Written evidence from the Association of British Insurers (PAE

Summary)

• The ABI welcomes the opportunity to contribute to the Work and Pensions Select Committee’s inquiry into automatic enrolment implementation. The ABI remains committed to automatic enrolment as the best means of ensuring people save adequately for retirement.

• The rollout of automatic enrolment has seen a significant increase in the number of individuals saving for their retirements through workplace pensions. The ABI commends the efforts of the Department of Work and Pensions (DWP) and the Pensions Regulator (TPR) in supporting large and medium sized employers through the staging process.

• However, it is generally accepted that the automatic enrolment contribution of 8% of qualifying earnings will not be sufficient for many savers, with Pensions Policy Institute research identifying the need for a minimum contribution of 11-14% of band earnings. The Government should include the feasibility of increasing contribution rates across the board, or mandating automatic escalation, within the scope of the 2017 automatic enrolment review.

• In addition, a number of critical and growing demographics are not benefitting from automatic enrolment under the current eligibility criteria. The Government should also include possible mechanisms to extend the coverage of automatic enrolment to multiple job holders within the scope of the 2017 review.

• Reframing pensions tax relief as a ‘Savers’ Bonus’ and introducing a flat rate of pensions tax relief would also simplify the incentives for self-employed individuals to save and enhance communication of the benefits of pension savings to employees.

• It is essential that any changes to pensions tax relief builds on the success of automatic enrolment, and continues to minimise the number of individuals opting out, as well as encourage contributions above the statutory minimum. Automatic enrolment has been designed to work within, and therefore complement, the current marginal rate relief system. Conversely, a tax-exempt-exempt system (as the Chancellor of the Exchequer is considering) risks undermining employer support for automatic enrolment, and therefore the success of the programme as a whole.

• Relying on inertia will not be sufficient to ensure people save adequately and make informed choices at retirement. Government and industry should harness the opportunity presented by the current public interest in pensions resulting from the introduction of the New State Pension and Freedom and Choice reforms to improve engagement with retirement saving under automatic enrolment. This would be aided by promoting the services of an extended Pension Wise and coordinating efforts to increase engagement through the creation of a ‘pensions dashboard’. In addition, the FCA should investigate options to encourage employers to signpost employees towards suitable advice in its response to the Financial Advice Markets Review.

• Immediate action to improve the regulatory framework for trust-based schemes used for automatic enrolment is required to ensure ongoing public confidence in automatic enrolment. This should include making the Master Trust Assurance Framework (or a similar framework) mandatory for non-FCA regulated master trust providers, and making TPR and FCA jointly responsible for regulating master trust schemes used for automatic enrolment, with the FCA becoming responsible for competition and market integrity, and TPR retaining responsibility for the protection of members’ benefits. In the longer term, the Government should consider the creation of a single regulator for all pension schemes.

For many, defined contribution pensions schemes will be the primary source of retirement income

1. The value of the state pension in the UK is low relative to most other OECD countries, with average earners solely reliant on the state pension receiving the third lowest replacement rate within the OECD.[1]

2. The provision of defined benefit (DB) occupational pension schemes peaked in 1967, with around 8 million active members. It has since declined to 1.4 million active members, and over 85% of DB schemes are closed to new members.[2]

3. Schemes used for automatic enrolment (the vast majority of which are defined contribution (DC) schemes) will be the main vehicle through which people support themselves through retirement in the future. It is therefore essential that the coverage, contributions and regulatory settings for these schemes encourage long-term savings and provide adequate protection for members.

So far, automatic enrolment has successfully increased the number of individuals saving

4. The introduction of automatic enrolment has successfully increased the number of individuals saving for their retirements through a workplace pension scheme. DWP analysis now estimates that 9 million workers will be newly saving or saving more as a result of automatic enrolment by 2018. This is in part due to a much lower opt-out rate of those who have already enrolled than anticipated, with the actual opt-out rate of employees who have staged estimated to be between 8% and 14%, compared to original policy estimates of 28%.

5. Employer compliance has also been higher than expected, with 99% of the employers required to declare their compliance with automatic enrolment duties by 1 September 2015 having done so.

6. Pensions providers are committed to promoting member outcomes, and have worked constructively with government to improve the quality of schemes used for automatic enrolment, by initiating the creation of Independent Governance Committees to improve oversight of contract-based schemes and supporting proposals to cease new and historical commission payments.

