The future of workplace pensions

22 November 2013

Stakeholders in the world of pensions can feel the ground shifting beneath their feet. People are spending longer in retirement, more people are entering retirement with debt and more retired people have younger and/or older dependents. This means that not only is it important to ask whether individuals are saving enough for their futures (accumulation) but also whether they are making the most of their assets when they reach retirement (decumulation). Given this need for, and the challenges of, change, Reform held a roundtable lunch with Dr Gregg McClymont MP, the Shadow Pensions Minister, on the future of workplace pensions. As well as Dr McClymont, Dr Yvonne Braun of the Association of British Insurers and Kimberley Trewhitt of Reform also outlined their thoughts. The discussion was held under the Chatham House Rule.

One starting point for debates on workplace pensions is financial literacy. As the Money Advice Service has illustrated, for example, “when shown a sample bank statement, 16% of people failed to correctly identify the available balance, with this rising to over a quarter of those aged over 55.” This poor financial literacy is reflected in a lack of engagement on pensions and a failure to understand the risks that changes to workplace pensions pose. As the Money Advice Service also showed, “when asked to identify whether inflation at 5 per cent would have eroded the purchasing power of money in an account paying 3 per cent interest, over a third of people (35%) got this wrong.”

This failure to understand inflation risk is especially important with the continued roll-out of auto-enrolment. This will amplify the move towards a world of defined contribution (DC) pension schemes and shift more of the risk onto savers with, for example, the final pension pay-out received depending on investment returns and not just contributions made or time spent in work. This is an important change and could pose a real challenge as the UK moves from an “op in” to an “opt out” workplace pensions system. Unless savers appreciate the risks they are taking on there is a threat that auto-enrolment will experience real reputational damage.

This then raises questions around the sequencing of reform. Will the increasing take-up of DC pensions (a demand side change) be a catalyst for industry and regulators to continue to lift their games? And will this, in turn, improve the products being offered and encourage consumers to be more informed? Or, alternatively, should the industry’s skeletons be sorted out (change on the supply side) before the coverage of these pensions is extended? One priority for reform should be to address the issues facing the DC pension market identified by the Office for Fair Trading. And in responding to these recommendations it is important to not only recognise the interests of government and industry, but also employers and consumers too. To quote the title of a recent Reform conference, what is needed is “a team effort”.

Yet a big question remains. Just how active can we expect people to be when we move to an opt out system? Will this transform the retail market in the way hoped (making consumer choice the driver of change) or should focus instead go on getting the defaults right? One key lesson from the experience of New Zealand, which is several years further down the track in implementing auto-enrolment, is the importance of the default. There also needs to be a greater focus on pension companies’ roles as asset managers, not just as providers, improving governance and disclosure (such as employing standard definitions and writing in plain English), and reducing fragmentation. The end of the journey (the decumulation phase) also requires attention, but how realistic is it to expect people to become engaged at retirement when their accumulation of assets has largely been based on relying on default settings?

By launching a “comprehensive review of the products, information and advice available to people as they reach retirement” the ABI has shown that industry is up for the challenge of making auto-enrolment work. Yet, as the discussion at this lunch showed, this challenge should not be underestimated, and will require new thinking from industry, government, employers and families themselves. And with auto-enrolment continuing to roll-out the window for making improvements is narrowing. 2014 will be a critical year in shaping the future of workplace pensions.

A blog by Dr Patrick Nolan, Chief Economist at Reform, following an event on the theme “The future of workplace pensions”, led by Dr Gregg McClymont MP, Shadow Pensions Minister.

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