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11 February 2015
Good morning. Thank you for inviting me to say a few words about pensions and the rapidly changing landscape of retirement saving.
The last ten years have seen an almost unprecedented set of reforms in pension policy. These changes have been necessary in order to respond to the equally unprecedented changes in demographics which will change forever the face of Britain over the next twenty years or so. The inescapable truth is that we are getting older. We should celebrate this fact. It is a tribute to decades of achievement in our health, welfare and economic policies. But with these great changes comes great consequences and there is a great deal to prepare for.
In my view, these changes in the nature of our society pose public policy challenges of first order importance. The good news is that this challenge is being recognised and responded to. Successive Governments have devoted considerable effort and energy in trying to get ahead of the curve. This has helped initiate a major public debate about how we as individuals can best prepare ourselves for retirement, and in the process, help keep our society and our economy strong and fair. So I very much welcome this initiative today. The more voices that are heard in this debate the better.
And this debate has taken on one very important characteristic in recent years. This has been a very important development which underpins the entire framework that has been put in place in recent years.
In previous decades, perhaps the starting point in any debate like this would have been the question “what is the welfare state going to do about it?” Now the right question to ask is “what can I do to make myself financially secure in retirement?”
It has been clear since the final report of the Turner commission in 2005 that the principal burden of responsibility for ensuring we retire on an adequate pension must now move from the State to the individual. We should make this transition because we ought not to burden future generations of taxpayers with the enormous liabilities which might otherwise be generated. So, this is our way – the best way – of helping our children and grand children prosper and thrive in the future. Keeping taxes and public borrowing as low as possible. Giving our economy the best chance to succeed and grow.
The changes to the state pension system reflect this new fundamental paradigm of pension policy.
The role of new single tier flat rated state pension is the alleviation of poverty – it is not to provide the principal source of retirement income. If we want to secure financial sufficiency in old age then we will have to save enough throughout our lifetime of work which can then secure an adequate flow of income covering all of the growing number of years we will now spend in retirement.
We have to become a nation of savers. People save for all sorts of reasons – usually it is to purchase a big item like a house or a car. I am talking about something different. I am talking about retirement saving. Something for the longer term. Something uniquely able to provide financial security for the time we give up all forms of paid employment. To do this we will have to bring about a fundamental change to the way we think about our long term financial self sufficiency. This is a huge challenge and won’t happen overnight.
So, building on the reforms to the state pension, it is clear that auto enrolment is the key to the long term success of our new pension policy framework. Its architecture builds on the simple foundation of establishing the path of least resistance – the default option that does everything for you. It gets you into a pension scheme and then manages your savings for you. You don’t have to do anything yourself. Brilliant!
And so far so good. Nearly 5 million new pension accounts have been opened since 2012. Things have started well. But as you would expect, there are still a number of major issues to be settled. We should debate these openly and give ourselves time to make any necessary changes.
My list of outstanding questions would include the following.
First, are people saving enough? My answer is – almost certainly not. There is now a lot of evidence that people will need to save considerably more than the maximum amounts envisaged under auto enrolment if they want to enjoy the sort of lifestyle they expect in retirement. If I am right, then the next question is “how do we get more people to save more for their retirement?” Auto escalation will obviously be a part of the solution, but I don’t think it will be enough.
I think some of the answers will be found in how we communicate to the public the scale of the challenge we face. By “we” I mean Government, employers and pension schemes themselves. Do we really know how much we should be saving and what our pension pot will actually provide for? I don’t think so. It doesn’t help if all we talk about is the size of the pension pot as this tells us very little about the sort of income this might generate.
We may need to go further than this. Is there anyone out there who could help us answer this question about the adequacy of our savings? Maybe – but we know that very few people seek or secure independent financial advice. So perhaps one thing to think about is whether or not we need to establish a trusted voice, someone independent of both Government and the financial services industry, someone who has no axe to grind and no product to sell or endorse and who might best help people think about how much they will need to put away for their retirement years.
