House of Commons - Progress with automatic enrolment and pension reforms

Progress with automatic enrolment and pension reforms - Work and Pensions Contents

3 Future challenges for auto-enrolment

Measuring effectiveness

19. One initial measure of the effectiveness of AE is the number of employees who have chosen to opt out of their employer's pension scheme within one month of being auto-enrolled. The Department for Work and Pensions (DWP) originally projected opt-out rates of around a third but the actual figures have been much lower at 9-10% in 2013 and 12% in 2014.[32] DWP has pointed to these lower than anticipated opt-out rates as one of the major successes of AE and witnesses acknowledged this achievement.[33] DWP has now revised the headline estimated opt-out rate to 2018 from 28% to 15%.[34]

20. Maintaining low opt-out levels will be an important factor in ensuring the continued effectiveness of AE. Some witnesses have speculated that the level will be affected as AE is extended to smaller employers and as minimum contribution levels increase (see next section).[35] However, TPR, amongst others, did not anticipate that any increase amongst smaller employers would be significant.[36] The Minister noted that there was uncertainty about whether opt-out rates would be affected by the extension of AE to smaller employers and believed that planned minimum contribution increases could be achieved without a great impact on opting out.[37]

21. Opt-out statistics only cover the initial one-month period following an individual being auto-enrolled and do not therefore provide an indication of "persistency" in contributing to pensions.[38] Rates for subsequent withdrawal from AE schemes (known as "attrition rates") appear to be low and the Minister and providers were satisfied that they raised no cause for concern.[39] However, the prospects for sustaining pension saving over the longer term remain uncertain, particularly taking into account the possible impact of increases to minimum contribution rates (see below). Witnesses therefore believed that ongoing participation should be carefully monitored.[40]

22. The low opt-out rate for AE to date is an early indicator of the policy's effectiveness in enrolling people into workplace schemes. However, it is not a meaningful measure of the effectiveness of AE policy in the longer term. We recommend that DWP and The Pensions Regulator (TPR) monitor and report on the number of employees leaving AE schemes after the initial opt-out period ("attrition rates") so that levels of ongoing participation in pensions and the impact of increases in minimum contributions can be assessed. The new independent pension commission which we propose should advise on how the effectiveness of AE can be measured in the longer term.

Minimum contributions

23. Employers and employees are required to make minimum contributions under AE. The Government decided to stage and phase the contribution rates, from a starting point of 1% each for employees and employers, rising to a total of 8%, as shown in the table below.[41] This approach is intended to familiarise individuals with the concept of pension saving at a comfortable level before gradually increasing their commitment.[42]

Table 2: Staging and phasing dates for minimum contributions

Date Employer minimum contribution Employee minimum contribution Tax relief Total minimum contribution

Employer's staging date to 30 September 2017 1.0% 0.8% 0.2% 2.0%

1 October 2017 to 30 September 2018 2.0% 2.4% 0.6% 5.0%

1 October 2018 onwards 3.0% 4.0% 1.0% 8.0%

In our 2012 report, we concluded that 8% was a realistic initial target for minimum contributions, but that it was unlikely to be adequate in the long run.[43] The Government is keen to encourage saving beyond the 8% minimum. However, it is concerned that increasing the minimum too soon "may increase individuals' perception that saving for retirement is an insurmountable challenge", and possibly lead them to opt out.[44]

24. Witnesses generally agreed that minimum contributions needed to rise beyond 8% but also believed that the burden on individuals and businesses should be minimised.[45] The options available for increasing minimum contributions include "auto-escalation", which would link pension contribution rises to salary increases. The Minister stressed that proposals to increase minimum contributions needed to be developed early in the next Parliament, as significant planning and consultation would be required before an agreed approach could be established.[46]

25. We continue to believe that minimum contribution rates will need to increase beyond 8% if AE is to be effective in ensuring that adequate retirement income levels are achieved. We recommend that the new independent pension commission which we propose (or the new Government) undertake a consultation on when and how minimum contributions should be increased, as soon as possible after the General Election, with a view to implementing changes before the end of the next Parliament. This is likely to require a reassessment of the definition of what constitutes "adequacy" of retirement income a decade on from the previous Pensions Commission's work on this.