However, the current level of contributions under automatic enrolment are insufficient to provide a comfortable retirement

7. Despite the success of automatic enrolment in increasing the number of individuals saving for their retirements, a crucial longer-term challenge remains to ensure that individuals’ contribution rates are sufficiently high to achieve an adequate level of retirement income.

8. The minimum level of contributions that employers and employees must jointly make into a pension scheme under automatic enrolment is being increased over time, and will reach 8% of band earnings (of £5,824 to £42,385 in 2015/16) by April 2019, including a 3% minimum contribution from employers.

9. Currently, the average employer contribution into a DC pension scheme within the UK is 2.9% of salary, with the average employee contribution of 1.8%.[3] The average total contribution of 4.7% is significantly lower than the average combined contribution rates of 10-14% in the USA, 12.4% in Australia and 11.1% in Ireland.[4] It is also significantly lower than the average total contribution rate for UK DB schemes of 20.9% of pensionable earnings, comprised of 5.2% for members and 15.8% for employers.[5]

10. Recent research undertaken by the Pensions Policy Institute (PPI) highlights that 8% will not be enough for most people to reach their target replacement income (of 67% or working life income for a median earner).  This research highlights that a median earner would have less than a 50% chance of maintaining the same standard of living in retirement that they enjoyed while working, and would need to contribute 11% - 14% of band earnings to have a two-thirds chance of having an adequate income under the same assumptions.[6] The required contribution rates are even higher for those on higher incomes, for whom the new state pension will constitute a lower proportion of their retirement income.

11. Further modelling commissioned by Columbia Threadneedle and undertaken by the PPI uses projections of the growth in the median DC pension pot size, based on the number of individuals currently contributing to a pension fund with their employer, to estimate the adequacy of savers retirement incomes. This modelling projects that the median DC pension pot could grow to around £56,000 (in 2015 earnings terms) for those nearing retirement age in 20 years’ time, and converts this into a retirement income (alongside full eligibility for the new state pension). Should this ‘median’ pot be withdrawn in lump sums, it would generate an adequate income for only six years following retirement (assuming a replacement rate of 67% of working life income). Alternatively, if this pot were to be converted to an annuity (given 2015 annuity rates), this would result in an income shortfall of at least £7,000 per annum.[7]

12. These studies’ findings assume consistent contributions from age 22 to state retirement age, which is improbable due to common interruptions such as career breaks, unanticipated unemployment, periods of self-employment or prioritisation of other financial goals (such as paying down student debt or saving for a deposit on a first home). The state pension triple lock is also assumed, which may not be retained over the long term.

13. Whilst both employers and employees are able to contribute more than the mandatory minimum contribution to automatic enrolment schemes, a key concern is the widespread perception from passive savers that the minimum contribution rate is the ‘right’ amount, or has been endorsed by government as a suitable target. This ‘anchoring’ behaviour, where savers in automatic enrolment who would otherwise have chosen a higher rate of contribution, instead chose a lower default rate, has been observed in academic studies undertaken on 401k schemes within the United States.[8]

14. One option to ensure adequate retirement income is to increase minimum employer and employee contribution rates gradually over time. A recent survey undertaken by the Association of Consulting Actuaries found that over four out of ten employers were prepared to see minimum contributions rise in 2020 to 4% from employers and 5% from employees, or higher.[9] In addition, focus group research undertaken by Standard Life in 2011 suggested that 70% of people would not find it difficult to save an additional £50 per month if they had to, with 48% admitting it would be easy.[10] Such an increase would be equivalent to a 3% increase in pension contributions from someone on an income of £20,000.

15. Another effective option could be to introduce automatic escalation of contribution rates through legislation. This approach, promoted by behavioural economists Shlomo Benartzi and Richard Thaler, enables savers to prospectively commit to increasing their contribution levels in the event of future pay rises. This diminishes the effect of ‘loss-aversion,’ or the tendency for individuals to weigh losses more than gains, which might result in savers otherwise choosing to ‘opt-out’ in order to avoid reductions in their take-home pay. Like automatic enrolment, this could be done on an ‘opt-out’ basis to ensure financially engaged individuals retain the flexibility to prioritise other possible financial pressures.

