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The White Paper issued by the Department of Work and Pensions

Comments from ACCA
September 2006

Executive Summary

The aim of the current exercise must be to lay the foundation for a long-term consensus on UK pensions policy. In this context, it is essential that any measures to introduce a new form of pension scheme aimed at lower and middle earners are based firstly on a realistic assessment of individuals’ ability to save and, secondly, on a clear and credible commitment on the part of government to ensure that those saving via any new scheme will be better off in retirement than if they had not saved and simply relied on additional state support. We do not believe that the proposals set out in the White Paper for the new system of personal accounts make out a sufficiently strong case in respect of either of these criteria. We consider that the Government should re-consider the case for an expanded, flat rate basic state pension, supplemented by a private pensions sector which is available to all those who wish to save through it.

Despite the fact that the Government’s original objective in setting up the Pensions Commission was to develop ideas for reinforcing confidence in occupational schemes, the White Paper gives little tangible encouragement to the occupational sector. In fact, the introduction of the proposed new system of ‘personal accounts’ could undermine it further. We do not believe that such an outcome would be in the long-term interests of the Government or employees. If the Government wishes to see final salary schemes survive in the private sector, as well as in the public sector, then it must offer more incentives to employers to retain them.

We agree with the reasoning behind the proposal to raise the state pension age. But if older individuals are to be kept off state benefits, the proposal will mean that many more of them will have to find employment, or stay in employment, before they reach the raised pension age. It will be essential for the Government to adopt effective and co-ordinated policies and practices to ensure that these individuals are able to compete fairly in the employment market.

The Government must work to avoid a situation whereby more generous defined benefit schemes become available only to workers in the public sector while workers in the wealth-generating private sector are only able to save via more risky defined contribution schemes.
General Comments

At the outset, we welcome the speed with which the Government has followed up the exhaustive research carried out by the Pensions Commission. As the Commission’s report demonstrated, this is an issue which is of great social, economic and political importance for the future of the country and it is right that the Government places a high priority on taking appropriate action sooner rather than later to ensure that the pensions sector is capable of meeting the nation’s retirement needs in the years to come. It is therefore encouraging that the Government is now framing broadly-based plans to this effect within a relatively short time of the publication of the Commission’s report.

That being said, we find that the account given in the White Paper of the present state of the pensions environment is incomplete and inaccurate in certain respects which are relevant to any consideration of what needs to be done to remedy current problems. Paragraph 24 of the White Paper discusses the reasons for pensions undersaving. There is no mention of the direct responsibility of the present Government in this matter, in particular for the consequences for both DB and DC schemes of the decision to abolish ACT relief in 1997.

That action has played a significant part in the decisions of many employers to review their sponsorship of DB schemes. It has also had a direct effect on the returns of DC schemes and hence on the potential marketability of such schemes as alternatives to final salary schemes. It has recently been estimated that the accumulated losses to pension funds caused by the abolition of ACT relief is now equivalent to the total pension deficits of the UK’s private DB sector.

Furthermore, the increasing financial and regulatory costs of running private sector DB schemes - until comparatively recently the cornerstone of the UK’s successful private pensions sector – can be linked directly to the problem of undersaving. The NAPF has estimated that the typical employer contribution to a DC scheme is 7% of salary, as compared with about 16% in the case of a DB scheme. Accordingly, those employees whose employer considers it is no longer feasible to operate a DB scheme, and who replaces it with a less well-funded DC arrangement instead, may find themselves adding directly to the national problem of undersaving. We consider that the White Paper has failed to respond constructively to the problems experienced recently by the occupational sector – in particular by the DB sector – and has failed to acknowledge the important contribution which we believe the occupational scheme can still play in encouraging retirement saving.

A full analysis of the reasons for pensions undersaving should also take into account the wider range of factors which influence the amount of disposable income people may feel able to allocate to pension saving. These factors include student debts, which many young people are now faced with paying off until well into their 20s, the dislocation between earnings levels and house prices, which has led to very high mortgage borrowings and repayments, and the increasing availability of consumer credit, which is now resulting in historically high levels of personal insolvency. A properly co-ordinated approach to pensions planning on the part of the Government should consider what contribution it might make to address such obstacles to saving. 

While paragraph 24 refers to the historical complexity of the pensions system, and to the perception that people do not trust private pensions, those points do not account adequately for the consequences, for people’s propensity to save, of the tendency of successive governments to over-complicate the whole framework and thereby to frustrate the potential of pensions to meet the requirements of savers.

If this exercise is to respond positively to the problem of retirement under-saving, it must acknowledge all the reasons why this may be happening and develop solutions which take them fairly into account. This should involve a co-ordinated approach to government policy on pension saving, taking into account all the relevant factors.