Eligibility and exclusions

26. To be eligible to be auto-enrolled, individuals must be aged between 22 and State Pension age and earn more than the AE annual earnings threshold and less than the National Insurance Upper Limit. Those who earn between the National Insurance Lower Limit and the annual earnings threshold may choose to be enrolled.[47] At the end of December 2014, the proportion of individuals who had been auto-enrolled and those who were ineligible for AE was roughly equal, as shown in the following table.[48]

Table 3: Workers auto-enrolled and ineligible for AE

Number %

Workers who are already active members of a qualifying scheme on the staging date. 9,258,000 47

Eligible jobholders who have had the defined benefit or hybrid scheme transitional arrangements applied to them. 427,000 2

Eligible jobholders automatically enrolled into an automatic enrolment pension scheme 5,135,000 26

Workers who do not fall into any of the above categories 5,090,000 26

Some witnesses believed that the eligibility criteria mean that too many people are excluded, particularly those in traditionally "under-pensioned" groups, such as low-paid workers and the self-employed.[49] The TUC believes that AE should be triggered from the first pound of pay.[50]

LOW-PAID WORKERS

27. The AE annual earnings trigger was initially linked to the income tax threshold and is reviewed each year. Previous reviews have concluded that aligning AE with the income tax threshold "strikes the right balance", noting that, for persistent low earners, the State Pension alone will give them a retirement income which is similar to that in working life.[51] Following the most recent review, the Government announced in December 2014 that it would fix the threshold for 2015-16 at £10,000 per annum (which was the income tax threshold for 2014-15), rather than increasing it in line with the rise in the 2015-16 threshold. It acknowledged that there were competing arguments for and against lowering the earnings threshold, but concluded that £10,000 would be administratively simple whilst including those individuals who would benefit from pension saving. The Minister reiterated DWP's view that those who earn less than £10,000 per annum would receive a similar standard of living in retirement to that achieved in their working lives through the State Pension alone. Little benefit, if any, would therefore be derived from them being auto-enrolled, which would involve a regular contribution of only a matter of pence per week, with all the accompanying bureaucracy for employers and pension schemes.[52]

28. Particular concerns have been expressed about those individuals, primarily women, who cumulatively earn more than £10,000 per annum in multiple low-paid jobs but who do not reach the AE earnings threshold in any single job.[53] The Minister believed that this group was relatively small but agreed that it would be useful to carry out more research about those who are affected. In particular, it would be worth having "time series data", to establish whether people tended to spend their whole working lives in multiple low-paid jobs, or mainly shorter periods.[54]

SELF-EMPLOYED PEOPLE

29. AE does not apply to self-employed people. Recent labour market statistics show a growing number of self-employed people, totalling 4.59 million in April-June 2014, the highest number at any point over the last 40 years.[55] ONS statistics also show that the percentage of self-employed men belonging to a personal pension scheme fell from 37% in 2005-06 to 25% in 2009-10, and then to 22% in 2012-13.[56] The Minister was sceptical about promoting pension saving options to the self-employed, such as saving with NEST, noting that simply encouraging individuals to save into pensions does not work, which was the reason why the AE approach was needed. However, he accepted that pension provision for this group is "a big and growing issue" which no government has really grasped.[57]

30. The AE annual earnings threshold currently excludes a significant number of low-paid workers. We accept that AE needs to be limited to those who will benefit; and that the State Pension is likely to produce an adequate replacement rate in retirement for workers who earn at low levels throughout their working lives. However, it is not clear how many individuals will be affected by the earnings threshold, particularly those in multiple, low-paid jobs, nor whether their exclusion from AE is more likely to be over the short or longer term. We agree with the Minister that more research on this is necessary. We recommend that the new independent pension commission which we propose give early consideration to whether the AE annual earnings trigger needs to be adjusted, and to how those who are currently excluded from AE, particularly self-employed people and those who are in multiple low-paid jobs over longer periods, might be supported to make adequate provision for their retirement.

