Session 2013-14
Pensions Bill
Supplementary written evidence from NAPF (PB 50)
What is the problem?
Automatic enrolment is expected to bring between 5-8 million people into pension saving. Many of these new savers will be low paid workers, or workers who frequently change jobs. There is a risk that these workers could build up lots of small pension pots, which are then left behind in their old schemes.
It can be difficult and expensive to turn these small pension pots into a retirement income by purchasing an annuity. There is also a danger that these pots could become stranded when members leave them behind. Members may not know how to find their old pots when they come to retire. Indeed, around one in six employees in the UK have lost track of their pension funds after changing jobs.
The Department for Work and Pensions estimates that if we do nothing, there could be 50 million pension pots left dormant by 2050. 12 million of them would have a value of under £2,000.
What does the Government propose?
The Government proposes a ‘pot follows member’ system to automatically transfer small pension pots as members move jobs. When a member joins their new workplace scheme, any old small pots would be transferred into their new scheme.
The Government believes that such a scheme would be popular amongst consumers, and has quoted evidence from the Association of British Insurers showing that 58 per cent of respondents would prefer their pot to move with them as they change jobs. The Government also believes that this is an efficient system for consolidating savers’ small pension pots.
At the same time the Government is proposing abolish Short Service Refunds for defined contribution (DC) schemes. These are refunds for individuals who have been contributing to their pension for less than two years.
The Government’s ‘pot follows member’ proposal includes the following features:
· Automatic transfers will take place between DC schemes only;
· A pot will be eligible for automatic transfer either once all contributions have ceased and the individual has left employment or once all contributions have ceased for a certain period;
· A pot will be eligible for automatic transfer as long as the pot was created after a certain date;
· There would be a pot size limit of £10,000 with a requirement for the Government to review the limit and revise it if appropriate;
· There will be an option for members to opt out and leave their pension pots in their previous employer’s scheme, and a right to transfer their pot to an alternative pension arrangement;
· The Government may prescribe minimum standards for automatic transfer schemes;
· There would be a transfer process based on either a pot-matching solution involving an IT system or a member-driven approach using a ‘Pensions Transfer Information Document’; and,
· The Pensions Regulator (TPR) will be the main enforcement body for the automatic transfer process.
Why is the NAPF concerned?
The NAPF agrees that there must be a system for consolidating small pension pots. However, the Government’s proposals risk causing consumer detriment and increasing the regulatory burden on employers and pension schemes.
Consumer detriment
Pot follows member risks transferring members’ pots from well managed schemes, with low charges, into high charge schemes with bad governance. Figures from the OECD show that if these pots are saved in schemes with annual charges of 1% or more, they could lose 20% of their value over an individual’s working life.
NAPF modeling suggests that, in a worst case scenario, members could lose up to 25% of their savings by being shunted from good schemes into bad ones.
The Government has announced that it will explore minimum quality standards for DC pension schemes, but so far there is not enough detail to know whether this will do anything to address our concerns around consumer detriment.
Pot follows member also involves inherent risks to consumers which are not necessarily related to scheme quality. The regular investment and divestment of members’ entire savings as they change jobs, for example, carries considerable risk where markets are volatile. It also risks stifling investment innovation if schemes opt to invest members’ savings in assets which have high liquidity but low growth prospects as the money may need to be accessed quickly in order to disinvest.
The Government’s belief that its proposals are popular is misguided. The NAPF conducted consumer research which came to precisely the opposite conclusions. Our research showed that 59 per cent of consumers would prefer their savings kept in a scheme that meets certain standards and has low charges.
New regulation
The Government’s proposals appear to involve a substantial regulatory burden on the pensions industry, with pension schemes apparently expected to fund the architecture for automatic transfers, such as a database and transfer mechanism. Just as the Government is trying to cut red tape for businesses, this policy imposes a large new regulatory burden on employers and pension schemes.
The Government is rushing ahead with legislation, but with no accompanying impact assessment. The most recent impact assessment was produced over a year ago and before much of the detail of the proposals emerged. The impact assessment does not, for example, consider the costs of a database for tracking small pots. The NAPF urges the Government to seriously consider the impact of its proposals before they are put on the statute book. The danger is that this new system will be very expensive, and that those new costs will be passed onto savers.
Bizarrely, the Government is going to abolish Short Service Refunds far earlier than a system for transferring small pension pots can be implemented. There is a possibility that a new generation of small pots will be created in the interim. The NAPF would prefer that short service refunds were abolished at the same time as a new system for automatically transferring small pots is introduced.
Short Service Refunds are also used to fund pension schemes. This is because only employee contributions are refunded, while the employer’s contributions remain in the scheme and can be used to fund scheme management or advice for members. This means that abolishing Short Service Refunds could result in higher charges for members.
These proposals come at a period of rapid change for pension schemes. Auto-enrolment was introduced less than a year ago and continues to be rolled out. Schemes are also preparing for the new State Pension and the end of contracting out. There is a growing consensus across the industry, including employers, schemes, providers, employee benefit consultants and consumer groups, that this policy should be delayed.
What is the solution?
There is much evidence to show that pensions are better delivered at scale. Large schemes can benefit from economies of scale and are likely to have the purchasing power to access high performing assets. Where scale is combined with good governance, in Super Trusts, the NAPF estimates that members’ outcomes could be up to 28% better.
The NAPF would prefer to see small pension pots consolidated together in these large schemes. These aggregator schemes could be licensed to ensure that they meet high standards. As only a proportion of members’ savings are transferred when they change jobs, this also reduces the investment risks for members. The aggregator solution is much easier for the pensions industry to implement, so the regulatory burden and costs for members are lessened.
There is no reason why a system of aggregators cannot achieve the same, or similar, levels of consolidation than the pot follows member system.
The graph above shows how, according to the Government’s figures, there is little difference between the levels of aggregation achieved by the two systems. For a person starting to save f or a pension today as a result of auto-enrolment, the number of pots that they have at retirement is likely to be the same regardless of whether the aggregator or pot follows members system is used.
Crucially, though, the aggregator system allows just a small number of large, very high quality schemes to consolidate small pots. This means that members are exposed to less risk. While they may have the same number of pots, our modelling shows that they are likely to be bigger, giving individuals a better income in retirement.
July 2013