Very importantly, the Government must appreciate that, if more individuals are to be encouraged to channel their present incomes into any form of long-term savings vehicle – where the funds are ring-fenced and inaccessible until retirement - they must be provided with sufficient tangible incentives to counter the substantial investment-related uncertainties – regarding growth rates, annuity rates, future changes in government policy etc – which are associated with long-term saving.  These incentives must be such as to hold out the reasonable prospect that at the time savers eventually come to take their retirement benefits they will be better off than if they had invested their income in an alternative way. The necessary incentives need to cover both reasonable encouragements for funds to grow and, on retirement, freedoms for individuals to take their benefits in the ways that appear most suitable and attractive to them in the light of their own personal circumstances.

For those at the lower end of the income scale, there will be no encouragement  to save if individuals are led to believe that means-tested state benefits will be available to them at broadly the same or even a higher level than the level they could hope to achieve by saving for a private pension. Current Government policy in this area will play a big part in creating this impression among those who do not currently save. Unless there is a strong and credible commitment on the part of government to ensuring that it is financially worthwhile for lower earners to save for a pension, we suspect that many in that group will not do so.

We would like to make one other general point about annuities, which we do not feel is addressed adequately in the White Paper. Given the recent trend in the occupational sector away from DB schemes in favour of DC schemes, and given that both stakeholder schemes and the proposed personal accounts will require most savers to annuitise their funds at some stage, the disadvantages of annuities are likely to affect more and more people. The two major problems facing annuitants are firstly cost and secondly absence of reasonable certainty regarding income levels after retirement. There is an understandable perception, held by many people, that the annuity is a form of ‘lottery on life’, where the losers in that lottery can see the value of their savings decline substantially. The fact that the residual value of an annuitised fund will not be available to dependents on death adds to the widespread lack of confidence in the annuity as a vehicle for providing post-retirement income.

While we fully agree that efforts need to be made to increase the rate of savings through pension funds, there is also a need to ensure that the income that those savings generate after retirement is maximised (and reasonably certain). The Government is looking to make pensions attractive to potential savers by seeking to reduce their cost, but it has yet to extend this aim to the annuity market. We would like to see similar emphasis placed on the cost of providing income after retirement.

Chapter 1: Encouraging and enabling private pension saving

The White Paper accepts the Pensions Commission’s finding that millions of people in the UK are not saving enough to meet their income expectations in retirement. To meet this shortfall the Government proposes a new form of national pensions savings account to which all employees would be enrolled automatically after the scheme’s introduction 2012. Employers would be required to make a minimum contribution of 3% of gross salary in respect of employee earnings of between around minimum wage level and £33,000 pa. 

We support the idea that public policy should encourage saving for retirement. All those who have the financial resources to save for a pension should be encouraged to do so provided that the system is able to ensure as far as practicable that individuals will not be as well off or even better off had they not decided to save.

But in the context of encouraging people who are ‘undersaving’ to save, there is little appreciation in the White Paper of the effect that different rates of saving (as a proportion of income), and age of starting saving, can have on the saver’s level of income in retirement. It is not sufficient in our view, nor is it necessarily in the best interests of individual savers, to impose a blanket view that all should save for a private pension regardless of any consideration of the rate of saving and the duration of saving. Before lower and middle earners are enrolled automatically into any new scheme, we suggest that some research be carried out into the effect that annual pension forecasts have on scheme members, in particular on whether these forecasts cause members to adjust their rates of contribution.

In itself, and despite the fact that it appears to be similar in purpose to the stakeholder pension (which has not proved to be a conspicuous success in reaching its own target market), we consider that the proposed new scheme has a number of attractive characteristics. Removing from the individual the responsibility of choosing and setting up a pension plan, and enrolling him or her automatically into the scheme, would overcome an obvious practical obstacle to expansion. An account would be portable, so holders would be able to continue building up the value of their fund as they move from employer to employer: this would reflect the reality of the UK’s flexible and mobile labour market. There would be a minimum overall level of contribution, including a contribution from employers: this would address the conclusion of several research studies which have confirmed the existence of a close relationship between making of employer contributions and levels of scheme membership. The plan would also allow the self-employed to take out personal accounts if they wished to do so.  

We have concerns, however, over aspects of the practicality of the proposed scheme and its suitability as a central element of a sustainable long-term consensus on pensions policy. As we have suggested already, the core purpose of any new pension saving vehicle must be to encourage those persons who do not currently save to attain a higher level of income than would be available to them via means-tested benefits. Before the new scheme is given the go-ahead in its current form, there must be broad agreement between Government and the industry that the scheme is indeed capable of achieving this outcome. We do not believe that such a case has yet been adequately made out. We are aware that the Pensions Policy Institute, for example, has said that ‘even a very successful personal account scheme will not significantly reduce the numbers of people eligible for Pensions Credit…conversely a potentially high level of eligibility for Pensions Credit threatens the success of personal accounts.’ Even allowing for the positive aspects of the proposed new scheme, the PPI’s projections must cast serious doubt on the ability of the new scheme to serve its purpose. 

