerned about the outcomes. It is the outcomes that we get from pensions. So, as a consumer, what am I interested in? I am interested in how much pension income this thing is going to give me in 30 or 40 years’ time. One of the things we need to think about is whether or not the regulatory framework is focusing sufficiently on outcomes or more on processes. The things that I think are important are things like the contribution level-whether there is enough going into these pensions to lead to adequate incomes-and investment performance: are these funds performing as they should and what is the level of charges? I think sometimes we are not that clear what the regulatory system is trying to measure. I would like to see a greater focus on the outcomes that pensions produce and less, perhaps, on some of the processes about how we get there.

Q35 Chair: In terms of what NEST has done, what difference has that made to the way that people understand pensions and what is happening?

Chris Curry: There have been a number of different innovations that NEST has brought in over the past 18 months or so, in a whole host of different areas. So they have made much more use of plain language in their communications. There has been interesting debate around the level of charges. I think notwithstanding what we have already heard today, NEST is very much a low charge provider. They have also had some innovation in their investment and annuity strategies as well. So the investment is very much focused on their target market. Their research suggests that when people with low incomes are making small levels of savings, they are particularly loss averse, and so having an investment strategy that makes sure that these individuals do not see any reduction in their fund when they put money in over the first few years has been quite important. That is quite different from what happens elsewhere in market.

In the context of what we have just heard, their annuity strategy is interesting. That is with a separate panel of providers, which covers a whole range of different types of annuity that could be on offer to members, again focused at people who only have small pension pots, which may not necessarily be able to be transferred in the open market, and receiving advice and information from these providers. I think the panel is going to be changed every now and then, so it will retender to make sure it is still the most competitive.

They are all really important developments in the market, but I think it has really been driven by NEST focusing on what the best type of pension provision could be for people on low to median earning levels. So I think it has all been really important and it could lead to further development. We are already seeing that they are being copied elsewhere in the market, at least some aspects of them, in that the low charging structure is important. I think there is now much more of a focus on plain English and good communication.

Q36 Chair: Has the rest of the industry taken that to heart or just been paying lip service? We heard from previous witnesses that it is still impossible to find out what the charges are.

Chris Curry: I think there are two issues. Firstly, on the face of it, in terms of the charges we do know about-the annual management charge, for example-the external headline level of charges is very much being copied by providers like NOW: Pensions, which has come over from Denmark and the People’s Pension provided by B&CE. Both have low charges. I think there is a very different debate about the transparency of charges and what is included in those charges and what is not included in those, and perhaps NEST might have an opportunity to do something similar in that sphere. I think because it is a simple scheme with simple funds, and only a small number of fund choices, it might be an opportunity for NEST to clarify some of the total charges and the fund charges that are not transparent in the market. So there could be some more work to be done in that area, but I think certainly the plain language is starting to go through.

I think the one that has not necessarily filtered through, but may not be appropriate outside the target market, is the investment strategy, but that kind of investment debate has been overtaken by events to a certain extent and the idea of some of the risksharing that we have just been talking about in the previous session, but also the idea of having some kind of guarantee on defined contribution funds as well.

Q37 Chair: What is your view of the restrictions that have been placed on NEST, particularly the cap on yearly investment and transfer of funds?

Niki Cleal: I think this is clearly a finely balanced issue. The original intention behind the limit on the NEST contributions was to try to ensure that NEST was focused on its target market of low to moderate earners. That was part of the deal that was struck, if you like, with the employer bodies and the pension providers in particular, to try to ensure that NEST did not wholesale move monies from the existing pensions industry in the UK across to NEST, because, frankly, what policy objective would have been achieved in that scenario?

I think, though, a couple of things have moved on, and some of these, I think, are just genuine practical considerations. I am certainly sympathetic to the argument that a small business-PPI is a small business; we have seven employees-would not want to have two separate pension schemes: NEST for some employees and a separate pension scheme for the higher earners. We would not. If I think about it with my PPI Director hat on, I can totally see how having a contribution limit would preclude us, as a small business, from using that scheme.

I think the other thing that has changed since the policy was first discussed is that we have seen quite a lot of new entrants to this market. So, as Chris was saying, we have seen the new entrants in the form of NOW: Pensions and the People’s Pension by B&CE, and of course those new players are not subject to the same restrictions that NEST is. So I think there is a legitimate question about whether NEST is competing on a level playing field, or is it always going to struggle because of these restrictions?

So I think where we have come to is to say that the Government is right to review it. The world has moved on and this needs looking at again, but I think you have to look at both sides of the argument and recognise what the original intention was behind having these limits in the first place.

