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NEST- the irrefutable case for “Scheme Pensions”.

henry tapper

NEST is due to launch in April 2011 and it’s high time that we got some answers on a key question

just how are NEST pensions going to be paid?

There are two options available to the Trustees.

  1. People can be given the option to buy an open market annuity or – if they have the means – drawdown from their accumulated funds – of which their NEST account may form a part
  2. People can be paid an income from their accumulated NEST account – “A Scheme Pension”

This is what the Pension Regulator has to say about Scheme Pensions.

A pension is paid by the trustees direct from the scheme. An actuary calculates how much pension could be provided directly from the scheme using the member’s money purchase fund and a scheme annuity rate chosen by the trustees.

There is a risk that the member (or dependant) outlives the scheme retirement savings, ie the pension has to be paid for longer than the trustees anticipated when the annuity rate was determined.

Spot on! Few trustees of DC occupational pension schemes are going to offer Scheme Pensions – there is too much risk – insufficient accumulated capital and no apparatus to do so.

NEST, which will be an occupational scheme will be different. NEST will be accumulating pensions for upwards of 5 million people. The vast majority of money will accumulate in target dated funds which will mature at set dates. A conservative estimate suggests that the target dated funds will mature with over £250,000,000 from 2020 onwards. Once the scheme has reached maturity, the target dated funds will be worth upwards of £1,000,000,000. Each year, hundreds of thousand of us will be drawing pensions from NEST.

NEST is likely to be so different in terms of its economics from the typical occupational DC scheme of today that Scheme Pensions are not only an attractive option THEY ARE THE ONLY OPTION.

Firstly, there is no way that a conventional annuity option will work

  1. There is not market capacity to support conventional “insured annuities” from NEST
  2. There is no infrastructure necessary to support a viable annuity broking service to support an open market option
  3. There is insufficient financial awareness among the UK public for the Open Market Option  to operate and there is no default annuity option
  4. Conventional annuities give poor value  to those with small pots.
  5. There seems to be no appetite from Government to underwrite a default annuity option (though the apparatus for doing so is there).

On a more positive note, there is every reason for NEST to pay pensions from these target date funds.

  1. NEST is a nationwide scheme that is ultimately underwritten by the UK taxpayer. It is capable of taking risk because it has recourse to the covenant of the UK taxpayer, past , present and future.
  2. NEST, as mentioned above, has sufficient funds arising each year to afford , apply and manage the complex risk management techniques successfully used by large DB plans.
  3. The time horizons of the payments (cash flows) from the accumulated DC target date funds are long – we currently assume that a substantial proportion of those of us living to 65 will live to 100. Annuitising (either individually or on a bulk basis involves an inappropriate investment strategy for such a timeframe).
  4. The logistical issues surrounding paying pensions from the fund are within the scope of NEST’s administrators, especially if they were to work with the UK Government’s existing pension payment agency (who pay our state pensions).

With less than six months till the launch of NEST, I find the reticence of the NEST Corporation to make any statement on how NEST pensions will be paid, to be at least, surprising.

Since the payment  of Scheme Pensions would require the target dated funds to remain invested in NEST for many decades, Scheme Pensions would form as important a part of NEST’s function as the pre-retirement phase of its operation.

That we have spent no time discussing the deaccumulation of NEST funds is a scandal. It is time for this subject to be put on the public agenda – if it is not, then NEST should be branded a half-baked project.

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