We consider also that a new scheme administered on one or other of the centralised bases proposed in the White Paper would have some difficulty in wining the confidence of both the industry and the target market. Both will be aware that there have been several high-profile cases in which government  computer and administrative systems have proved inadequate and expensive. If the object is to encourage people to save through a reliable and low-cost vehicle, then this may not prove to be an easy message to get across.  

We have additional concerns about the feasibility of the proposed scheme, as follows below.

1. It is suggested that the annual management charge of the plan could be kept to as little as 0.3%. We consider that this figure is unrealistically low and would turn out to be somewhat higher in practice, given the inevitable operational and compliance demands on it. If a series of administrators were appointed to run the scheme, as is one of the options put forward, this would certainly result in higher costs. 
   
   
2. While enrolment into the scheme would be automatic for new employees, it will be possible to opt out. While the Government expects between 5 and 8 million to remain opted in, and says that up to 10 million ‘could’ be saving in a personal account, we suspect that these forecasts have little meaning - if people have neither the ability or the inclination to save for a pension they will opt out. We acknowledge the positive feedback reportedly generated by the DWP’s pensions roadshows on the likely response by workers to mandatory employer involvement in the new accounts. But we suggest that great efforts would still need to be made by the Government to convince those persons who currently choose not to save, even when their employer operates and contributes to a workplace scheme, of the long-term advantages of doing so. The White Paper itself reports the Pensions Commission finding that, on average, people persist in saving for only around five years. As long as there is urgent competition for the disposable income of lower and middle income earners, and unless there are very strong incentives in place to encourage long-term pension saving – this is not simply a question of presentation but substance – then sustained commitment to material levels of pension saving must be a matter of doubt.
   
   
3. There is no provision in the proposal as set out in the White Paper for any financial advice or information to potential savers. This will give rise to an element of investment risk. Even the stakeholder pension makes provision for basic information to be made available. On page 22, paragraph 43 there is a reference to choice. The ability to exercise choice is clearly a good thing but many people will not fully appreciate the alternatives to be able to make value judgments on the level of risk to take with their investments. They would require strong guidance in order to make their choices – to suggest otherwise would risk misleading them.
   
   
4. The minimum contribution that each employer would be asked to make will doubtless be seen as a tax on employment. Small firms in particular will find this a financial burden: should the plan be taken forward, the Government needs to consider ways of helping them bear this burden. Early indications are that employers will seek to recoup the additional expenditure by freezing either recruitment or wage rises.
   
   
5. The Paper proposes that workers will begin to be enrolled into the new scheme at around the minimum wage level. There needs to be research carried out into the extent to which employees at the lower wage ranges are likely to exercise their right to opt out. If large numbers of low earners are enrolled into the scheme but soon after opt out, as we suspect is likely to be the case given the low level of contributions in question, then enrolling them in the first place will have been not only a waste of the employer’s time and contributions but a significant administrative burden for the scheme administration.
   
   
6. The plan would need to incorporate some workable protection for employees against being pressurised by employers to opt out.

We accept that the Government has considered and for the moment ruled out the option of establishing a simpler, two-tier system involving a strengthened basic state pension and additional private provision on a voluntary basis for those with the means to save for it. But in principle we believe that this would have several advantages over the system which is being proposed, as follows:

1. It would be in the interests of simplicity for the industry, for employers and savers alike.
   
   
2. It would help create long-term certainty for all concerned and would be easier to ‘market’ politically.
   
   
3. It would acknowledge that private pension saving by the low paid, whether or not supplemented by employer contributions, can not normally be expected to accrue a level of retirement pension which will exceed the level available to them via the existing Pensions Credit.

We still believe strongly in the potential of private pensions to improve the quality of life for those in retirement. We support the principle of encouraging people to save for private pensions where it is feasible for them to do so. The Government should provide tangible incentives for people to save through  private schemes, whether they be occupational, personal or stakeholder schemes. But we do not believe it is realistic or fair to expect all to have private pensions, especially if the availability of state benefits is likely to render life-long saving effectively futile for many people. We believe that a simplified two-tier system of this kind is still the most suitable basis for the long-term pensions consensus which the country needs.