Q38 Chair: We heard in the last session the different amounts that pensioners, the ones that have pensions in payment, can receive from their pension pot depending on the charges that they have been subject to throughout. Have you done any work on those kinds of things? Is there anything you can share with the Committee that reinforces what we heard from the last session?

Niki Cleal: Yes, we have looked at this. We did some work for the National Association of Pension Funds earlier in the year, and we basically looked at the factors and choices that could influence a medianearning man’s outcomes from his defined contribution pension. The work that we did specifically on charges suggested that if that medianearner was saving in a pension that had a charge level at the maximum of the stakeholder legislation-so 1.5% annual management charge for the first 10 years, and 1% thereafter-his pension could be 13% lower than if that same man had saved in NEST. So, yes, there is a genuine and tangible difference. I think the one thing I would add to that, though, is that was not the factor or choice that we looked at that made the biggest difference. The thing that made the biggest difference was getting that man and his employer to contribute 12% of their band salary instead of 8%.

Q39 Chair: So they put more money in.

Niki Cleal: That led to a 50% uplift. Or if the man was to work for two years longer, then he would get a 20% uplift. So what I would say about this is, yes, charges matter, but they are not the only thing that matter. We also need to get contribution levels up. We need to get the debate going about when people are going to retire. But yes, all other things being equal, obviously a lower charge scheme will lead to higher pension incomes.

Q40 Chair: But if you have increased contributions and a high charging scheme, then one could cancel the other one out, so presumably it is low charging, higher contributions that is the key.

Niki Cleal: Yes, you want both. You want higher contribution levels and you ideally would also like a low charge scheme, and certainly in the work that we have done the NEST scheme is one of the benchmarks that we use when we are looking at low charge schemes.

Q41 Chair: Have you done any comparison with straightforward saving in an ISA10, for instance, so somebody who is in a pension scheme where obscure charges turn out to be really quite high compared with somebody who just saved the same into an ISA? I know with an ISA they won’t have the employer contribution, but say they have saved 8% of their income in an ISA.

Chris Curry: It is not something that we have looked at explicitly, and I think there will be a whole range of different factors we would need to take into account, not least the different tax treatment as well as the lack of the employer contribution as part of that. I am not an expert on ISAs. I am not sure if the charges are much clearer, higher or lower in ISAs than they are in pensions.

Q42 Chair: I don’t think there are any charges; that is the point. It is just a straightforward savings vehicle.

Niki Cleal: I think it is, but one of the key differences between a pension and an ISA is that certainly going forward employers will contribute to a pension on behalf of their employees in a way that most ISAs will not. There are one or two large employers, I think, that have started workplace ISAs, but they are very much in the minority. I think there is something about getting a very clear message across to people that once auto-enrolment has come in, if you remain saving in this pension, by law your employer will, over time, have to contribute at least 3% of earnings on your behalf, and that is very important, and then the Government will put in the tax relief on top of that. That is the message that we need to get across to people: "Look, if you opt out of pension saving, you are turning away what is almost free money to you," and we need to try and get people to understand that this is quite a good deal. We would have to think quite carefully about how we made that a like-for-like comparison, given that employers tend to contribute in a pension but tend not to in an ISA.

Q43 Graham Evans: I think you are on to something there, Anne, and this is really quite interesting, because I think you are on to something too, Niki, and I would encourage you to be a wee bit more ambitious. There is the ambiguity and uncertainty of pensions. Even you said, "I have not really looked into ISAs and I don’t know about the charges." The moment you mention something simple to financial people there is always something that is not straightforward. You don’t get taxed in an ISA, for a start. You don’t get bloody charges. Well, that is really quite attractive, isn’t it? But don’t you think you could just become a bit more ambitious and start looking at, for example, Pensions for Dummies-a nice, easy-to-read book that can expose the charges of the pensions industry based on your understanding? So it could just use that example of the stakeholder pension. Was it a 15% improvement if you invest in NEST?

Niki Cleal: 13%.

Q44 Graham Evans: 13%. Most people would be interested in that. My ears pricked up. Then you said, "All things being equal, if you increased your contributions by 5%, 10%, 15% over this time, this is what you would gain." You would then be sending a message to the industry that we now have some real competition here, because if you kept it simple and straightforward and really pushed the boat out, you would be revolutionary within that industry, because everybody, for the first time, would be able to see that they could invest safely. They would see the charges. You would expose some of the hidden charges within the industry, and you would be paving the way for a revolution. So what you would say to young people leaving school or university in their 20s is, "If you come to NEST, we would have to increase the amount you can save in, etc, but if you come to NEST, this is what we would be able to almost guarantee you. This is what you get in the stakeholder, but if you go to the big City boys out there, cop for that, there is the ambiguity in this," and so on and so forth. I think there is a real opportunity if you grabbed that.

