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Progress with automatic enrolment
Automatic enrolment (AE) requires employers to enrol their employees in a workplace pension scheme, provided employees meet the qualifying criteria and do not choose to opt out of the scheme.
The policy was developed during the years following the 2005-06 Pensions Commission, as part of a package of pension measures, with the aim of increasing both the number of people saving for retirement, and the amounts being saved.
Implementation of AE began in October 2012 with the largest companies, and the process will continue through all medium, small and micro businesses until 2018. There are some lessons to be learned from the process but it is widely regarded as having been very effective to date. One indicator of success is that current opt-out rates, at around 12%, are much lower than anticipated.
However, only 3% of employers have so far been through the process. The next step-hundreds of thousands of smaller employers enrolling their employees over the next three years-will be a challenge of a very different scale and nature.
The context in which AE is being implemented has also dramatically changed in the last year. In Budget 2014, the Government announced new pension flexibilities which allow people much greater freedom in how they take and use their pension savings.
This has very significant implications for AE. It could make retirement saving a much more attractive proposition and help to achieve AE's aims; but there are also some risks.
Reviewing auto-enrolment and advising on future pension policy
There is almost universal agreement that one of the key reasons for the success of AE to date is that it was based on political consensus, an evidence-based approach and full involvement of stakeholders, having emerged as a policy proposal from an independent commission. The current Government's recent pension reforms have not benefited from the same considered process.
The next Government should establish a new independent pension commission as soon as possible after the May 2015 election. Its role would be to assess thoroughly the impacts of AE and the full consequences of the new pension flexibilities and to advise on any necessary changes, and on amendments required to the legislation. This new pension commission would also be best placed to advise on the range of outstanding AE and wider pensions issues identified in this report. If the new Government chooses not to accept this recommendation, it will need to tackle the issues raised in this report itself, as a matter of urgency.
Bringing smaller employers into auto-enrolment
1.2 million existing small and micro employers will be brought into AE in the period to April 2017, enrolling around 4 million employees. The challenges smaller employers will face are considerable, given that they are generally less well-equipped to cope with employee pension arrangements; are unlikely to have existing schemes; and have fewer resources, including staff, to help them administer the process. This group of employers will need proper support from the Government, the regulators, and pension providers to help them cope, including effective and timely communications about what is expected of them and how they can most easily meet the regulatory requirements AE places on them.
Workers who are currently excluded
Although AE is achieving its objectives in terms of bringing more people into retirement saving, some people likely to benefit remain outside its scope. The AE annual earnings trigger has now been set at £10,000 for 2015-16 (and was previously linked to the income tax threshold). This provides some clarity and simplicity but it means that people on the lowest incomes do not qualify for AE, including those in multiple low-paid part-time jobs. Self-employed people are another significant group excluded from AE.
Reassessing the annual earnings trigger and considering ways of supporting low-paid and self-employed people who are not currently eligible for AE should be early tasks for the proposed new independent pension commission.
Pension scheme charges and governance
Public confidence in the value for money and level of security which pension schemes offer is crucial to increasing retirement saving. This is particularly important now that millions more people are being brought into pension saving for the first time by AE, given that they have not chosen this course of action, nor the pension scheme in which their employer enrols them.
The Government has made good progress in tackling excessive and unnecessary charges in AE qualifying schemes. The 0.75% charge cap to be introduced from April 2015, and the ban on consultancy charges and deferred member charges which will follow, are very welcome. However, transaction costs remain a potential source of detriment to pension savers. The charge caps and bans will also only apply to AE schemes: high charges and poor governance in older "legacy" schemes remain to be effectively tackled. The new independent pension commission should consider these issues as a priority.
Automatic transfers
AE means that a greater number of small pension pots are likely to be created because there will be millions more individuals saving at low levels. An accumulation of small pension pots can cause problems for individuals who may lose track of them, and for pension providers because of the relatively high administration costs.