16. The Government should consider a possible increase in contribution rates or possible mechanisms to facilitate automatic escalation within the scope of its 2017 review of automatic enrolment. There is a risk that these approaches would be seen as another unwelcome cost to employers, many of whom are financing deficits in legacy DB schemes and/or are currently facing wage pressures due to the phasing in of the living wage. There is also a risk that these approaches could increase the opt-out rate amongst employees, should they begin to feel the reduction in their take-home pay. Any recommended changes could be implemented post April 2020, and be contingent on the level of opt-out following completion of the rollout of automatic enrolment to micro-employers and the staged increases in minimum contribution rates, to mitigate these risks to support for automatic enrolment.

Additionally, a number of critical and growing demographics are missing out under the current eligibility settings

17. Individuals have to be aged between 22 and the state retirement age, and earning over £10,000 per year (in 2015/16) from a single employer, to be an eligible jobholder under the current automatic enrolment settings. The ABI supports the existing earning threshold, as those earning less than £10,000 will be able to maintain a similar standard of living post retirement from the new State Pension.

18. At present, 70,000 multiple job-holders who are earning more than £10,000 per annum are not being automatically enrolled because their earnings from an individual employer do not meet the earnings threshold. An additional 250,000 are only being automatically enrolled from one of their jobs, meaning they are missing out on contributions from their employer and tax relief from their second jobs, and will likely be undersaving for their retirements.[11] The Government should explore options within the 2017 review of automatic enrolment for HMRC to prompt employers to automatically enrol part-time employees, should the employees combined earnings from the previous tax year from more than one employer exceed the automatic enrolment threshold.

19. A critical demographic currently excluded from the benefits of automatic enrolment are the self-employed. Research undertaken by Prudential in 2015 highlighted that the number of self-employed workers making personal pension contributions is at its lowest since 2001, despite the number of self-employed individuals within the UK (at 4.6m) being at record highs.[12] This research highlights that fewer than one in 10 (9 per cent) self-employed people paid into a personal pension in the 2012/13 tax year.

20. Whilst self-employed individuals are ineligible for employee contributions, they are still eligible for tax relief. However, the current system of tax relief is overly complex and is not widely understood by savers. The ABI recommends that the Government should introduce a new, upfront ‘Savers’ Bonus’ based on a single rate of tax relief in its response to the consultation on Pensions Tax Relief at Budget 2016. This system, where payments made into personal pensions would be topped up at a rate of £1 for every £2 or £3 put in (depending on where the rate of relief is set), would target help more fairly between low and high earners (both self-employed and employed) and would increase the number of self-employed saving into a pension by clarifying the incentive to save.

It is essential that any changes to pensions tax relief builds on the success of automatic enrolment

21. The ABI believes that it is essential that any changes to the pensions tax relief system does not undermine the widespread support for automatic enrolment. An effective pensions tax system will continue to minimise the number of individuals opting out and encourage employer contributions over and above the statutory minimum.

22. In addition to clarifying the incentives to savers, a great strength of the current marginal rate tax relief system is that automatic enrolment has been designed to work within, and therefore complement, it. Conversely, the option of shifting to a ‘tax-exempt-exempt’ system would likely undermine the level of pension contributions.

23. Survey evidence commissioned by Aviva[13] shows that in a ‘tax-exempt-exempt’ system employers would expect their staff to value employer contributions less, and also expect staff to save less. This suggests that many employers would reconsider how much they contribute to employee pensions should we shift to this system. As employees are guided and incentivised by the size of the employer contribution into DC schemes (schemes in which the employer contribution more than matches the employee contribution typically results in a much greater than average combined contribution) this could have the effect of undermining the level of contributions to schemes (above the statutory minimum) under automatic enrolment.

24. The same survey also showed that without applying tax at the saver’s highest marginal rate at the point of withdrawal (as occurs under the current ‘exempt-exempt-tax’ system), employers would be concerned that employees would be increasingly likely to spend a large part of their fund prematurely and be unable to afford to retire. By reducing the value of pensions as a tool for employers to manage an ageing workforce, pension contributions would become less appealing to employers also.