Niki Cleal: I think, to be fair to NEST-Chris touched on this in his answer to Anne’s question-I do think that NEST are being quite innovative in some of their communications work and how they really are trying to use simple language and trying to explain some of these issues to people in terms that they understand. One of the difficulties with pensions is, for example, the way charges are expressed. There are at least three or four different ways that a provider can express their charges. Yet if you look at the banking world, we have APRs for a reason. We have them there so that people can make sensible comparisons, and I think we do not have that same easy way of making comparisons in the pensions industry. Now, I think the NAPF in their recent code of conduct are starting to explore some of these questions and think about whether there should be a requirement that providers should say their charge is equivalent to a 0.5% annual management charge or a 1% annual management charge-something that enables consumers to make a sensible informed judgment. I think there is quite a lot more that could be explored there to try to help consumers to navigate their way through what is a very complex system.

Graham Evans: But it is complex, unreasonably so, and like I said, with the Pensions for Dummies you could say, "This is what you would get from NEST; this is us. However, the competition will smoke and mirrors you with this," and you could show exactly what you have just described there: "Some people describe it as this and this is the uncertainty of that, and some providers will say this and these are the uncertainties there." It all points to NEST and simplicity, and exposes the industry, and they have to change.

Q45 Chair: I think some of these may be questions for NEST when we get to them.

Chris Curry: I think there are certainly some things that we could say are unambiguous, like: if you put more money in, you will get more money out; if you have to buy an annuity, look around to get the best deal you can get-that will definitely improve your outcomes. You can say even that saving in a pension is a better tax deal than saving in an ISA. So there are some things that are key. I think the difficulty with the charges is that we can give examples, but there are some schemes that charge as low as NEST do. It is not the whole industry. In fact, very few stakeholder providers charge the maximum stakeholder level. Looking at research from the DWP, the average charges that come out across accrued personal pensions and workplace sponsored, contract or trustbased schemes are less than 1% even for relatively small schemes. So trying to do something that would not get us into trouble for not being accurate or not being fair is one problem for us, but there is certainly scope for us to provide it and for the industry as a whole. The challenge is really how to get that information out there. There are key messages that people should be aware of and should know, but finding the best channel to communicate that to young people in particular I think is the real difficulty and the next issue to tackle head on.

Q46 Chair: There is that question, but of course it is not the employee’s decision as to which pension scheme they are auto-enrolled into; it is their employer’s. So the focus on the employee is to make sure they do not opt out immediately they are opted in, but they are then dependent very much on the decisions their employer makes. What happens if their employer makes a bad decision on their behalf and is bamboozled by the industry and by some of the schemes with charges that sound a lot less than those of, say, NEST? We know that some of the industry is already doing that. What leg does an individual employee have to stand on if their employer auto-enrols them into a pension fund that is not the best for them?

Chris Curry: In the first instance, it is going to be difficult for them. It depends on the size of the employer, but they could try to encourage their employer or perhaps good employers will be consulting their employees before they decide which scheme they are going to be opting for, for auto-enrolment. This is, I guess, a feature of the system that the UK has opted for, where it is the employer’s decision which scheme they auto-enrol all of their employees into. You are right it does set up this tension, where the providers are targeting the employers in helping them reduce their administration costs, which may lead to higher charges being passed on to the members. The members are not necessarily involved in that decisionmaking process in every case, and I am sure good employers will want to make sure that they get that balance right, but we know that not all employers will do that.

Q47 Chair: At the moment, where does the employee go? Is there a regulatory body? Will The Pensions Regulator be there for them to then say, "Hold on. I have been sold a bad deal by my employer"? Does The Pensions Regulator have the powers to intervene? I have the sense it probably does not.

Chris Curry: I don’t know if the Regulator will have that power or not. I think they are very much focused on employers rather than necessarily on employees, but that is not something that I could be 100% sure on.

Niki Cleal: Just to come in on that, under the current framework I don’t think the Regulator could do anything. I think the system is very much focused on the employer’s choice and the employer, it is envisaged, will look across the offering-so look at what NEST is offering, look at what some of the competitors are offering, perhaps look at what the deal is within their existing scheme-and will make that decision. Now, in terms of to whom they turn for advice, I think some of the larger ones may turn to an IFA11 or an accountant. Some of the smaller ones, though, are perhaps less likely to do that, and I think there is a genuine question about how smaller employers are going to make that decision. Now, to some extent, that is part of the rationale for NEST, because it is there as a very plain vanilla, low-cost scheme that has to accept all business, however small. One of the things we found, as PPI, when we retendered our own pension a few years ago was that many providers were not interested in offering a scheme where you only had seven employees. We are too small. It is just not worth their while. Had NEST been around, then I think that is something we would have considered.

