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The inquiry conducted by the House of Commons Work and Pensions Committee

A submission from the Association of Chartered Certified Accountants
September 2002

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have the opportunity to contribute to the House of Commons Work and Pensions Committee's inquiry into the future of UK pensions.

The private pension industry is currently experiencing a difficult period in which many individuals are losing faith in the industry's ability to allow them to accumulate material levels of retirement savings and then to convert those savings into good levels of retirement income. Many of the employers who are deciding to close their final salary schemes, either on the grounds of cost or otherwise, are choosing to start up money purchase schemes instead and are, it is alleged, choosing to fund these on an inferior basis. Individuals who have saved for years in money purchase schemes are finding that a combination of factors is leading them to receive pensions in payment which are substantially less than they had expected or had hoped for.

Employers must be left to make their own decisions as to which, if any, pension scheme is right for them and their workforces. But the Government does have a responsibility for creating conditions in which employers can consider it worth their while to offer good, well-funded schemes, whether these be final salary or money purchase in nature. In recent years, partly but not wholly due to Government policy decisions, these conditions have deteriorated, with adverse consequences for employer support of pension schemes and pensioner wealth.

Government policy needs to focus on restoring the conditions in which pension schemes can thrive as vehicles for retirement saving. We believe that policy initiatives need to concentrate on three areas: first the provision of tax incentives to encourage appropriate investments which will fund growth; secondly, the re-structuring of money purchase schemes; and thirdly, reform of the current restrictive rules on annuities.

The Future of UK Pensions

1. ACCA applauds the Prime Minister's statement that he wants to build a consensus on pensions policy and is encouraged by the committee chairman's own statement that he would like the current inquiry to be the platform on which that consensus might be built.
   
   
2. Consensus is vital if the UK is to create a pension system which not only encourages saving and offers the prospect of decent levels of retirement income but, crucially, lends itself to stability. Pension saving is by definition a long-term undertaking and individuals should be entitled to assume that the plans which they make and pay for during their working lives will not be undermined by dramatic changes in policy later on, particularly near to and during their retirement.
   
   
3. In answer to the first question raised in the Committee's announcement of its review - is there a crisis in UK pensions provision? - we would respond that there has begun to appear a substantial and widening gap between those in society who have been fortunate enough to benefit from a well-run final salary scheme and those, particularly on lower earnings, who have to plan for their retirement, and pay for it, via money purchase schemes. Recent research conducted by Wentworth Rose suggested that, whereas the average annuitised fund is worth no more than £25,000, the equivalent value of the retirement pension of a long-serving public sector worker is around £300,000 for a man and £350,000 for a woman. In the case of money purchase pensions, the combination of low stock market returns, low annuity rates and restrictive benefit rules currently combines to make money purchase schemes an unattractive prospect and an unfair reward for those who have saved through such schemes throughout their working lives.
   
   
4. At the same time as problems have multiplied in the money purchase sector, increasing costs have resulted in a rising number of employers concluding that they should close their final salary schemes, either completely or to new entrants. The Department of Work and Pensions' own figures show that the proportion of private sector organisations offering some form of provision has declined from 34% in 1998 to 29% in 2000 (although, admittedly, many small firms will by now have 'designated' stakeholder pension schemes). Figures published by OPRA show that, in 2001, 750 occupational schemes were either frozen or closed to new members (compared to only 44 in 2000). Many industry observers are predicting that final salary occupational schemes will virtually disappear within the next twenty years. The political consequences of this trend are already becoming apparent: legal disputes and industrial action are already occurring and, unless confidence is restored in the ability of the private pension system to produce decent levels of benefit, the state will face having to meet a higher, rather than a lower, bill for retirement income.
   
   
5. In some cases, decisions to change the basis of individual occupational schemes are linked to an assessment that a money purchase scheme would be more appropriate to the employment conditions of the employer's workforce. In many cases, however, cost to the employer is a major, if not the most important factor, in such decisions. The cost to the taxpayer of public sector pensions - currently £2.9 billion pa for the Principal Civil Service Pension Fund and considerably more for public sector workers generally - suggests that the difficult decisions currently being taken in the private sector may need to be considered before long in the public sector as well.
   
   
6. We have, therefore, a situation in the UK in which more and more individuals are being required to save for their retirement through money purchase schemes, yet those same money purchase schemes are suffering from serious structural problems which inhibit their ability to produce attractive returns to savers and pensioners. These structural problems can be exacerbated if the level of employer contributions to new money purchase schemes turns out to be substantially less than was the case under pre-existing final salary schemes.
   
