UK: Reassurance needed, not insurance
As longevity improves and fewer people are saving for pensions, Malcolm McLean argues for the industry to rebuild confidence
The pensions minister, Steve Webb, has said he would like to see a type of "money safe" insurance arrangement for DC pension schemes and intends to put out a consultation paper on the subject in the autumn.
As yet details are scant, but the idea seems to be that a member joining such a scheme would feel reassured that their pension pot on retirement would amount to at least the combined value of their contributions, any employer's contributions and the tax relief given.
It has been estimated that setting up an insurance contract to guarantee this would require annual premiums on the contributions of 0.75% or an equivalent amount levied on the fund. But it is not clear whether this would depend on the actual investment strategy chosen. Would there be a standard rate for a safer option, with a higher rate for a more risky one? Who would pay for it - the employer or the member - and would it be voluntary or compulsory?
We shall doubtless get the answers to these and other points in due course but before then I believe there to be some bigger questions about the underpinning policy as a whole that need to be addressed.
Fundamentally, what are we seeking to achieve here and has it any chance of succeeding?
My guess is that Mr Webb has one eye on the start of auto-enrolment in October and is concerned, as we all should be, at the possibility of millions of would-be contributors opting out, either immediately or after a short while, if and when they perceive their contributions to be stagnating or dropping in value. By offering them a guaranteed pension pot he would hope to allay fears and encourage them to stick with the scheme.
A laudable aim, no doubt, but I do not see an insurance plan of this nature as the answer or even part of the solution.
In the first place, I don't imagine that many people are going to be especially enthralled at contemplating the prospect of a pension plan that might only deliver a return of little more than the contributions made - and possibly having to pay for the privilege as well. Why would they want to bother - they might as well put their money in a bank or building society?
And, in reality, how many longer-term investors are going to end up with less than has been paid in even if the returns achieved over the period are not that great? Very few, I would imagine. Rather perversely, if they are having to shell out money from their pension savings to pay for insurance premiums, that in itself will reduce the value of their pot and could result in the exact opposite of what it is hoped to achieve.
The NEST approach to investing has much to commend it in that in the early few years the members' money is put into safe, if unspectacular, investments. This is intended to try to ensure that the fund maintains or increases its value so as not to put the new member off and precipitate their coming out of the scheme before, in the second ‘growth' phase, a more volatile, but potentially more rewarding, longer term investment strategy is adopted.
Of course, if an insurance plan were to be bigger and better then it might be perceived as more worthwhile. If members were to be given a specific guarantee of a pension as distinct from a pot of money, one worth half their average earnings say, then that would be different. But that is unlikely to be affordable under any insurance contract that I can envisage and would be better pursued under Steve Webb's other big idea, that of a defined ambition type of pension where risks are shared amongst employers and employees.
I have not spoken to anybody in the pension industry who is enthusiastic about the minister's insurance plan. That is not to say there is no cause for concern - there clearly is. Pensions are currently in the spotlight for all the wrong reasons - poor returns, high fees and charges and rapidly diminishing annuity rates, to mention just three of the areas attracting adverse comment. All this is undoubtedly affecting consumer confidence and trust in the system and the industry that supports it.
And yet we know from recent Office for National Statistics figures that longevity is increasing at a rate of knots, whilst fewer people are saving for their retirement and are sleepwalking into a financially uncertain old age. So there is a need to re-invigorate pension saving and obviously auto-enrolment has to be a major plank in the government's strategy. But will it work? At this stage we just don't know.
I can't help feeling that the key component in all of this is the attitude and approach of employers. They have without doubt a pivotal role in the delivery and ultimately the success or otherwise of auto-enrolment. If they could be persuaded to provide better-than-average workplace DC schemes or even something more approaching a guarantee on the defined ambition model then there would be no call for any half-baked insurance plans.
We have to accept that DB pensions are on their last legs in the private sector, and for many employers who have had a bad experience with this type of "guaranteed pension" in the past, anything with a guarantee in it for which they are responsible will be difficult to accept. That said, every effort needs to be made by both government and the industry to engage with employers and support all attempts to provide better quality pensions for their employees.
In so far as individuals are concerned, the message has to be that for those who can, saving for their old age is a must. The state pension on its own will never provide them with other than a basic standard of living and they have to take responsibility themselves for their financial well being in their later years. It is vitally important for the industry to show that it is worthy of their trust and that it is capable of delivering good pension schemes and products at reasonable cost.
In the future it seems that reassurance, not insurance, is needed if confidence in pensions is to be restored and the long term problems of an ageing society are to be adequately addressed.
Malcolm McLean is a consultant at Barnett Waddingham and former chief executive of the Pensions Advisory Service