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The Minister cannot accuse employers of cheating with this group of amendments, but he may respond to them, as well as to those for basic earnings, that a definition that resulted in less saving for some jobholders would be unacceptable, and that the implementation of the Bill in terms of producing replacement income in retirement must be tested at the most granular level
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Amendments Nos. 64 and 65 attempt other ways of solving the problem. Amendment No. 64 says that the Secretary of State could fix the pay reference period for the purposes of the quality requirement in Clause 19 as a different period, so that the quality requirement for the employer schemes could be tested, say, annually, instead of by reference to the individual pay reference period linked to payroll. That is not the same as the aggregate test, as it would still require the test to be met at the level of the individual employee, but it would be established over a longer period, which would allow employers to get the benefit of not having their schemes ruled out because of the spike effect of particular variable pay in certain pay reference periods. Amendment No. 65 is a last-ditch attempt to preserve existing schemes and says that if, when calculated over a longer period, there is still a shortfall in contributions, the employer can make up the difference within three months.
It is far from clear that employer-based schemes will be preserved if we cannot use employer-specific definitions. The NAPF has pointed out that there are big legal and actuarial costs involved in changing scheme rules to meet the Bill’s definitions and that the monthly calculations will add administrative costs. If employers adopt the Bill’s definitions to replace their own, the DWP will have forced employers onto a path that leads inexorably to levelling down. It will not be surprising if employers decide that if they have to change the definition of earnings, they might just as well change the bands as well and, if they go that far, why not just use the minimum percentages or the personal accounts scheme? Levelling down is a big danger and, whatever the DWP’s surveys from last year show, now that employers are confronting the detail, the NAPF and the ABI are reporting that levelling down is now the most likely path. Currently, employers pay an average of 6 per cent into DC schemes, which is double what the Bill requires; that is what is at stake.
The issue is not just one of the complexity and cost of handling pension contributions on a different basis than current practice, though that is certainly important. We also have to add the cost and complexity that will be caused for the compliance regime, especially for small and medium-sized employers. Employers are concerned that the Government have not appreciated the real burdens that build up under the Bill.
I said at the outset that I would be asking the Minister about the definitions of qualifying earnings and defined benefit schemes. My initial thought was that the issue of qualifying earnings had no relevance
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My amendments seek to amend the Bill to give flexibility for both existing and future occupational pension schemes. We on these Benches want employers to own the concept of retirement provision for their employees. There is another route, which is based on protecting existing schemes, but forcing new ones into the Bill’s straitjacket; grandfathering. The Minister expressed concerns at our last Committee day that grandfathering has its own problems for sustainability and complexity over time, but it is another possible route and it should be carefully considered. I hope that the Minister will agree that we need to amend the Bill and that he will have something positive to say in response to my amendments. I beg to move.
Lord Oakeshott of Seagrove Bay: I indicated where we stand in general on these amendments in my comments on Amendment No. 42 on the previous Committee day, so I do not propose to say much more at this stage. I reiterate how grateful I have been for the representations and meetings that we have had with people such as the EEF and the NAPF and providers such as Norwich Union, Scottish Widows and Standard Life. They make a fair point. I quote the Norwich Union, saying that accepting fluctuating contributions, including bonuses and overtime,
- “is not standard industry practice and would therefore increase the costs of running pension schemes by tens of millions of pounds, reduce returns for savers and add complexity to employers’ decision making and administration”.
The response that we heard at the end of the previous Committee day did not encourage me that the Government were thinking hard enough about how they could deal with these points and ensure that unnecessary costs were not imposed on good quality existing schemes.
I do not share the rather extreme concern of the noble Baroness, Lady Noakes, who asked whether the Government were set on the destruction of the remaining vestiges of defined benefit pension schemes. That is rather alarmist, and if the Government are having that effect it is by not really thinking things through properly. I do not think that it is deliberate. This is a genuinely difficult problem on which we all need to work together to find a solution. Again, I stress that I thought the People’s Pensions Coalition had some good points when it was concerned to maximise the effective employer contribution in schemes, particularly for lower earning employees who are obviously most at risk. If they do not build up their pension enough, they will fall into the means-test trap.
I am sorry if I sound rather on the one hand and then on the other, but these are genuine points. Grandfathering is a possibility but I am afraid—this is
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7.30 pm
Baroness Hollis of Heigham: I also share some of the concerns. Like the noble Lord, Lord Oakeshott, I do not want to repeat the comments I made briefly at the end of the previous Committee day. Clearly, there are concerns about investment behaviour, burdens on industry and trying to establish what the appropriate contribution rate would be on short-term payments of earnings when overtime in the retail trade, for example, might fluctuate each week by two or three hours, requiring adjustments to be made.
I do not have a solution, but I understand that the industry and the Government are seeking ways though it. They may need more time. The noble Baroness seemed to suggest that she would come back on Report, which is likely to be in October, and that discussions would take place over the summer. My noble friend should be in no doubt that concern is widespread and that the Government will have to address these issues.
