UK: Shifting the balance of provision
Occupational pension provision in the UK has been a substantial success, says the NAPF, but the problems associated with the ‘under-pensioned’ still need to be addressed
Two aspects of the UK pensions system are particularly surprising to the overseas viewer. First, the state system is extremely meagre by European standards. The basic single person’s state pension entitlement for an individual, with more than 40 years of national insurance contributions, amounts to little more than £5,000. Secondly, notwithstanding minimal state provision, private provision is voluntary. Employers are under no obligation to offer pension plans to their employees and workpeople are not obliged to join such schemes even when they are on offer.
That part of the working population that has access to occupational pension schemes is on course for a reasonably secure retirement. Prospects for the other 50% are much bleaker. The present government is seeking ways of extending pension coverage to the under-pensioned without doing collateral damage to that part of the system that is working well. At the same time, the government wants to shift the balance of pension provision even further into the private domain. At present, approximately 60% of pensioners’ income emanate from public funds and 40% from the private sector. The government wants to reverse these proportions.
For the last 30 years, the most prevalent form of occupational provision has been of a defined benefit (DB) nature. Recently, there has been a resurgence of interest in defined contribution (DC). Going forward, it looks as though there will be a mix of the two approaches. Sometimes both approaches will be found within a single employment.
Reasons for the resurgence of interest in DC provision are twofold. Some employers think that this form of provision is more appropriate for their employees. More worryingly, the regulatory burden borne by DB schemes is more onerous than that applied to DC counterparts. Notwithstanding the voluntary nature of UK private pension, the regulatory framework has a major impact on that which is on offer. The Department of Social Security lay down minimum standards, while the tax authorities influence scheme design by imposing limits on the amount of pension provision that can be made on a tax assisted basis.
While acknowledging that occupational pension provision is a great 20th Century success, the government feels that there is a limit now for such provision to be extended. The government’s chosen tool for pushing back the boundaries of pension coverage is the Stakeholder pension plan. It is hoped that these schemes will benefit from the eco-nomies of scale in that they will cover large numbers of employers and their workforce through a centralised group of providers. The government will also limit the charges that can be associated with these schemes.
Cheapness is often viewed as being synonymous with excellence. The hope of the NAPF is that employees will be able to take advantage simultaneously of occupational and Stakeholder plans. Ironically, concurrent membership of more than one type of pension plan is currently outlawed. This is due largely to the view of the tax authorities that such dual membership would carry unfair tax advantages. Most non-state pension provision in the UK is funded in advance. The tax system has encouraged this pre-funding and the desire to separate long-term pension assets from shorter-term assets of both employer and employee has been a cherished form of financial security. Coincidentally, the accumulation of assets within pension funds has contributed to the well-developed capital markets that are the hallmark of the UK financial system.
UK pension funds currently hold in excess of £1.2trn. Although all of this money has been hypothecated for pension financing, politicians, from time to time, suggest that a proportion of these assets might be channelled in the direction of ‘worthy causes’. In the past, major public projects have been earmarked by politicians as potential homes for pension fund assets. Currently, the UK government is encouraging pension scheme trustees to think about the extent to which they may be pursuing policies that are socially responsible, ethical or environmentally sensitive. The Prime Minister, no less, has recently issued a clarion call to pension funds urging them to use more of their assets to back venture capital or other forms of private equity.
In the past, only a minority of pension scheme trustees has made full use of the voting rights that are attached to their UK equity holdings. Even though voting in the UK is relatively easy by European standards, the proportion of votes cast lags far behind the levels achieved in the US. The NAPF is taking a number of initiatives aimed at encouraging trustees to adopt structured voting policies.
Trustees are increasingly adopting a structured approach to the investment of their assets. First of all, there is a much closer intellectual link between a scheme's liability profile and the asset strategy adopted for its investments. Even where trustees do not slavishly pursue a liability-driven investment strategy, few would decide on asset allocation without first checking the scheme’s liability profile.
In addition to paying increased attention to asset allocation, trustees are regularly weighing the relative merits of active and passive management, of balanced and specialist mandates, and the optimal number of managers for a particular value of assets. Given that most trustees are lay people with full-time jobs to undertake, there is a limit to the number of managers and complexity of structures with which they can cope.
The Pensions Act, 1995, provided further statutory backing for the application of trust law principles to UK pension planning. One of the most beneficial aspects of this legislation was an obligation on trustees to produce a statement of investment principles. Those trustees who accepted this challenge in a positive fashion now chronicle their attitude to a whole range of investment issues surrounding that all-important balance between security and affordability. Crafting a statement of investment principles helps establish the continuum between actuarial valuation, asset allocation and investment manager agreement.
The trust is at the heart of scheme governance. Accepted wisdom suggests that a broadly based trustee board made up of lay people is an ideal form of governance for a traditional employer-sponsored pension plan. Increasingly, questions are being asked about the ability of lay people to monitor complex investment structures or their willingness to accept responsibility for the investment arrangements of money purchase schemes. Some trustees feel they might be sued if they offer too narrow a range of investment choices while others fear the same fate if a wide range of options is offered to a clientele which is not financially literate. Looking forward, it will be interesting to see whether the trust concept which has performed so well in the context of DB schemes is equally appropriate in an era where individual choice will be ascribed a higher priority than collective security.
National Association of Pension Funds
Contact: Sheila Longley
Chairman: Alan Pickering
Director General: Ann Robinson
Address: 12-18 Grosvenor Gardens, London SW1 0DH
Telephone: 0171 730 0585
Facsimile: 0171 730 2595
Date formed: 1923
Number of members: 1,450
Population aged between 16 and retirement age of 59/64 latest figures 1995: 57.9%
Population over retirement age of 60/65: 16.9%
Funded retirement assets: £800bn
The NAPF is the most broadly representative pensions organisation in the UK. Now in its 77th year, the association has more than 1,500 members of whom 1,000 are plan sponsors or trustees with the remainder being professional service providers – actuaries, accountants, lawyers, fund managers etc.
The NAPF has a governing council of 25 pension practitioners who work in tandem with a professional secretariat of 25. There is also a network of 16 local groups who bring members together for networking on a regional basis.
The NAPF has a twofold relationship with its members. Firstly, it provides a range of membership services covering both the asset and liability side of the pension equation. Secondly, the NAPF is the voice of its members. Its over-riding aim is to create an environment in which employer-sponsored pension provision can flourish.
It is in regular dialogue with governments and non-governmental organisations at home and overseas. At home, representation is quite difficult since no fewer than three government departments have an active interest in either the asset or liability side of the equations or, in some instances, both. Abroad, the NAPF is increasingly using the EFRP as a conduit for its views.