So it is difficult, and I think there is particularly an issue for the small businesses, but part of that story, I think, is that many of those companies-who, frankly, are focused on whatever their business is-may just say, "We will use the NEST scheme, because we know that it is low cost and that it is focused on a target market." But that does bring us back to this question about whether, if you have the contribution limit in there, that hinders their ability to do that.

Q48 Teresa Pearce: Just on that, in most industries it is consumer pressure that improves the industry, because people want more transparency of what they are paying for and they want better service. This is unique, because it is not like your gas bill that you pay every month or your phone bill or your food bill. You only get it when you are 65, so it happens to you only once, and it is only then that you realise that you have not got value for money, and you were not the person who chose it in the first place. It is really hard for consumers to do anything. However, one of the things that both of you have mentioned is contribution levels, and if people are putting in very small amounts, they are going to get very little back. What level of contribution do you think people need to make to have an adequate retirement income? Do you have any figures on that from your research?

Chris Curry: It is difficult to say, in a way, but there are some rules of thumb, I think. Certainly, as you say, we have mentioned already the minimum contribution level-8% of band earnings. You could just add that to people’s expectations that a state pension is not likely to give them what they might constitute to be an adequate income. I guess you have to be a bit careful about what you mean by "adequate" or something they are happy with in retirement. You can look at that as enough to keep you out of poverty, which is quite a low threshold, and maybe that might be something that you could do on minimum contribution levels and the state pension, depending on what form of state pension we have by the time people get to retirement. But that is only £150 a week, something like that, which is not necessarily a very high target. If you are looking more at allowing people to continue with the standard of living in retirement that they were used to when working, which is probably what I think many more people will consider to be adequate by the time they get there, depending on what your income level is during your working life, you are looking at trying to replace about twothirds of the amount of income that you had just before you retired with your income in retirement for a median earner. If you are a lower earner, that is maybe about 80%, because you have higher fixed costs; if you are a higher earner, you maybe need to replace only 50% of your income when you get to retirement.

Now, you do not necessarily have to do that all through pension income. You could use other forms of saving. You could use equity in your house. You could work a bit longer in order to meet that extra income that you need. But if you are looking at doing it purely through a combination of the state and private pension, for a median earner the Pensions Commission estimated you would probably need broadly double the minimum contribution level, so 15%, 16% of your band salary as a contribution in order for a median earner to hit that twothirds of final salary.

Q49 Teresa Pearce: How can the Government and pension providers and all of us encourage people to put more into their pension? That message might make them think, "What’s the point? I am going to put this amount in and I am not going to get much out. I might as well just invest it in something else." How do we solve that?

Niki Cleal: I think one of the issues is all of our work and a lot of the Government’s own work suggests that auto-enrolment will bring many millions more people into pension saving, but we also know that contributions of 8% of a band of earnings for most people is not going to meet their expectations, if what we are talking about is having a comfortable standard of living in retirement. All of the international evidence is, once you use automatic enrolment, people are very sticky. They tend to stick with the defaults. So whatever the default investment strategy is, they will probably stick with that. Whatever the default level of contributions is, when you look at KiwiSaver12, most of them stick with those defaults. So I think there is a challenge for policy, which is how are we going to engender a culture whereby not only do people not opt out but they also voluntarily save more than the minimum 4% that is going to be taken from their pay packet?

Now, if you look across to the US, there have been some quite innovative "Save More Tomorrow" schemes. There is definitely something about people being more willing to commit to an action if it is a bit more in the distant future. So you might commit to putting an extra 1% into your pension from your next pay rise rather than right here right now from today’s pay packet. So there are some interesting ideas around how we can try to get people to Save More Tomorrow, as they phrase it in the US. But I do think this is a real challenge, a very big challenge, because there is equally a concern that people will think, "Well, I have not opted out. I have done what I have been ‘told’"-in inverted commas-"to do, and so I am okay now," and the evidence does not support that.

As Chris said, between them and their employers, a median earner needs to be putting in double that amount-15% of salary-and we need to try to get some simple messages out. Much in the same way as we have 5 A Day for fruit and vegetables or whatever, we need to get some simple messages out about how much of your income you need to be saving. Now, it is difficult, because, as Chris mentioned, a low earner will not need to save that much, because the state pension will provide a greater proportion of their replacement income. So it is difficult, but it cannot be beyond the wit of man to try to think about whether we can express this in a more simple way-in a way that intuitively people can understand more easily.