Extension to smaller employers

31. We acknowledged in our 2012 report that AE would be particularly challenging for small and micro businesses, but that it was also necessary for them to be included, as their employees have been the hardest to reach in terms of workplace pension provision.[58] The Making Automatic Enrolment Work Review, which the Government commissioned in 2010, considered excluding employers with fewer than five workers, but concluded that it would be unfair to deny access to AE to the 1.2 million workers who would be affected.[59] The Government has, however, accepted that smaller employers are likely to face difficulties with AE and that they will need support from a variety of bodies.[60]

COMMUNICATIONS

32. A number of witnesses expressed concern that some employers did not yet understand their obligations under AE.[61] TPR acknowledged that further extension was "still a big challenge" and said "we are really eager that all employers realise that this duty applies to them".[62] TPR has committed to write, early in 2015, to all employers who have not yet staged to inform them of their AE obligations. This is in addition to its standard communications process where it contacts employers 12 months ahead of their staging date and then at intervals until they enrol.[63]DWP and TPR acknowledged that the communication needs of smaller employers differ from those of larger organisations. DWP has tested communication changes to ensure that the "messaging and tone" meet the needs of employers with fewer than 30 employees. TPR has simplified its own communications with employers and also plans to simplify and rationalise its template letters which are used by employers to inform employees about AE.[64]

SELECTING A PENSION SCHEME

33. TPR research indicates that choosing a pension scheme is one of the biggest concerns amongst smaller employers in relation to implementing AE.[65] NEST noted the lower level of resources and expertise which smaller employers have to assess pension scheme quality.[66] Employer representatives suggested that the range of options offered by pension providers may be narrower or less competitive for smaller employers.[67] Witnesses also highlighted the potential vulnerability of smaller employers to whoever might be giving them advice, and their need for support in selecting a provider.[68] DWP and NEST noted that, along with TPR, they were targeting information to the third parties to whom small employers might go for advice, such as accountants, bookkeepers, payroll providers and independent financial advisers, to ensure that they had the right knowledge to support them.[69]

34. TPR is considering publishing a list of providers who will offer AE qualifying schemes to smaller businesses to help them make a choice. It has also developed a "directed journey", intended to guide smaller employers through a simplified enrolment process. This removes many of the choices usually available when an employer auto-enrols, in response to those who asked simply to be told what they had to do in order to comply with the requirements. [70] The Minister noted that NEST is specifically mentioned as a potential provider in TPR communications with employers regarding their AE duties.[71]

35. The People's Pension believed that some providers might face a challenge in coping with large numbers of smaller employers coming to them in a short space of time.[72] However, DWP noted that the six-year timeframe for implementing AE had been set in order to help manage this demand, and other providers were generally confident that they had adequate capacity and efficient processes in place to cope with this.[73] They believed that the increased volume of employers would be balanced by small employers' needs being less complex in terms of the range and variety of employees who would need to be enrolled. This would entail "a less bespoke service".[74] The Minister agreed with this point and TPR and DWP both noted that capacity concerns have so far proved unfounded.[75] NEST pointed out that, because of its public service obligation to take any employer, there were capacity implications if other large providers unexpectedly left the AE market; it would need six to eight months to adjust its resource plan to absorb the additional demand, but this could be achieved.[76]

