The major review of UK pension provision on which the new Labour government embarked in 1997 is now coming to fruition. Its objective is to widen pension coverage overall and reverse the current proportions of retirement income from
60% state:40% private to 40% state:60% private. The current government sees a clear link between work and saving for retirement and, following its second election victory in June this year, announced the creation of a new Department for Work and Pensions (DWP) to replace the Department of Social Security and the Department for Education and Employment. The government’s policy affects the three ‘pillars’ of pension provision: state pensions, occupational pensions and individual arrangements, and all three areas are now undergoing major changes.
The legislation is in place for the introduction of the State Second Pension (S2P) in April 2002. Its prime purpose is to ensure that carers and the low paid – particularly those earning less than £10,500 (e17,000) a year – are able to build up a higher level of state pension than under the existing Earnings Related Pension Scheme (SERPS). However, the new arrangements will benefit all employees earning up to £24,000 and, as a result, the government has promised a ‘top-up’ pension to all employees with earnings up to this level whose employers have contracted them out of the state scheme, to ensure that they are no worse off.
A significant increase in state pension provision will clearly not achieve the government’s objective of reducing the percentage of overall retirement income provided by the state, unless accompanied by other initiatives. A key element of government policy, therefore, is to persuade those on average and higher earnings with no private retirement savings, to begin to make provision for themselves. The vehicle for achieving this is the stakeholder pension, available since April 2001 but mandatory for employers without other arrangements to provide for their employees (if more than four) from October 2001.
Stakeholder pensions are revolutionary in several ways. First, they must meet standards (CAT marks) set out in legislation for their costs – charges must not exceed 1% of the fund value each year; access – with few exceptions, they must be available to all; and their terms – they must be flexible, permitting individuals to vary contributions and transfer between providers without penalty. Second, they are available to those who have no earnings – a radical policy change in the UK. This means that pensions (with the associated tax reliefs) can be taken out, for example, for non-working spouses and children, with a maximum annual gross contribution of £3,600. Third, they are also available to existing members of occupational schemes if their earnings are less than £30,000. This concession was agreed after intensive lobbying by the NAPF and other pensions bodies, overturning the long-standing prohibition of concurrent membership of an occupational and individual pension arrangement.
It is too early to assess the success of stakeholder pensions in extending retirement provision to those on average earnings who have no other pension savings, although early anecdotal evidence shows that the target group may not yet be tempted. There is also a question about whether those who do start a stakeholder plan will be able to save enough to increase their income in retirement significantly above the minimum level set by the government. To address this concern, the government intends to introduce a ‘pension credit’ in 2003 that will ensure that those with moderate pensions or savings gain a positive advantage from their thrift. However, the absence of any requirement on employers to contribute to their employees’ stakeholder pensions does mean that, unless employers contribute voluntarily, the whole burden of providing for retirement will fall on the individual.
Occupational pension schemes
This brings us to employer sponsored pension arrangements. The UK is justifiably proud of its funded second-tier provision. Occupational pension schemes have contributed to a significant rise in the overall standard of living of retired people in the UK over recent years. The funds have also had a positive impact on the availability of capital and, consequently, on the UK economy as a whole. However, coverage has been declining slowly for a number of years, particularly in respect of defined benefit arrangements. The reasons for this decline are complex.
Minimum Funding Requirement
Perhaps the most significant of the new Pensions Act measures was the Minimum Funding Requirement (MFR) – an artificial and inflexible measurement of a scheme’s funding level compared with its projected liabilities. Responding to widespread criticism of the MFR, in 1999, the government announced a review, initially by the actuarial profession but subsequently extended to a more general review. The NAPF lobbied hard for the removal of the MFR and in March this year, it was announced that the requirement would be abolished. Employers and trustees are now awaiting publication of the government’s proposals for replacing the MFR with a “scheme-specific long-term funding plan”.
Review of institutional investment
At the request of the Treasury, the chairman of Gartmore, Paul Myners, carried out a major review of institutional investment between March 2000 and March 2001. This review addressed a wide range of issues about the way trustees carry out their investment responsibilities, and the Myners Report, published in March, proposed a set of principles that trustees should either follow or explain to members why they did not. The government is expected to publish the final principles very shortly and trustees will have two years either to amend their procedures and practises or disclose why they have not done so. The government has said that it will consider legislation if, at the end of the two-year period, there has been an inadequate response by trustees.