Q50 Teresa Pearce: That brings me on to the thing about the single-tier pension. In what way do you think that the interaction between savings, means-tested benefits and the tax system acts as a barrier to people coming in? What sort of policy should we be looking at here?

Chris Curry: That was something that was very much I think in the forefront of policy minds when the Pensions Commission reported when auto-enrolment was coming in, in that there are particular circumstances where, if someone is auto-enrolled, they may end up not increasing their retirement income very much and depriving themselves of income during their working life as well. So, for example, if they are eligible for combinations of different types of means-tested benefit, like pension credit, housing benefit and council tax benefit, from the research that we did three or four years ago there are some very important issues for people, in particular in receipt of housing benefit in retirement, where for every additional pound of income they get through a private pension, they can lose 91 pence of their means-tested benefits if they are on a certain combination of different benefits. So you get very little actual increase in their income for having saved. There are also issues for people who have long periods selfemployed and so end up not having as much state second pension as you would have got if you had been employed during that time, so there is a bigger gap to fill up with the private pension saving before you get above means-tested benefits.

Now there are some proposals obviously being made for a single-tier pension at a level that is just above the Guaranteed Credit level. We do not know exactly what it will look like or exactly when it will be introduced or how it will be indexed or a lot of different bits and pieces. But from the work that we did around the Green Paper, there was certainly some improvement, I think, in that fewer people would be expected to get means-tested benefits in future. So, for example, instead of their being 45% of people over state pension age in 2050 being entitled to one of the three major means-tested benefits, there would only be 35%. If you look at the very basic Minimum Guaranteed Credit level, only 5% of people would be likely to be entitled to that under the single-tier pension, as it was set out in the Green Paper. So that means that the means-testing issue seems to be much smaller than it would be if the current system were to continue.

However, that does not mean that it goes away completely. There are still issues. So, for example, if you are eligible for housing benefit, you will still find that you will lose reasonable amounts of housing benefit for having saved. So certainly a single tier will reduce the pressure and reduce the number of people who are really seriously affected by this interaction between private pensions and means-tested benefits, but it will not, unfortunately, eradicate it completely.

Q51 Teresa Pearce: So there has never really been a better time for clarity about language and charges and whether it is a good deal for you. This is really a time to totally change. If you say "pension" to someone, if it is a word association, they think "difficult", because that is what people think it is, and it is not really that difficult. It is just the language makes it difficult, so people don’t understand and they turn off. But if we are going to change the culture of people thinking their pension is their responsibility and they need to save, then we need to change all of this really.

Niki Cleal: I would very much agree with that, and I think the single-tier state pension will make things easier. It will send out a very clear message that the state is only going to provide for you £140 a week, or whatever the figure ends up being. If you want to live on more than that, you are going to have to save for yourself. I think that is a far simpler proposition than the current system, where you have to get into: "Have you contracted out of the state second pension?" Frankly, most people do not even know what the state second pension is, let alone whether or not they have been in it. So I think a simplification of the state pension would help, because it then becomes much clearer: "Okay, this is what the state is going to give you, which is not very much, and if you want to have a more comfortable standard of living in retirement, you are going to have to save for yourself." The demographics are just working against us. There is no easy other answer here. So I think that simplification in the state pension does provide an opportunity to try to give out some simpler messages than we have been able to in the past, and then, hopefully, that will also enable us to try to encourage a culture of private pension saving, because the reality is, unless people save for themselves with their employer, they are going to be very disappointed in retirement. Even at £140 a week, that is not going to be a very comfortable income in retirement.

Q52 Teresa Pearce: Given that many people now are in and out of work, in parttime jobs or flexible working, gone are the days when you started work somewhere when you were 18 and stayed there until you were 65. How important is consistency in saving and how can we encourage people, even when they are moving jobs all the time, to consistently save?

Chris Curry: It is very important. We have already talked about the levels of income you could get if you only made the minimum contributions. Obviously, that is still based on the premise that you are saving every year while you are working and you are earning. One of the key things to determining how much income you end up with is not just how much you contribute but how often you contribute. One of the key issues that has been raised recently is about how to encourage young people to start saving. Some work we did towards the end of last year suggested that if people opted out for the first 10 years of their working life, they would be reducing their retirement income by 20%. So you can see it is really important that not only do people save consistently but they start saving early and then get into the habit of saving, so it becomes almost second nature and they really don’t even notice they are saving, to a certain extent.

