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Put retirement saving above politics

    The case for an independent Savings Commissioner

    John McTernan, former political secretary to Tony Blair, recently commented that, in the aftermath of the Budget, without consultation, the entire structure of the British pension settlement was torn up by the Chancellor… is the death of private pensions, it is the death of occupational pensions in the medium term and the death of pensions in their totality.[1]

    He may be right about the long-term outcome, but the cause is debatable, and certainly not unique.  Let us consider each of the three pension pillars.

    Private pensions

    The writing was on the wall for private pension products well before the recent Niagara of legislative activity.  Contributions are down 25% over the last six years (to £7.7 billion in 2012-13, a figure which includes basic rate tax relief), whereas subscriptions to stocks and shares ISAs are up 59% over the same period, to £16.5 billion (with no tax relief incentive).  Clearly, lack of ready access to pension savings is a huge deterrent, too high a price to pay for up-front tax relief.  In addition, private pensions are complex and expensive, and the industry is widely distrusted, which deters engaging with it (and partly explains our lack of a savings culture).

    Consequently, the word “pension” does not resonate with Generation Y, in particular.  Pension products’ inflexibility is at odds with how the under-35s are living their lives: they want to be in control.  The stark truth is that the pension product is from a bygone age, before college debt, rising labour market volatility (leading to fragmented careers) and unaffordable housing.  Indeed, Generation Y is so disengaged from private pensions that the industry’s next cohort of customers will be very thin.  It is reasonable to conclude that, in the long term, the private pensions business is finished. 

    Occupational pension schemes

    Occupational schemes are now, essentially, a defined benefit (DB) desert, the exception being the public sector, which will continue to enjoy certainty of income in retirement until death, largely paid for by private sector employees (who face total uncertainty in retirement).  The latter will have to be satisfied with pensions likely to be about one third of the public sector’s, notwithstanding the introduction of auto-enrolment into workplace schemes.  This will help rejuvenate workplace saving, but only at the margin; by the DWP’s own admission, the number of people facing inadequate retirement incomes may reduce by only one million, to 12 million.[2] 

    But this already bleak assessment is based upon today’s misleadingly low opt-out rates, which do not reflect “non-active” scheme members who opted out after making some initial contributions.  And this is at a time when the statutory minimum employee contribution is only 1% of qualifying earnings.  In 2017 this threshold will start to rise, ultimately to 4% (plus 3% from employers, and 1% in tax relief), more than likely coinciding with rising mortgage rates squeezing disposable incomes (and potentially after a decade of negative real earnings growth).  In addition, smaller employers have yet to start the enrolment process, and they are likely to experience higher opt-out rates than corporations with HR departments and in-house schemes.  

    What matters is the number of people who are actively paying into a pension (today, not enough), and the amount they contribute (for most people, woefully inadequate).  In addition, auto-enrolment does nothing for the fastest growing employment sector, the 4.5 million self-employed (15% of the workforce) who are without a benefits sponsor.  Furthermore, the pension minister’s aspirations for Collective DC (hybrid schemes residing somewhere between DB and DC) are unlikely to be met.  These rely on risk pooling amongst employees, totally at odds with the Budget’s annuities liberalisation that embraces freedom and liberty for the individual.  In conclusion, private sector employees, in particular, cannot rely on occupational pensions to meet their retirement income expectations. 

    The State Pension

    The Government Actuary’s Department (GAD) recently forecast that the National Insurance Fund (the Fund) will be exhausted by 2035-36.  While Fund exhaustion may be of little economic significance (it is an accounting curio rather than a real fund), it will be a symbolic event, indicating that the new State Pension is unsustainable.  In reality, fund exhaustion is quite likely to arise in 2016 due to persistent negative real earnings growth (down 11% since 2008), a bizarre coincidence given that the new single-tier State Pension is being introduced that year.  

    The prospect of Fund exhaustion should encourage the Treasury to pull some cost control levers, including the perennial favourite of sending the State Pension age further into retreat.  Currently destined to reach the age of 68, in 2046, 70 seems inevitable, and perhaps on an accelerated basis.  More immediately, the Treasury must surely be tempted to abandon the State Pension’s triple lock indexation[3]; GAD itself hints at the need to do this, reverting to a simple earnings up-rating by 2020.  

    Our ageing population, combined with Generation Y’s diminishing disposable incomes and the UK’s deteriorating public finances (the national debt increased by £108 billion last year), will continue to demand that the State Pension be progressively watered down.  Sooner or later will we have to debate a fundamental question: “in the long-term, is any meaningful State Pension financially viable?”