The Government has legislated for changes which mean that pension pots below a certain level will automatically transfer when people move jobs, from the old employer's scheme to the new employer's scheme ("pot follows member"). A solution to the small pots problem is clearly necessary but it has taken too long for firm proposals to be developed and pension providers have concerns about the cost and logistics of the system. The recent publication of more details about how the process will work is welcome, but implementation is still not due to begin until autumn 2016. The next Government needs to confirm the plans for automatic transfer at an early date, and act quickly to develop workable IT solutions in cooperation with the pensions industry.
The new "Freedom and Choice" pension flexibilities
In Budget 2014, the Chancellor of the Exchequer announced reforms which will allow people much greater freedom to access Defined Contribution pensions, by changing the way that pension saving is taxed when it is accessed. The most significant of the changes, which will be implemented from April 2015, is the removal of the requirement to annuitise.
These new flexibilities were initially broadly welcomed, although some concerns have since arisen. It is recognised that these changes will give individuals greater freedom in how they use pension saving and may encourage increased retirement saving as pensions will not be "locked away" to the same extent.
The pensions industry will need to be innovative in devising a wider range of retirement investment products. This should include more flexible annuity products, given that annuities are likely to continue to be the most appropriate option for many people who want a secure and predictable income in retirement, but who may wish to combine an annuity with a lump sum and/or drawdown arrangement.
Protecting savers
There are also significant risks for individuals from the new freedoms. These include: failing to make provision for the whole period of retirement or making decisions resulting in insufficient income in retirement; and exposure to fraudulent, mis-sold or detrimental financial products.
The Government has acknowledged the potential risks and has established a guidance service, branded as Pension Wise, to provide support to savers at the point at which they can access their pension pots. This is a welcome and necessary step, but it will not be sufficient in itself to mitigate the risks that individuals will face. It is questionable how meaningful a 45-minute guidance session can be, given the general low level of savers' understanding of retirement saving and financial products. Savers who choose not to use Pension Wise also need to be protected, including from the pensions industry itself.
A key underlying issue is the continuing "asymmetry" in the relationship between the pensions industry and savers in terms of levels of awareness and understanding of pensions. This asymmetry is probably greater in pensions than in relation to any other consumer goods or services and gives rise to a lack of trust in pension saving.
This lack of trust has been exacerbated by the pensions industry's poor record on acting in savers' best interests when they access their pension pots, particularly in relation to annuities. Savers have previously suffered detriment because some providers did not do enough to ensure that they purchased the right annuity product from the right company. This is unacceptable. Pension providers need to do more to save consumers from taking poor decisions, by focusing on consumers' best interests rather than their own.
This will be assisted to some extent by the Financial Conduct Authority's (FCA's) recent change of view on the need for providers to offer "additional protection" to savers (also known as the "second line of defence"), beyond signposting them to Pension Wise and discussing the tax consequences of their decumulation options (the point at which savers are able to access their pension saving). From 6 April 2015, providers will now have a duty to carry out some basic checks with savers about their personal circumstances, before they take decisions on using their pension saving. This is a very welcome improvement to the protections for savers.
The regulatory framework
Responsibility for pension regulation is currently divided between The Pensions Regulator (TPR) and the FCA, with HM Treasury and the Department for Work and Pensions (DWP) also playing a part. The Government was previously reluctant to accept our 2013 recommendation that the case for a single pensions regulator should be examined. The Minister for Pensions has recently indicated that he is now more attracted to the idea of a single regulator.
The case for taking this step is even stronger now, given the greater risks to savers from fraud, and detrimental financial products, which accompany the undoubted advantages of the new flexibilities. A single regulator would have a clear focus on the whole retirement saving process, from enrolment in a pension scheme to decumulation and beyond, which the current arrangement lacks. Savers would have clarity on who was responsible for providing guidance and redress, and employers and the pensions industry would have a single body to advise and supervise them. The Minister also suggested that it would be sensible for pensions to be dealt with by a single government department. This would reinforce the case for a single regulator.
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