I think there are certain things in place that will encourage that. The fact that everybody will be auto-enrolled when they start a new job means that it will happen, and I think if you have your first pay packet and auto-enrolment is already on there, you don’t miss the income, because you never had it in the first place. I think it will be different for someone who is auto-enrolled when they start their first job as opposed to someone, for example, who is auto-enrolled in the next three or four years who is currently in work and will see their pay go down from one month to the next, even though nothing else has changed. They might find it harder to take than someone who is starting a job for the first time and does not really know what their first pay packet is going to say. When they get there, they are auto-enrolled automatically, so therefore, hopefully, that will encourage them to stay in.

I think there are other things as well. The NEST investment strategy we have already mentioned is based very much on making sure that people do not opt out. So the fact that people are not seeing losses build up in the early years might encourage them to carry on saving when they get the opportunity. So there is something about getting people into the right mindset. I think the other part is reenrolling people every three years. Even if someone opts out, you come back three years later and put them in again. If people’s circumstances have changed in those three years, so they can now afford to save or the reason they opted out in the first place no longer applies, they are unlikely voluntarily to start saving, but if you reenrol them, there is a chance they won’t opt out again.

There are some things that will encourage people to save consistently whenever they can, but it is very important in determining how much income in retirement they have.

Q53 Teresa Pearce: One of the things you mentioned earlier was about how you organise your finances in your retirement, and you talked about people releasing some equity from their property. Now, all the forecasts we have say that the young generation now are less likely to be homeowners. How is that going to affect pensions? For many people, maybe my generation, your house is mainly your pension, but if people are not going to have a house that they own, what happens then? Have you looked at that?

Chris Curry: We have looked at how people can use property to support their retirement. It does only work if you have a property, obviously, which is true.

Q54 Chair: And if you are willing to sell it.

Chris Curry: Well, there are a number of things. You can sell the property and downsize and release equity in that way. You can use the equity release products available in the market, although they have not really been growing over the past few years in the way that people expected them to, and there are number of reasons, I think, behind that, to do with negative perceptions and that they look more expensive than other mortgage products because of the risks involved in them. The providers are taking on a lot of risk in both house prices and life expectancy.

Q55 Teresa Pearce: But many people put money into property viewing it as their pension, and that is not going to happen, so the pension pot is more important.

Chris Curry: I think we are in a transitional period at the moment. We are still expecting, over the next few years, there to be more people coming up to pension age who have housing wealth than have done in the past, because I think the big increase in home ownership during the 1970s and 1980s is only just coming through to people coming up to retirement age.

Q56 Teresa Pearce: But the people we are trying to get into pension schemes now will be after that bunch.

Chris Curry: There is a lot of uncertainty in what is going to happen in the housing market. Obviously we know that it is taking people much longer to get on to the housing ladder; we know that the average age of first-time buying is going up, to the late30s, compared with where it was a few years ago, so it is difficult for people to get in to buying a house for the first time. I think what is not clear is whether people will not buy a house at all or whether they are delaying purchase, and whether this is also something to do with trends in household formations. We are seeing a big increase in the number of single-person households, and maybe it is more difficult for people to purchase a house with a single salary compared with in the past, where there were a lot more joint households with two earners potentially putting the money together.

Owning a house is still going to be something that the majority of people do. I think we see projections going up into the mid-80s in terms of the percentage of people over retirement age being homeowners by the time they get to state pension age. That may come down. It may come down slightly, but I think there is a lot of uncertainty as to how quickly and how far those changes will go through, and whether it is a real effect and a step down again or whether it is a delay, and potentially whether people will inherit houses at older ages, if their parents are living longer. It might just take them a bit longer to get the house from parents or grandparents.

Niki Cleal: Yes. There is this whole issue of: "Do I save in a pension or is it really that it is my house and it is my property?" When we have looked at this in the past, we have found that either people tend to have both, so they have both a pension and a house, and that is fine, thanks very much, or they have neither. The idea that somehow your house substitutes for a pension does not seem to be supported by the evidence.

I also think we need to try to get young people to understand more about diversification of risk. In this kind of environment, housing is not a riskfree asset by any stretch of the imagination. Lots and lots of people had their fingers burnt with buytolet, for example, in the past, and I think one of the fundamental principles here, just on a very simple level, is do not put all your eggs in one basket. If you are young, the power of compound interest says that if you start saving early, it will be easier for you to build up a substantial pension pot. But I think we really do need to try to just simplify these messages and try to get across, particularly to young people, that if you start early, it will be much easier for you to build up a pension pot, because you will have investment returns cumulating upon themselves, but people do not really understand that. Even the term "compound interest" is going to put a lot of people off, so we need to try to think about ways of conveying those concepts. All people really need to know is it is a good thing to start early. They don’t really need to know why that is.