    So, who is at fault?

    John McTernan accused the Chancellor of being the cause of pensions’ forthcoming demise, but this allocation of blame is purely political, unreasonable and inaccurate.  The real culprits are primarily:

    • the inefficient pensions industry, which has failed to align its interests with its customers’, by cutting costs, embracing standardisation and adopting complete transparency;
    • the fund management industry, which has been unwilling to adapt to the realities of quantitative easing (notably persistent low interest rates), resulting in excessive costs (including remuneration) and (related) abysmal performance.  Across Europe, pension funds have delivered an average real return of minus 1.6% per annum over the past five years, excluding fees or taxes; and
    • those with fiduciary obligations who, for example, pointlessly pursue market-beating returns through active fund management, without questioning whether the additional costs (relative to passive investing) are justifiable.  In addition, many with governance responsibilities exhibit a staggering lack of curiosity about the cost of having lengthy chains of agents, as well as a reluctance to harness economies of scale (by merging schemes).

    This is not to exonerate the political fraternity.  Pensions have long been parked in the “too difficult” box: it is always easier to perpetrate intra-generational injustice by kicking the can down the road.  For decades, for example, improvements in longevity have been permitted to outpace the State Pension age.  In addition, no one has robustly challenged the wisdom of 2012-13’s spend of £54 billion on incentivising pension saving, when it is predominately used as a personal tax planning ruse by the wealthy.  It has certainly failed to catalyse the broad-based savings culture required to fuel investment, and thence economic growth. 

    In addition, the industry is drowning under a Niagara of hugely complex rules, and it is ultimately customers who pay for the industry’s regulatory burden.  The blunt instrument that is classical regulation is wholly unsuited to engendering trust between consumers and the industry and it has, to date, failed to control the industry’s excesses. 

    Finally, individuals must assume more responsibility for providing for their own retirement incomes.  The corollary of today’s excessive consumption is under-saving for tomorrow. 

    A way forward: an independent Savings Commissioner

    Retirement saving needs to be placed above politics, not least to confront some very difficult home truths, and facilitate some tough decision-making.  The DWP and the Treasury should co-sponsor an independent Savings Commissioner (supported by a small team) tasked with developing policy, free of the electoral cycle, to catalyse a broad-based, retirement saving culture.  Co-sponsorship is important; successive governments (irrespective of political hue) have exhibited pushmi-pullyu behaviour.  The DWP wants people to save, whereas the Treasury favours consumption (not least to bolster VAT receipts). 

    The Commissioner’s guiding principle should be to act in the long-term national interest, ideally with nothing deemed “out of scope”.  To be clear, the Commissioner would not be in a position to implement policy; the role would be to make recommendations to government, which, given the Commissioner’s independence, would be hard to ignore.  Ideally, in time, the Commissioner’s credibility would become akin to that of the Office for Budget Responsibility’s (OBR).

    With Generation Y very much in mind, the word “pension” should be de-emphasised; in this sense, John McTernan’s prediction for the future of pensions may be right.

    Michael can be contacted on [email protected]             Twitter:  @Johnson1Michael

    [1] Money Marketing, 18 September 2014.

    [2] DWP; Framework for the analysis of future pension incomes, September 2013.

    [3] The minimum of 2.5%, average earnings growth or CPI growth over the previous year.  

    Michael trained with JP Morgan in New York and, after 21 years in investment banking, joined Towers Watson, the actuarial consultants. Subsequently he was responsible for the running of David Cameron’s Economic Competitiveness Policy Group.

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    Ian Neale - About 2569 days ago

    My personal view largely accords with Michael's prognosis. Expenditure is spread throughout life, but income for the majority will fall quite dramatically upon ceasing to earn. Therefore some income in working years needs to be somehow sequestered so that it is available in later life. But individual savings alone can never be sufficient for all cases. The culture of individualism, apparently burgeoning, will have to be corrected by an acceptance that living in a human society involves responsibilities to each other. We need to develop not only a political consensus but a societal, inter-generational, consensus that instils the necessary confidence. To build that is the real challenge, especially at a time in history when respect for institutions is so low.

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    Anonymous - About 2567 days ago

    Thanks for this article. Nice to read an article on pensions that is so clear and easy to understand.

    PS - The links to the Microsoft Word documents are pointing to your C: drive and not to documents on the web site. (Bit of a security risk too as it gives away some info about usernames and systems used.)

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