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The UK pensions system still doesn’t know what it wants to be when it grows up.
That is the impression left by a flurry of consultations, calls for evidence, government responses and reports published after Jeremy Hunt’s Mansion House speech. The frantic airing of ideas and soliciting of views doesn’t inspire confidence that there is a clear “direction of travel”, as promised by the chancellor.
That is most obvious when it comes to the future of defined contribution schemes, the most important area in terms of inadequate pension provision and, ultimately, the opportunity to invest more adventurously.
DC schemes, where workers and employers put money into an individual pot to fund retirement, are on their way to becoming the largest part of the pensions market.
Old-style private sector defined benefit schemes will increasingly be bought out by insurers, thanks to improvements in funding levels as interest rates have risen. By the end of the decade, the UK could (very roughly) have £900bn of pensions in the insurance world, £800bn left in defined benefit schemes and — thanks to automatic pension enrolment rules that came in about a decade ago — £1tn in defined contribution.
In fairness, the government is making sensible moves to try to tidy up small DC pots, offer savers an easier set of options at retirement and increase trustees’ focus on value for money.
The longer-term ambition is to have bigger pots of money, better managed, investing more in higher-returning assets and delivering better outcomes for savers. The government said it will “facilitate” consolidation. But the easy wins from simply merging subscale schemes are overstated. The number of DC schemes has already fallen from 55,000 in 2008 to about 27,000. And 95 per cent have fewer than 12 members, according to the Association of British Insurers, of which 84 per cent are executive pension plans rather than workplace schemes.
One lesson from the much admired Australian market, a DC system with higher investment allocations to unlisted equity and infrastructure, is that progress comes faster by getting bigger schemes to work together. Australia’s occupational schemes created their own vehicle to pool investment management, cut costs and avoid paying layers of fees.
It is a shame that the voluntary “compact” announced by the largest UK DC schemes, to allocate 5 per cent of their default funds to unlisted equities by 2030, didn’t take the extra step and form such a vehicle, with a broader mandate. Even the biggest and most expert of the UK’s schemes lack the heft to compete globally with funds from Canada, Australia and the endowments of US universities.
The government instead is flirting with another model entirely — a version of the Dutch model of collective defined contribution schemes. This isn’t a new idea: the notion of a halfway house between the DB and DC worlds has been kicking around since (at least) 2013, when then-pensions minister Steve Webb dubbed it “defined ambition”. The idea is that by pooling risk across many people you can offer savers a “target pension” rather than just a pot of money, and ultimately a higher retirement income. A UK system set up specifically to facilitate the flotation of Royal Mail (which has yet to launch its scheme) could be expanded to allow the kind of multiemployer or industry-wide schemes seen overseas.
This looks pretty fraught in practice. The Dutch have rolled back the collective nature of their scheme after multiple problems. CDC suffers from offering something that might appear guaranteed but isn’t. Benefits vary with performance. The appeal to employers already in the DC world is questionable — as is the merit of simply introducing another complicated model into a market that is already fragmented and poorly understood.
There is, of course, general agreement on one simple thing that would improve retirement outcomes and mean more funds for investment: higher contributions from employers. Average employer contributions to private sector DC pension schemes were 3.5 per cent last year, compared to 22.2 per cent for defined benefit, says the ABI. UK auto-enrolment contributions are at 8 per cent of salary, mostly from the employee, compared to an Australian system moving to 12 per cent.
Here the government’s avalanche of paperwork was rather quiet — possibly because it is only now getting round to implementing the recommendations of a 2017 auto-enrolment review to lower the entry age to 18 and start contributions from the first pound earned. That rather sums up the delayed and confused state of UK pensions policy, something that the latest efforts have yet to change.
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