Chapter 2: Strengthening existing provision

We consider that the practice of successive governments of constant tinkering with the regulatory framework of pension schemes has been a major factor in the decline of employer support for occupational schemes. In recent years, the law has changed so frequently, and the scale of regulatory requirements has risen so much, that employers and their advisers have had to spend considerable amounts of time keeping up to date and complying with new requirements. The frequent, piece-meal changes have also led to legal and regulatory rules becoming so complex that even experienced professional accountants find them difficult to understand. In some cases, rules are now simply technically incorrect.

We therefore support the thrust of the outline proposals in Chapter 2 to review the state of pensions legislation and to reduce the administrative burden on employers. We are not convinced though, in the light of our experience of the conduct of the Tax Law Re-Write Project, that a pensions equivalent would achieve better or more effective results. In the case of the tax project, any achievements that may have resulted from it tend to be cancelled out by the continuing practice of the Government to put forward Finance Bills which increase in size annually and which result directly in the ever-increasing complication of tax law. We consider that any initiative in the pensions field must avoid the mistakes committed with regard to tax law. There are a number of superfluous regulations currently in force which we consider could be repealed without undue delay and without detriment to any party.

With regard to the proposals on conversion of the GMP, the White Paper says  that the Government intends to bring forward legislation to enable this change ‘as soon as a suitable opportunity permits’. This appears to be a rather weak commitment. On the rolling programme of de-regulation, which is also outlined in the Paper, this offers an opportunity to identify aspects of regulation which can be pushed back. But we would advise that any new wave of changes should be co-ordinated rather than implemented in the piece-meal fashion which has caused employers so much difficulty in the past.   

In general though, we find it disappointing that there is little in the proposals in Chapter 2 to offer positive and tangible incentives to employers to run occupational schemes. The proposals regarding the new personal accounts could well encourage employers to forget about running occupational schemes altogether and invite their staff to join the new scheme instead. We consider that the occupational sector has over many years proved to be very successful in terms of providing scheme members with retirement incomes which enable them to live independently and which are sufficient to keep them off state benefits. We do not believe that there is anything for government to gain from allowing this sector to decline.

We also consider, in the context of the aim of developing a long-term consensus on pensions, that it would not be satisfactory for government to allow a situation to develop whereby generous defined benefit schemes were increasingly available only to those in the public sector while workers in the private sector were obliged to assume greater levels of risk via defined contribution schemes of one kind or another. Apart from the political problems that this situation could give rise to, we consider that there could be wider long-term economic consequences if the disparities in pension provision were to cause younger people to forsake careers in the wealth- and employment-generating private sector for the greater security of the public sector. We hope, therefore, that the Government will, in the months to come, agree that active encouragement of the occupational sector should be a key element of any long-term pension strategy. 

Chapter 3: Providing a foundation for private saving

We agree with the reasoning given for raising the state pension age and with the proposal to link the basic state pension with earnings. We would only query whether the rises in the state pension age need to take quite so long to come into effect.

We also support the commitment to restoring the link between the state pension and average earnings. 

Chapter 4: Extending working life in an ageing society

Measures to facilitate the continuing involvement in the workforce of older workers are a necessary corollary to the Government’s plans to raise the age at which individuals can draw their pensions. If workers are to have to wait longer to draw their state and private pensions, it is crucial that unreasonable obstacles to their continuing involvement in the workforce be removed.

This will require the Government to develop and implement a co-ordinated policy approach, which must involve not just legislation to outlaw age discrimination in employment but action on issues such as skills training and  immigration policy. It will undermine the whole of the White Paper’s plans if older people are unable, in future, to secure the employment that they will need because of continuing high levels of immigration of younger people who are prepared to accept employment at or even below the minimum wage level. Firm action on this particular issue is crucial if the Government is serious about meeting its targets of eliminating pensioner poverty and increasing the number of older workers by 1 million.

The new legislation coming into force in October on age discrimination in the workplace has a vital role to play and it is important that it succeeds. ACCA is a member of the Age Partnership Group which has been campaigning to promote employer awareness of the new regulations and of the business case for the adoption of age-diverse policies. The legal changes are, however, only one part of this agenda and there will continue to be a need to spell out to employers the implications for employment of the changing demographic landscape of the population. 

Government must take the lead in this. Given the statements made under paragraph 4.43 of the White Paper about how government departments are committed to improving working practices for older workers and using their influence to ensure non-discriminatory practice elsewhere, it was disappointing to see reported recently that health authorities and local councils are apparently forcing older workers to retire before the new 65-year default retirement age comes into effect in October. If such practices are considered to be acceptable in the public sector for reason of temporary financial pressures, then government must acknowledge that the private sector is even more vulnerable to such pressures. If it can not set the right example for how the private sector should embrace the employment of older workers, this will not help the Government achieve its aim of keeping such workers off state benefits.  

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