COMPLIANCE

36. TPR stated that its approach to compliance was based on the assumption that "most employers want to meet their obligations […] and do the right thing" and was therefore focused on informing employers about their duties, followed by an initial response of support for those who were not compliant.[77] In September 2014, DWP noted that over 99% of the largest employers auto-enrolled without TPR needing to use its statutory powers, assisted in part by the "educate and enable" approach TPR had taken.[78] However, TPR anticipated an increase in the need to use its statutory enforcement powers as the number of employers staging rises significantly. The latest TPR figures on compliance and enforcement support this, showing a significant rise in the number of times it has exercised its powers against employers, especially through Compliance and Fixed Penalty Notices.[79] The Pensions Management Institute (PMI) was concerned that limits on TPR's resources might make it difficult to monitor employers who were deliberately non-compliant, particularly in the case of employers encouraging staff to opt out.[80] However, TPR was confident that it had sufficient resources to deal effectively with compliance, referring to detailed modelling, its discrete funding stream for these activities, and the ability to apply to DWP if more resources were needed.[81]

37. The challenges associated with the roll-out of AE to smaller employers are significant, given that small businesses have limited resources and time to devote to the process, and less experience in pensions and access to specialist advice than larger employers. It is important that small employers are fully supported to comply with the obligations that AE places on them and that the burden on them is kept to a minimum by making the process as straightforward as possible. TPR appears to have taken this on board to date, particularly in relation to simplifying communications and offering a "directed journey" which removes many of the complications from the enrolment process.

38. We recommend that the next Government take the lead in ensuring that support for smaller employers continues to be coordinated across regulators and providers. The intermediaries which small employers regularly use, such as accountants, bookkeepers and payroll providers, will also have an important role to play and should be used as an effective resource by ensuring that they are properly connected to the process. The new independent pension commission which we propose should assess progress with AE by smaller employers at an early date and advise on further support and adjustments which it identifies as being necessary to complete AE implementation smoothly.

Automatic transfers

39. The introduction of AE means that a greater number of small pension pots are likely to be created because there will be many more individuals saving, and saving at lower levels, and switching between numerous jobs during their working life. An accumulation of small pension pots during working life can cause problems for individuals because of the danger of scheme members losing track of multiple pots, and for pension providers because of the relatively high administration costs. DWP modelling estimated that, without change, there would have been around 50 million dormant workplace DC pension pots within the system by 2050, and that over 12 million of these would have been under £2,000.[82]

40. The Government has therefore taken action to address the small pots problem. It plans to introduce 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"). This was legislated for in the Pensions Act 2014. The Government rejected the alternative approach, on which it initially consulted, of having an "aggregator scheme" for small pots.[83]

41. When we took evidence in December 2014, pension providers raised significant concerns about the lack of progress in determining the details of how pot follows member would work and the timetable for its introduction. Some witnesses also had more fundamental doubts about whether pot follows member was the right solution. The NAPF said that it was not convinced that it was "practicable in the short term" and that its preferred option was still the aggregator fund model which DWP had rejected. The Association of British Insurers (ABI) believed that there were still "policy challenges" around governance and the necessary technology. Otto Thoresen of the ABI said that he did not have a sense that the policy was "totally thought-through".[84]

42. The People's Pension said in written evidence that pot follows member was the wrong solution. It argued that the industry had "grudgingly gone along" with it but "we are not aware of any provider that honestly believes it will work" in the current system. There was also concern that it would be expensive to operate. When giving oral evidence, Patrick Heath-Lay, the CEO, was more positive. He acknowledged that, "as a concept" pot follows member was a good idea but believed that it was important that it had "good cross-party support" and that the timetable for its implementation did not adversely affect the AE timetable.[85] Legal & General pointed out that establishing an effective scheme member identification system, to ensure that "the right pot goes to the right member when they change jobs", was still being worked through.[86]