Amendments Nos. 63 or 64, which will allow annual terms of reference so that calculations can be done just once during the year, may be the very least that the Government should be moving towards. We all want to ensure that an individual ends up in the best-buy outcome. We all want to build in checks against perverse behaviour by employers, which can perhaps be seen by regulation by the TPF. We also want to ensure that there are no other hassle inducements for employers to desert their existing schemes. Clearly the advantage is both higher rates of contribution and not having that first £5,000 basic excluded because of the problems of calculating weekly or monthly contributions that both employer and employee have to make.
I hope that my noble friend will bear in mind the serious concern that has been expressed around the Committee and that over the summer he will work towards a more satisfying and satisfactory solution than we currently have on the table.
Lord Hunt of Wirral: I rise to support my noble friend. She highlighted a number of problems that have also been mentioned by the noble Lord, Lord Oakeshott, and the noble Baroness, Lady Hollis.
I have been made aware of the research on this issue, which shows that the cost of levelling down in the insurance-based pensions market alone could witness a fall in annual contributions of £900 million. If someone on average earnings of £24,000 a year is switched from a typical DC scheme to personal accounts at the minimum statutory level, they could be £5,000 a year worse off in retirement.
That is why I was very pleased to hear that a group comprising the Association of British Insurers, the National Association of Pension Funds, the Institute of Chartered Accountants in England and Wales and the Society of Pension Consultants has united to seek
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Lord McKenzie of Luton: My Lords, I thank all noble Lords who have spoken on this issue, and the noble Baroness, Lady Noakes, for the manner in which she moved the amendment. I fully understand that this is airing issues with a view to getting the right outcome.
Clause 19 confirms that contributions into qualifying occupational money purchase schemes need to be at least 8 per cent on a band of earnings. The minimum contribution is based on the Pension Commission’s recommendations that an overall contribution of 8 per cent of qualifying earnings could set a median earner with solid state entitlement on course to achieve an income in retirement of around 45 per cent.
Amendment No. 60A would alter the basis of this contribution-based test by enabling the scheme to require an average employer contribution of 3 per cent of qualifying earnings. Amendment No. 61B has a similar effect. It would enable a scheme to require an average total contribution of 8 per cent of qualifying earnings. We understand that some of our stakeholders perceive the quality requirements for money purchase schemes to be complex because most existing schemes use basic pay as the definition of pensionable pay rather than qualifying earnings.
However, the amendments tabled do not simplify the quality test. If anything, they potentially complicate it. Employers and schemes would still be required to track the aggregate qualifying earnings for all jobholders to ensure that the correct contribution was deducted in each pay period. Furthermore, if there were a shortfall, it would be unclear to which members a top-up payment was owed. That could lead to greater complexity. What is more, these amendments would expose some jobholders to the risk of consistently saving well below the minimum proposed by the Pensions Commission. The noble Baroness acknowledged that.
We are listening to stakeholders and understand their concerns about the application of the test. We will work with them to explore practical ways to make the test as workable as possible without undermining the minimum level of saving required by the reform. If we are serious about addressing undersaving this must remain sacrosanct.
Amendment No. 61A would ensure that no more than 10 per cent of members receive a contribution below 3 per cent of qualifying earnings. Amendment No. 62A similarly requires that no more than 10 per cent of members receive less than the total contribution of 8 per cent required under the test. Taken alone, these amendments change the basis of the quality test in Clause 19. The test ensures that each individual in the scheme receives at least the default contribution required under the employer duty. A 10 per cent tolerance would mean that certain jobholders would not—or may not—be saving at the minimum level
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Taken together, Amendments Nos. 60A, 61A, 61B, and 62A have a different impact. They would ensure that under a scheme-average test no more than 10 per cent of members could fall below the minimum level. While this would provide some protection against significant inequalities between members, it would nevertheless leave vulnerable members exposed to the risks of undersaving I have just outlined.
As I explained during the debate on Clause 12, the definition of qualifying earnings is a core element of the Pension Commission’s proposition to set a median earner with solid state entitlement on course to achieve an income in retirement of around 45 per cent. Any measure that undermined this would put the outcome of the entire reform at risk. Amendments Nos. 61, 62 and 63 together could do exactly that by enabling employers and trustees to define earnings within their scheme rules.
We recognise that many employers already provide generous contributions on basic earnings and would be likely to continue to do so in good faith. However, these amendments would leave members vulnerable to changes in pay structures occurring for perfectly legitimate business reasons, which could reduce the value of the contribution below the level proposed by the Pensions Commission. Even if such an amendment were limited to apply to existing schemes only, under grandfathering arrangements, there would always be a risk that future changes to the scheme or the employer’s pay structures would reduce the value of the contributions. We cannot legislate to leave people vulnerable to saving below the minimum in this way. Not only would it put the outcome of reform in jeopardy, but by permitting the minimum standard for contributions to vary across employers, it could also potentially lead to discrimination against vulnerable groups.
