Let’s get the issue in focus; defined ambition is not about giving people certainty about their pension savings, it is about being more ambitious about the outcomes they get for saving. For employers who are prepared to make a pension promise, we need to do redefine “promise” in terms of best endeavours rather than guarantees, for employers embarking on funding their staff’s pensions- no matter how low that funding- this is about making the money they put into member’s pots- work efficiently.
Right now employers who put money into their staff’s DC pots cannot be sure the money will efficiently purchase a pension. We need to change that if auto-enrolment is to sustain its initial promise.
Similarly employees need to feel that giving up earnings today for a pension in the future- is worth it. If they don’t they won’t pay the much needed voluntary contribution- they may opt-out. We need to get more ambitious!
The “lock-down” of DB is a failure of ambition. It converts mutual endeavour to the logic of the accounting room. The lock-down of DC is just as bad – it converts equities to gilts too early in the lifecycle and requires guarantees for which annuitants pay too much for the value they give. Finally the annuity purchase mechanism is so clumsy that it has become a national joke (if the loss of pension involved can be thought of as funny).
We do not have to start again. We have 95% of the apparatus to make our pensions work, we just need the Government to encourage the last 5%. To demonstrate what I mean, let me give three case studies, one a large employer sponsored proprietary DC scheme-(Lloyds Bank’s for instance). Secondly a large master trust with target dated funds (NEST for instance) and thirdly a common or garden GPP (Leg’s workplace savings plan for instance).
|
Case Study one – large single employer occupational pension scheme. Current The employer wants pension contributions to buy more pension without taking on extra risk; the trustees currently invest in a lifestyled default and members buy annuities at retirement with some help from a broker. Future The trustees engage agree that from the point a member wants to draw down an income they will absorb the member’s fund into a common investment fund and pay a scheme pension to the member at a pre-agreed rate. At the employees 90th birthday, the trustees will purchase an annuity for the member based on investment returns and the prevailing annuity rates What’s good about this? It’s efficient as the employer already has a pensioner payroll and an investment apparatus (for DB assets). This has minimal extra risk for the employer. It provides considerably more pension upfront as the conversion factors of cash to pensions are based on scheme pension rates (laid down by GAD) which are approximately 35% better than individual annuity conversion factors (laid down by GAD) The annuity conversion at 90 only impacts those surviving. Studies by David Hutchings and others suggest that annuitisation at this lifepoint is currently efficient. The scheme can of course change the annuitisation point or dispense with it altogether. The point is that the agreement is based on trust between employer and trustee and member based on “best endeavours”. What’s bad about this? It will not provide the absolute certainty of individual lock-down. It is far too simple for the lawyers, it cuts out several layers of intermediation and it relies on trust between the employer, trustees and members. |
|
Case Study two – GPP. Current Most GPPs invest in equity funds which phase into gilt and cash funds on a glide path to the annuitisation date (lifestyle). At the appointed date- set by the employer, the money is converted to a pension using an annuity or individual drawdown. Future The default position switches from annuity purchase to a transfer to a collective drawdown fund (an example being Alliance Bernstein’s Retirement Bridge product. This works in the same way as the occupational scheme and income is set at the GAD scheme pension rate rather than the individual annuity conversion rate. What’s bad about this? As with case study one, it relies on a degree of trust between members and NEST based on the NEST investment team making their best endeavours. Clearly there may be additional perceived risk since there is less employer involvement but in reality there is no employer obligation to bail out its pensioners either way |
|
Case Study three – Mastertrusts (NEST) Current NEST accumulates member pots in target date funds. These funds mature at a given date in the future (2030 for instance) and it’s planned that at this date- selected by default at a member’s most likely retirement age, the member buys an annuity or individual drawdown plan. Future The target date is the point at which the fund switches from accumulation to decumulation and starts paying a pension. Again the pension is paid at GAD scheme pension rates. Again there is a target date for annuitisation at which point the fund is wound up, for the sake of consistency , let’s say this is the 90th birthday of the fund members. What’s good about this? Members get 35% more pension and there is minimal disruption (no switching of funds at the pivot point between accumulation and decumulation (one of the structural advantages of target date funds). What’s bad about this? As with case study one, it relies on a degree of trust between members and NEST based on the NEST investment team making their best endeavours. Clearly there may be additional perceived risk since there is less employer involvement but in reality there is no employer obligation to bail out its pensioners either way |
If we are to leave pensions to the lawyers and the accountants, we will not have ambitious pensions. Instead we will continue to have the current lock down.
The great British public has got to decide if they want to have the current system- which provides certain outcomes but little prospect of value, or a more ambitious system that exchanges absolute certainty for the prospect of considerably more value.
We argue that if you are going to have gilt based pensions, pay more taxes and get your pensions from the state. If you are going to have private pensions, trust the private sector and don’t shackle pensions as they are being shackled by the current system of lock-down.
We need choice, giving people the choice between efficient gilt-based (the basic state pension) and inefficient gilt-based (individual annuitisation) is no choice at all.
The proposals in this blog are not costed and need a lot of work on them, if that work is carried out by those who have no ambtions, my proposals will end up with all the other proposals, in the DWP’s waste paper bin. But if the DWP and in particular Steve Webb, are prepared to be ambitious, I think they will find my proposals refreshingly workable!