43. DWP told us that it had "moved away from the conception of a centralised database and towards an industry-led federated model where different organisations can offer pot matching and pot transfer services to schemes, creating a competitive market".[87] The Minister explained that the "federated model" meant that DWP would not provide the database for the system; private companies would set up "registries" which would operate the databases which would then provide and exchange the data on pension pots held by pension providers. He also made clear that automatic transfers would initially operate on an "opt-in" basis because "that way […] you have validated that it is the right person and the right pot"; requiring savers to opt out would entail more risk in terms of ensuring "you've got the right person" and that the pension pot was going to the right place.[88]

44. DWP published further details about how automatic transfers will operate in February 2015. This confirmed that pots will be transferred where they are worth less than £10,000 (the pot size limit will be reviewed every five years, as set out in the Pensions Act 2014); and first contributions were made from July 2012. It also confirmed that the "federated model" would be used and that the system will be phased in. Phase 1 will be limited to a certain number of schemes and will operate on an "opt-in" basis; Phase 2 will aim to incorporate all schemes and move to pots being automatically transferred unless members opt out, so that even disengaged savers are included. DWP sets out that "any solution must be industry led with the government providing a legislative framework only where necessary to enable an effective solution". It also acknowledges that the challenge of "identity verification of the individual by pension schemes" remains to be resolved. Progress is not expected to be rapid: the next step is to begin to develop the legislation so that the process can be implemented "from October 2016".[89]

45. We acknowledge that a system for automatic transfers is essential for auto-enrolment to work effectively. However, progress on developing a satisfactory process has been slow and a significant number of pension providers remain to be convinced that "pot follows member" is the right solution. Publication in February 2015 of the latest detailed plans for automatic transfers is a welcome step, although implementation is still not scheduled to begin until October 2016. We recommend that the next Government confirm the plans for automatic transfers at an early date. DWP will also need to continue to work hard to persuade the pensions industry of the merits of pot follows member. This will be assisted by more rapid progress with the development of workable and robust IT solutions, particularly in relation to scheme member identification, in cooperation with pension providers.

32 HC Deb, 2 September 2014, col 196; DWP, Employers' Pension Provision Survey 2013, July 2014, para 5.3.4; DWP, Automatic enrolment: Qualitative research with employers staging in 2014, January 2015, p 18 Back

33 See, for example, B&CE The People's Pension (AEP0020) p 1; Now: Pensions (AEP0026) para 6; Standard Life plc (AEP0012) para 13; TUC (AEP0008) para 1.2 Back

34 DWP (AEP0027) para 25 Back

35 See, for example, Institute and Faculty of Actuaries (AEP0033) para 4a; Mercer Ltd (AEP0019) para 3; NOW: Pensions (AEP0026) para 6; Pensions Policy Institute (AEP0003) paras 8-9,. Scottish Life/Royal London (AEP0007) paras 12 and 14; Tax Incentivised Savings Association (AEP0014) para 10 Back

37 Qq238, 241 Back

38 The Pensions Management Institute (AEP0011) para 2.2 Back

39 DWP, Automatic enrolment: Qualitative research with employers staging in 2014, January 2015, p81, with DWP sample data showing that only 2% of employees left shortly after the opt-out period. See also Qq122-123, 126, where Legal & General reported a 3% "lapse rate" after the initial opt-out period, and The People's Pension indicated that opt-out increased from 5.8% to 6.3% over a 90-day period. Back

40 Q24; Qq78-84; Q241 Back

41 The Pensions Advisory Service, 'Automatic Enrolment: How much do I and my employer have to pay?', accessed 20 January 2015; TPR, 'Contributions and funding', accessed 20 January 2015 Back

42 Q81; Q241 Back

43 Eighth Report of Session 2010-12, Automatic enrolment in workplace pensions and the National Employment Savings Trust, HC 1494, para 48-9. See also the Second Report of the Pensions Commission which indicated that 8% was the minimum desirable level of contribution: The Pensions Commission, A New Pension Settlement for the Twenty-First Century: The Second Report of the Pensions Commission, November 2005, p 7 Back

44 DWP (AEP0027) para 29 Back