   
7. Employers cannot be blamed if they conclude genuinely that they can no longer afford to subsidise final salary schemes - members' pensions in such schemes are, after all, guaranteed only as long as the sponsoring employer remains solvent. Individual decisions on pensions matters by employers and individuals are not the responsibility of the Government. We believe, however, that the Government should accept its responsibility to try to create the conditions in which non-state pensions can flourish. In this context, the Government needs to agree two broad policy objectives: first it needs to create the conditions in which final salary schemes remain attractive to employers and, secondly, it needs to provide strong incentives for people to save in money purchase schemes.
   
   
8. In the light of these two objectives, we believe that Government policy needs to focus on the following issues.
   
   (i) Tax incentives
   Incentives for the accumulation of pension savings should be given the highest priority within the tax system. This should mean at the very least the restoration of the dividend tax credit which was taken away in 1997. The withdrawal of the tax credit is, in our view, the most important single contributory factor in the problems which currently afflict both money purchase and defined contribution pensions. Whereas, when the credit was withdrawn many schemes had surpluses in their funds, today the converse is the case. Restoring tax credits would help final salary schemes in coping with the current difficult stock market conditions and help sponsoring employers to confront their obligations under the accounting standard FRS17 - although the latter is currently suspended, its terms are likely to be broadly confirmed in due course through the adoption of a new international accounting standard.
   
   The Government should also firmly reject the proposal which is currently being advanced, namely to tax the lump sum payment which scheme members are entitled to take from their fund on retirement. The tax rules must provide a solid basis for encouraging individuals to believe that they will be better off if they save for a non-state pension. Introducing disincentives is a certain way of persuading people not to save at all and to rely on the state for their retirement income. We also feel strongly that reform of the annuity system, as discussed below, could reverse the drift towards a dependency culture.
   
   (ii) Money purchase pensions
   Given the increasing significance of money purchase schemes, savers and prospective savers must be persuaded that a money purchase scheme is likely to provide them with a materially higher retirement income than they would have if they chose simply to rely on state benefits. Not only should the dividend tax credit be restored but contribution and benefit rules should be made generous and flexible.
   
   The issue of employer contributions is also crucial: at the lower income levels, substantial employer contributions will be crucial in funding a worthwhile level of retirement income. In this respect, lessons should be learned from the experience, so far, of the stakeholder pension. This product was introduced in order to appeal to those on low to middle earnings who do not currently have alternative non-state provision. The sales levels so far suggest that the product is not succeeding in reaching its target market. We suggest that the main reason why this is so is because potential consumers appreciate that, unless the contributions made by individual members are supplemented substantially, low levels of funding will inevitably result in a negligible level of income in retirement.
   
   (iii) Annuity reform
   The current rules governing annuities are excessively rigid and in need of imaginative reform. We believe that there are a number of systemic problems which need to be addressed. The rule which compels retired individuals to buy annuities at the age of 75 has unfairly penalised those individuals who have had the misfortune to retire in recent years at a time of dramatically reduced annuity rates. The core requirement for funds to be converted into annuities has the effect that the entire residual value of each fund is lost on death, regardless of how long the individual lives after purchase. Compulsory conversion also denies individuals the opportunity to invest their own accumulated pension capital in retirement and to put that capital to alternative uses, which should, crucially, encompass health and nursing care. Further, because of the differential rates for men and women, annuities are actually discriminatory: allowing individuals to keep their funds intact would overcome such discrimination.
   
   The Government's recent proposals on annuities, as set out in the consultation paper 'Modernising Annuities' and in subsequent statements, have failed to take due account of the initiatives and experiences of countries such as the USA, Canada and Australia. All these countries have addressed criticisms of and complaints about the traditional annuity system and have come up with radical reforms which have proved highly successful in terms of encouraging individuals to save for their retirement. We suggest that, if progress is to be made in restoring confidence in private pensions in the UK, there must be significant movement towards greater flexibility in the uses to which money purchase retirement funds may be put.
   
   
9. To conclude, we note that, when addressing the September conference of EU Finance Ministers in Copenhagen, the Chancellor of the Exchequer repeated his claim that a lack of flexibility was holding back the EU economy. We would argue that, here in the UK, the Treasury's own lack of flexibility threatens to impede the much-needed reform of the structure of private pensions. While we would not necessarily agree that the current state of the industry merits the term 'crisis', we do believe that the situation is very serious and has the potential to become steadily more so unless corrective action is taken which acknowledges the needs and aspirations of the individuals who are actually saving for their retirement. Members of Parliament and civil servants should not underestimate the effects of this situation on the millions of employees and businesspeople in the private sector who are not eligible for the generous schemes which the former enjoy. Neither should the impacts on retirement home and nursing care provisions be overlooked.

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