Amendments Nos. 64 and 65 operate in a different way. Taken together, they could provide for an easement to the application of the quality test for occupational schemes. Amendment No. 64 permits a pay period of, for example, 12 months to be set for the purposes of the quality standard. That would mean that a scheme could be assessed over a longer period to allow some smoothing of contributions where they might otherwise fluctuate above and below the minimum level, the spike to which the noble Baroness referred. Amendment No. 65 relaxes the requirement that scheme rules provide for 8 per cent of qualifying earnings over the pay reference period provided the employer makes up any shortfall in contributions himself so that the 8 per cent is met.
We have been engaging with stakeholders on this issue and understand their concerns about the application of the test for existing schemes. We remain of the view that the quality standards laid out in the Bill will work for the majority of schemes on most occasions without the need for scheme rule changes. We expect that payroll software will support employers in monitoring that this is the case. Where it is clear that a scheme will
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Amendments Nos. 64 and 65 do not fully address the issues stakeholders have raised. They would not apply evenly across occupational and personal pension schemes. Furthermore, Amendment No. 64 is already achievable by virtue of the powers in Clauses 14 and 116, which enable us to set a longer pay period for the purposes of assessing money purchase schemes. Amendment No. 65 raises additional questions about how compliance against the employer’s duty to make shortfall payments would be monitored and enforced because it could cause confusion about whether the scheme itself fell below the qualifying standards or whether it was a matter of a failed payment by the employer.
We recognise that employers and schemes still have concerns and that these amendments represent genuine attempts to address them. We are keen to minimise any disruption to current arrangements, which is why the qualifying test must be designed in the simplest way. As noble Lords know, the Government are determined to ensure that all savers receive at least the new minimum level of pension contributions. For this reason, we have not been persuaded that grandfathering is the right answer.
We do not want to disrupt the smooth administration of existing arrangements that offer good pension outcomes for many savers. Therefore, if it were possible to perform the test in a way that reduced employer administration, perhaps by enabling the use of a range of assessment periods, that is something we would seriously want to consider, provided that it also preserved the new minimum level of pension saving.
The noble Baroness asked specific questions in moving the amendment. She asked how much disruption we want. We want minimum disruption to existing schemes. These proposals are designed to achieve that and to do all we can to prevent it. We are mindful of the risks of that, which is why we need to address the issues that she identified.
In all of this, we should be mindful that personal accounts would be a money purchase occupational scheme and the qualifying test will apply. If the qualifying test were to be changed to enable minimum contributions on aggregate earnings where only 10 per cent of individuals could fall below the minimum, that could seriously affect the scheme. First, as drafted, the minimum contributions into personal accounts would be considered across the membership as a whole. Given that the scheme is expected to be used by many thousands of employers, it would be complex to do that, and it would raise problems in identifying where an employer had failed to make sufficient contributions. Secondly, we estimate that 4 to 7 million people will be saving in personal accounts under the reform, and a system that would permit up to 10 per cent of those people to be saving at very low levels below the minimum would expose up to 700,000 people to the risk of undersaving in personal accounts alone.
The noble Baroness also asked about defined benefits schemes and qualifying earnings. Employers with a contracting-out certificate have met the scheme standard
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We acknowledge the challenges in making sure we get the right answer to all this. I think the noble Baroness will acknowledge that the specific proposals put forward do not do that, although I do not think there was an expectation that they would be received in those terms. We are determined to work with stakeholders to make sure that we can get through this. There are ways that we might do it. We have some time before we get to Report. On that basis, I hope the noble Baroness will not press her amendment. We acknowledge there is more work to do on this to see whether we can reach a proper outcome. We are aware of concerns in the industry. I am sure there is a way through this.
7.45 pm
Baroness Noakes: Before I decide what to do with my amendment, I shall ask the Minister a couple of specific questions. First, are the Government insistent that the new scheme must be satisfied for every employee in the land who comes within its scope? Are they unwilling to accept any form of averaging? Throughout the Bill, I have constantly said that the best is the enemy of the good. We are talking about getting millions of people into pension saving. Is it not good enough to have 99.5 per cent meeting the standard? I keep hearing from the Minister that we have to do this at the level of every single employee.
Secondly, in relation to the possibility that employers might manipulate their earning patterns or their pay structures in order to get some apparent advantage from the rules, does the Minister not accept that the compliance regime could be amended to work perfectly well to deal with that? The compliance regime could underpin, just as it will be able to deal with employers who induce their employees to opt out and things like that. It would be relatively easy to define a test that could be used by the Pensions Regulator in cases of employer actions or omissions for some deliberate purpose. I should be grateful if the Minister could answer those questions.
Lord McKenzie of Luton: I shall do my best. On the first question, that is done on a collective basis for defined benefit schemes, not on an individual basis. For money purchase schemes and defined contributions schemes, it has to be on an individual basis. We need to be clear that we are not asking for existing schemes to replicate the earnings band. What matters is that the amount that goes into the scheme at least equals what would go into the scheme if the 8 per cent of the band on the definition of earnings that is adopted were applied. We are not asking for that to be adopted in every scheme, simply that the contribution that goes into the scheme under the existing scheme’s rules produces at least that outcome. If there is a way of
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