The government and industry need to continue to work together to improve engagement of savers alongside automatic enrolment, in order to ensure continued participation and informed decisions at the point of retirement

25. A difference in approach exists between automatic enrolment, which harnesses the public’s passive approach to retirement planning to facilitate saving and investing, and the freedom and choice reforms, which empower individuals to take a proactive approach to retirement planning at and in retirement. Government and industry should continue work together to scale-up the level of engagement with saving and retirement planning and financial capability of individuals during the course of their working lives to ensure that automatic enrolment generates good retirement outcomes for members.

26. Industry is currently working to develop a pensions dashboard to helping people who have been automatically enrolled to better understand their entitlements and the appropriate contribution rate for their circumstances. We would urge the Government to continue to offer its backing, to help bring all relevant parties together and ensure compatibility with the DWP’s online state pension projection tool.

27. Taking a more integrated approach to the provision of guidance for pensions and retirement income will also be a critical step towards increasing the engagement of savers. This could be achieved, for example, by seeking closer integration of Pension Wise and the Pensions Advisory Service (TPAS), with TPAS acting as the first point of contact, at age 50, for a telephone based conversation about pre-retirement finances. TPAS is the logical first port of call as it can deal with queries from all consumers with a pension, regardless of whether they have DC, DB or State Pension entitlements. TPAS would then be able to triage consumers to Pension Wise, or other services as appropriate, including an independent financial adviser.

28. The ABI is keen to work with the Government and public financial guidance providers to test how this could work in practice, and ensure that government and broader statutory signposting to guidance services are widened and coordinated. The FCA should also explore whether employers (whom many employees implicitly trust to act in their best interests) can play a more active role in improving engagement with workplace pensions through signposting employees at age 50 toward accessing guidance as part of its response to the Financial Advice Market Review.

In addition, the Government should take immediate action to ensure that all schemes used for automatic enrolment provide excellent outcomes for members

29. Trust-based pension schemes (including master trusts) are regulated by the Pensions Regulator (TPR), and are not currently subject to the same stringent regulatory standards as contract-based schemes, which are regulated by the FCA. For example:

• there are limited barriers to entry for trust-based schemes, compared to the rigorous standards and capital and solvency requirements set by the FCA for contract-based pension providers.
• the FCA has the ability to issue rules to support its regulatory functions, whereas TPR is often forced to rely on non-binding guidance. This leads to practical differences in the regulation of trust-based and contract-based schemes, including lower standards for the specificity of risk warnings and the provision of communications to members for trust-based schemes.

30. A number of trust-based providers (including master trusts) will be unable to achieve scale. In the absence of strong regulation, these smaller schemes are more likely to result in poor outcomes for members, including:

• substandard investment returns from substandard governance and investment strategies, and
• costs associated with the dissolution of the trust, and transfer of scheme assets to an alternative provider.

31. Additionally, trust-based schemes are not subject to the high level of ongoing regulatory scrutiny and active monitoring given to contract-based schemes.

32. TPR also has a narrower focus than the FCA, and does not have a competition or market integrity remit, limiting its ability to respond to issues such as pension scams across occupational pension schemes, and potential conflicts of interests in master trusts that are run by advisory firms.

33. A single regulator could be best placed to remedy these inconsistencies and identify emerging issues across the long-term savings sector. It would also be able to coordinate industry-wide initiatives to improve customer engagement and customer service discussed above, and reducing the timescales for pensions transfers.

34. The ABI acknowledges that TPR and DWP are currently focused on the delivery of automatic enrolment, and creating a single regulator, alongside potential changes to pensions tax relief, would create capacity issues and jeopardise the success of these programmes. The ABI also recognises that TPR are taking immediate steps to improve the governance of DC trust-based schemes through the revised DC code.

35. However, deferring stronger action until after automatic enrolment staging has been completed will simply increase the risks and costs of scheme failures. In the short-term, the Government should take the following further steps to protect members of master trust schemes:

• Compliance with the Master Trust Assurance Framework (or a similar framework) should be made mandatory for non-FCA regulated master trust providers.
• The regulation of master trusts used as qualifying schemes for automatic enrolment should be joint, with the FCA becoming responsible for competition and market integrity, and TPR retaining responsibility for the protection of members’ benefits.

The ABI

The Association of British Insurers is the leading trade association for insurers and providers of long term savings. Our 250 members include most household names and specialist providers who contribute £12bn in taxes and manage investments of £1.8 trillion.

February 2016