We can try to just point out that if you start young, it will be much easier for you. You stand a far greater chance of being able to have a decent income in retirement. If you leave it until you are 50 and you have not yet started saving in a pension, it is going to be very, very difficult. It is, frankly, too late at that point, and we need to try to get that cultural shift. I personally think auto-enrolment offers a big opportunity there, because for the first time people are going to be in unless they do something else. That is a big opportunity to try to engender some positivity around pensions and around saying, "Look, this is about enabling you to take some active decisions to look after yourself in retirement," and trying to get a more positive message out there around pensions. Because I think you were absolutely right when you said that for a lot of people just the whole word "pensions" is a switch off. It is difficult; it is something that they don’t understand, and we need to get past that.

Q57 Sheila Gilmore: Just to follow up on this, auto-enrolment is great, but why don’t we just bite the bullet now and go for compulsion? Wouldn’t it be better just to do that from the outset and get on with it? We have a great deal of uncertainty as to what optout rates might be.

Niki Cleal: One of the big difficulties with compulsion is that we have to recognise that different people have different priorities at different points in their life, and particularly with the changes that we have seen in the education sector, for example, young people coming out of university may have very high levels of personal debt. In a situation like that, if they have commercially borrowed debt and are paying high levels of interest back on that, it might be logical for them to opt out of the pension for the first few years until they have repaid that debt down. I think the issue with a compulsory system is there is just no flexibility to deal with those different circumstances.

Q58 Sheila Gilmore: Could I just stop you there? In Australia, where the superannuation scheme is compulsory, they have also had a similar thing. They badge it as a graduate tax, but it is not so very different, perhaps, from some of the things here. They seem to be able to manage that and a pretty high level of young people going into higher education.

Niki Cleal: There is clearly a big debate to be had, but I think there are two issues. There is the issue about personal debt. There is also the issue, which we touched on earlier, around means-tested benefits and the interaction with them. I think one of your other witnesses in the earlier session touched on this: if you were to compel people to save in a pension, i.e. give them no choice whatsoever, in my mind, you have a moral obligation to absolutely make it cast-iron sure that it is going to be in their best interests. I have some questions about whether or not, with the current system as is, you could guarantee that, for some of the reasons we have touched on. Take for example someone who is maybe going to rent in retirement, an older person who has not yet started saving, or a younger person who has high levels of personal debt. I think for all of those people the right thing for them to do may well be to opt out of pension saving. So the auto-enrolment system I think gives you more flexibility to be able to cope with the fact that people have different life circumstances and different priorities at different points in their life.

Q59 Sheila Gilmore: Sorry to keep pursuing this, but is there not a danger-and I don’t know this will happen-that the people who opt out may be the young people for whom opting in might be the best thing, because they have the longest to go. The people who may not opt out are people, say, in their 50s who have not been in a pension before, who are suddenly thinking, "Oh my God, I’m going to be retiring in 15, 16 or 17 years’ time"-or whatever it is going to be-"I’d better save."

Niki Cleal: You are right. There are issues in a voluntary system like this. There obviously are risks about levels of opt out. I think when we look at the international evidence, the opt-out rate in the KiwiSaver scheme has been about a third, and in the KiwiSaver scheme participation amongst younger ages has been better than the New Zealand authorities expected. So you are right that there are these risks and issues. I think opt-out rates are something that are going to need to be monitored very closely going forward and inparticular are particular segments opting out, are young people more likely to opt out, are older people, are there any gender differences? All of that needs to be monitored quite closely, but I have some reservations about the fundamentals of compulsion within the UK system.

Chris Curry: I think the Australian system is based on employer contributions rather than employee contributions, so it might make it easier for people to accept compulsion if it does not feel as if they are paying it and their employer is paying it on their behalf. Whereas in the auto-enrolment system in the UK, there is a very hard limit of a 3% contribution from employers, and you would have to go through another Act in order to change that. So I think there is as difference there, and I think we also need to bear in mind we already have compulsion in the UK through the state pension system. If you are working and earning, you pay National Insurance contributions and so you take part there. So I guess the question is how much pension income should the state be compelling people to provide? Whether it comes through the state or through the private sector is a delivery choice in that particular respect.

Q60 Chair: I understand in Australia when it was set up they sliced 3% off the top of everybody’s wages. This is finally the last question. In the last session we heard some radical things about reshaping the whole landscape in terms of pensions: collective DC schemes or Michael Johnson’s idea of some annuity clearing house to get a better deal. What do you think of those? I said it was the last question and I throw a big one at you.