There is a precedent. To help us tackle the challenge of climate change, we set up the independent climate change committee. Its mandate is to keep us on a steady course to lower our carbon emissions. I think we need something similar in the area of retirement savings. Someone who can answer the question “how much should I be saving for my retirement?” This is going to be critical to the success of the current reforms.
A part of the answer might lie in promoting greater financial literacy. The new national curriculum is a step in the right direction. It might help lay these new foundations. Helping us to become a nation of savers.
We might need to revisit the whole question of compulsion. We don’t need to do this yet. I hope we will never need to do this. But we mustn’t lose sight of the ultimate goal of public policy here which is to ensure people are saving enough for their retirement. If they aren’t then we need to do something about it. Its outcomes that matter here – and the most important outcome is ensuring an adequate stream of retirement income for everybody.
The changes don’t stop here.
We now have to understand the implications of the new freedom to cash in your pension pot at 55 rather than take an annuity. It is not clear what impact this new policy is going to have. Giving people more choice and freedom seems the right thing to do – none of us want to be treated like children. But what happens if we make the wrong choices and compromise our ability to sustain the retirement lifestyle we aspire to? Will we repeat the experience in Australia – which has not required savers to annuities – and where many people deplete their savings very significantly in the immediate years following retirement. Many of them find that the money runs out sooner than they thought. This would be a terrible outcome. And of course in Australia there is a debate underway about requiring savers to annuities when they reach retirement.
Alternatively, will these new freedoms act to turbo power our transition to becoming a nation of savers by making retirement saving more flexible and therefore attractive to many more people?
We just don’t know.
There are reasons to be cautious. Inertia might triumph. People might not take up the new Guidance Guarantee. I am not sure how many will go further and take proper independent financial advice about their best options. There are reasons to be concerned.
And in all of the rhetoric surrounding this new reform, have we inadvertently undermined the concept of an annuity – something I personally feel very strongly should continue to be an important part of sensible financial planning in retirement. It is just too early to tell. The industry will need to respond to the changing landscape through new products that can help savers meet the need for sustained, inflation proof income for their retirement years. These products will, I am sure, remain in demand.
I also welcome the recent debate about defined ambition pensions. It is long overdue. We all know that DC will have to do the heavy lifting for the next generation of savers, but is DC a good enough brand? DC pensions are a good thing, but they have placed a heavy burden on savers to assume both the responsibility and the consequences for making complex financial decisions. Very few people are able to do this and no amount of education or engagement is probably ever going to overcome this shortfall. But the fundamental problem with DC is that we have lost the connection with retirement income and in its place we have substituted the language of asset valuations – exactly the opposite of DB.
The shift from DB to DC may well have reduced the financial liabilities of businesses but has paved the way to a new pension crisis for millions of savers as returns have fallen along with retirement incomes. In my view, DC schemes are built and regulated with the focus on the wrong risks. The most important risk to the saver is whether they have a sufficient income in retirement, not the fluctuating value of their assets. So, it is income not assets that should be at the core of everything and we might make progress in the right direction if we focused more on this issue than on anything else.
The most important issue for savers is the retirement income their pension plan will generate when they retire. The primary risk which should be managed in any DC plan is income – the same discipline that governs DB investment strategies. The DA debate has allowed this whole question to be opened up to greater forensic examination and that has been a good thing. I personally doubt whether there will be many takers for CDC – I could be wrong – but I do hope that market innovators will spot the opportunity that exists out there and help more people saving in DC schemes achieve greater income certainty in retirement. That is what we all want to see.
Despite all these uncertainties, one thing is clear. These changes to our pensions system are profound and far reaching. Change was necessary if we were to manage the winds of demographic change successfully – ensuring future generations of pensioners avoid falling into poverty in old age – the curse of every previous generation.
But in all of this change let us not lose sight of the purpose we should be keeping at the front of our minds and the yardstick by which we should judge the success or failure of any individual policy initiative – will it help encourage us to save more for our retirement or not? Will it help us to be a nation of savers?
If the answer is “no” then we must have the courage to change course – however difficult or politically inconvenient this might be.
Rt Hon Lord Hutton of Furness, Former Secretary of State for Work and Pensions