There are still potential problems on the horizonby Andy Davis / November 18, 2015 / Leave a comment
Early indications suggest that automatic enrolment of employees into workplace pensions has proved more successful than many had anticipated, with the proportion of people exercising their right to opt out some 30 percentage points lower than the assumptions that the insurer and asset manager Legal & General used in its modelling, Group Chief Executive Nigel Wilson told a round table discussion organised by Prospect at the House of Commons on the 10th of November 2015 to discuss how auto-enrolment can help those that need it most.
However, even though more than 90 per cent of those automatically enrolled into their employer’s scheme were choosing to stay in, Mr Wilson argued that a series of challenges remained in order to finish the roll-out of the system and to ensure that people are saving enough and protecting themselves against a wide enough range of risks. Several speakers agreed that while the initial phase had gone well, this resulted from factors that would not necessarily apply in future.
One of the major reasons for the successful roll-out so far, argued Henry Tapper, editor of Pension Playpen, was that it had included only the largest companies, which had strongly supported the project. “One of the weaknesses going forward is an expectation from small employers that all this will happen for them and that there is no cost attached,” he said. “The idea that there are 1.8m [small] employers out there that are going to play ball—that’s a bad assumption.” The progressive roll-out of auto-enrolment to smaller business is just beginning, although Mr Wilson said L&G’s data indicated that opt-out rates among employees in these firms were even lower than in larger companies.
Several speakers, however, pointed out that the very low rates of opt-out were partly explained by the modest contributions that employees were currently making: 1 per cent of salary for those earning at least £10,000. This would reach 4 per cent from October 2018, with the overall rate including employer contributions and tax relief at 8 per cent from that date. In order to generate large enough savings pots, however, employee contributions would need to be higher than 4 per cent and achieving this through progressive, automatic increases in contribution levels in future years—so-called auto-escalation—risked pushing up opt-out rates.
Chris Curry, Director of the Pensions Policy Institute, suggested that experience so far had proved the principle of auto-enrolment rather than the practice. “What happens when contribution rates to up to 4 per cent or 5 per cent?” he asked. “Research evidence suggests that with phasing in of contributions over time it’s not likely you’ll see high levels of opt-out but we still don’t know what’s going to happen there.” He also questioned whether auto-enrolment was in fact helping those that need it most. “As well as 5m people being automatically enrolled so far, there are another 5m people who work for exactly the same employers who haven’t qualified for auto-enrolment [due to age and/or income level]. When the Pensions Commission were putting forward their proposals I don’t think they envisaged that half of the workforce would be out of the scope of auto-enrolment,” he said.
Major uncertainty also existed, Mr Curry argued, because of the concern that the “triple lock” that guaranteed state pension increases of at least 2.5 per cent every year, would prove sustainable in the long run. The Institute of Fiscal Studies has cast doubt on this and basing decisions about how much people should save into employee schemes on an assumption that the pensions triple lock will stay in force may not be safe, as Pension Policy Institute calculations showed. Mr Curry said that if a full-time employee of 22 on median earnings put in the minimum contribution into a pension every year until they were 68, they had just under a 50-50 chance of having an adequate income provided the state pension triple lock remained in force. If it did not, their chances fell to 25 per cent.
Russell Higginbotham, CEO of the UK for reinsurer Swiss Re, agreed that “the savings rate has to go up quite significantly and the sooner the better,” although he too wondered whether this would prompt more people to opt out. However, he also pointed out that for all the talk of auto-enrolment’s success, it provided none of the protections such as long-term sickness and death-in-service benefits that people used to receive from final salary pensions. “So as well as putting investment risk on the shoulders of the individual, we are putting other risks on their shoulders as well.”
Mr Wilson said L&G believed that one of the major opportunities afforded by the roll-out of the auto-enrolment system was to use its “plumbing” as a low-cost way to provide insurance products to protect against other risks such as illness, loss of earnings or long-term care costs. L&G had already launched a digitally-distributed, low-cost insurance product of this sort in India, selling 2m policies in the first two months, and would develop a version for the UK. “We want to prove we can do it, to make it happen and let the government catch up and see the social benefits of using modern technology.” There was huge potential for digital technology to bring down costs and give people much better information about their pension savings and other assets.
Conservative MP Jeremy Quin, a member of the Work and Pensions Select Committee, argued that focusing simply on pension savings gave too narrow a view of an individual’s potential wealth and income in retirement. “People do view their property as part of their total personal savings,” he said, although accessing the capital tied up in property remained too difficult.
L&G believed that lifetime, or equity release, mortgages were part of the solution to this problem, as well as more purpose-built housing that “last-time buyers” could move into, said Mr Wilson. “There’s insatiable demand for these types of properties.”
Although equity release mortgages had very high customer satisfaction rates, he agreed that they remained expensive relative to conventional mortgages. This was partly because of the capital that regulations require to be held against the risk of providing a “no negative equity guarantee” as well as the “ridiculously high” transaction costs involved in taking out a lifetime mortgage. Changes in regulation, a cap on transaction charges and willingness by government to share the risks of providing protection against the risk of negative equity could help to unlock a much greater proportion of the £1.3 trillion of housing equity held by people close to or in retirement.
“Equity release is a £1.5bn market here in the UK but it could easily be a £20bn market,” he said.
This article is drawn from a parliamentary roundtable chaired by Prospect’s Andy Davis and supported by Legal and General on Tuesday 10 November 2015. The discussion marked the latest in Prospect’s activities on the future of pensions.
You can read an article setting out the key themes for this discussion by visiting: Imagine what we could do if we got pensions right
You can also access Prospect’s pensions reports below:
We’re all pension managers now
Meeting the pensions challenge