Chris Curry: It was very interesting evidence, and certainly you can see the advantages of things like Collective Defined Contribution schemes in the work that the Government Actuary’s Department did, and the other studies that have been looked at since, and the evidence from Holland suggests quite clearly that if you can get a system set up, if you can get it working, then you can end up getting higher returns than you might get in an individual framework.

I think there are also potential difficulties, although David Pitt-Watson was very good in raising them, about the intergenerational fairness issues and the governance issues. I think the way they work internationally is very different from the way pensions work in the UK. The UK has a pensions market. I think in the countries where they have collective arrangements, they do not have a market; they have tripartite agreements between employers, employees through union representation and government, and they are all equally involved in setting up the scheme. They all have a say as to how it will operate, so they are all, in a way, in it together. There is a mutual trust that has been there right from the start in setting it up, and I think if we are looking at trying to set up a Collective DC scheme through the market, the first barrier you come to is: who are people going to trust to set this up? Again David was very strong on needing someone basically unimpeachable, without a vested interest, to do that. It is very hard to find someone like that in a marketplace. There are real difficulties in seeing how it would work in practice, despite all the theoretical advantages that there are for a Collective DC scheme.

Niki Cleal: The other big question, which I think there is a need for much better evidence on, is just what is the employer attitude to these types of schemes? Someone raised in the last session that the DWP work suggested that there was not much employer appetite. I think before we were to go rolling off into collective DCland, I would want to see a largescale survey done of employers around whether or not they would be willing to set up these types of schemes, because we have seen a wholesale shift from Defined Benefit to Defined Contribution, and I think what work has been done suggests that there has not been much employer appetite. The NAPF did a survey on this and got very, very limited employer appetite. I think David PittWatson mentioned that the DWP survey suggested there was very limited employer appetite. Now, it may be that the pluses and the minuses were not conveyed in a suitably clear way to enable those employers to have made an informed choice, but I do think there are some issues about whether or not employers would be willing to take on what they may perceive as additional risks within a Collective DC scheme.

Secondly, I do think there are issues about whether or not individuals would have sufficient trust in the system, because under a Collective DC system you are essentially being told, "Well, we are hoping that we will provide you a pension of X, but we cannot guarantee it." As a scheme member, there is a leap of faith there that the actuaries are going to get their sums right and that you are not going to be penalised because someone did not get their sums right further down the line. Certainly, if you were a younger person, the question will be: "Will they have to make changes that might be detrimental to my pension income?"

So I think the issues with Collective DC are around trust and are around thinking about whether or not employers have any appetite for that. That said, I do think the scale that we have as a result of auto-enrolment does potentially provide an opportunity. NEST, for example, could theoretically be provided on a collective basis. That is not what was envisaged. It is not what is in the legislation, but it could be. There is an opportunity in that we are going to have scale in pensions in the UK for the first time. So I think it is a possibility, but there are lots of practical issues that would need to be explored further before coming to a final conclusion on that point.

Q61 Chair: It is interesting that many of the risks you associate with Collective DC schemes already exist in individual DC schemes writ large, in as much as people, when they come to annuitise, discover it is not worth anything and they cannot get a good return.

Niki Cleal: You are absolutely right; there are just different risks within an individual DC scheme. You carry all the longevity risk. You carry all the investment risk yourself, and it is a question of which risk people would feel more comfortable with. I genuinely do not know the answer to that question, and I am not sure anyone has really asked consumers about what they would feel more comfortable with. So I think there are two aspects to it. It is understanding what consumers’ attitudes would be and understanding what employers’ attitudes would be.

Chair: I think that brings us back to what Michael Johnson said: the consumer is often the one that is left out of the equation in all of this. Anyway, thank you very much for coming along this evening. Thanks for your patience. Thanks for staying longer than we anticipated. We really appreciate it. Your evidence will be very useful to us.

[1] Financial Services Authority which will be split into the Financial Conduct Authority and the Prudential Regulation Authority in 2013.

[2] Pension Protection Fund

[3] Michael Johnson, Put the Saver First , Centre for Policy Studies, 2012

[4] Office for Budget Responsibility

[5] National Audit Office

[6] Collective Defined Contribution

[7] RSA, Seeing through British Pensions: how to increase cost transparency in UK pension schemes , July 2012, David Pitt-Watson and Hari Mann

[8] Annualised Percentage Rate (for interest or loans or credit)

[9] National Association of Pension Funds

[10] Individual Savings Account

[11] Independent Financial Adviser

[12] The national workplace pension scheme operated in New Zealand

Prepared 11th February 2013