Stakeholder Pensions

- Tuesday, 30th October 2001

 

It is a pleasure to be invited again to address this very knowledgeable audience about Stakeholder pensions.

I shall endeavour as always to give an objective and non-partisan analysis of Stakeholder pensions.

The last time I spoke here, I was so non-partisan that Alistair Darling quoted me in Parliament implying I had given Stakeholder pensions a 100% clean bill of health: which proves that Ministers take note of what we say here.

He was of course quoting me out of context .

Still one should not complain too much about being quoted out of context. I recall that Enoch Powell brushed aside that complaint with the remark "all quotations are out of context ? by definition?.

Chart 2 - Key Actions This Year

The first chart simply recapitulates the key dates and events in the rolling out of Stakeholder pensions this year.

The government relaxed - some would say ?bent? ? a number of rules, including that on polarisation, to boost the industry?s marketing effort behind Stakeholder pensions.

It just got the regulations tabled the requisite 21 days before Stakeholder pensions became operational on the 6th April.

That cannot have made it easy for providers to be fully compliant by the start-up date.

Also IPAs.

The final key date was the 8th October by which time all employers, with more than five employees and with no existing company scheme, had to provide their employees with access to a Stakeholder pension by payroll deduction.

Chart 3

What has been the response to Stakeholder pensions so far?

48 providers are offering Stakeholder pensions.

By the end of August they had sold 357,000 Stakeholders pensions and the total could have reached 500,000 by now,

Interestingly, half the Stakeholder pensions sold by the end of August came from a single company called Building and Civil Engineering Insurance who provide pensions for the highly mobile and often self-employed workforce in the building industry.

The success of Building and Civil Engineering Insurance does mean that the 47 other suppliers have got off to a slow start ? sharing about 175,000 policies in the first five months.

Moreover, a significant proportion of those simply represent the transfer of existing group personal pensions or AVCs onto Stakeholder terms.

The ABI, naturally wanting to sound positive, has attributed the 50% increase in personal pensions in the three months since Stakeholder pensions started to a wider stakeholder effect.

They say some employers have been prompted to set up Group Personal Pensions Schemes similar to but not classified as Stakeholder pensions

However, it seems likely that most of this surge is due to employers moving their arrangements away from Equitable Life.

Alistair Darling has welcomed these early figures as ?an encouraging start?.

One wonders quite how low the level of sales would have had to be to be described as ?discouraging?!

Detailed official figures will only be available when scheme administrators make their first annual returns to the Inland Revenue for 2001/02 which they must do by October next year.

Fewer than half the employers required to designate a Stakeholder pension provider had done so by the end of August.

A survey commissioned by SunLife/Axa of firms with turnover of over ?1 million had either designated a provider or did not need to do so a couple of months in advance

There was undoubtedly a last minute rush before the 8th October deadline.

By the 19th October, OPAS had received only 211 complaints about non-compliance. OPAS will initially contact each employer with ?educational material and guidance? and will look for mitigating factors before any sanctions are applied.

But ultimately non-compliant employers could face a ?50,000 fine

To assess how well Stakeholder pensions are meeting their goals we need to remember what those goals are.

Chart 4 - The Goals of Stakeholder Pensions

They are:

? To provide a low cost personal pension.

? To make employers provide access to them and encourage employees to contribute into those scheme.

? To boost the proportion of people in the target group with incomes between ?10 and ?20,000 who save and to save more.

? Overall to increase the ratio of funded private pension provision to unfunded state Pay As You Go provision, from 40:60 now to 60:40 by 2050.

Chart 5 ? Are Goals Being Met

(A) Will Stakeholder pensions cut costs?

Many existing personal pension schemes charge an initial commission followed by an annual charge which may not be proportionate to the amount invested.

That has sometimes meant that those who stopped saving after a short time and saved small amounts paid relatively high charges, effectively subsidising those who stayed in the scheme throughout their working lives.

Stakeholder pensions can only levy a uniform charge proportionate to the value of assets in the fund, up to a cap of 1% per annum.

So small and intermittent savers will be protected from high costs at the expense of longer term and bigger savers.

Over all the level of costs is expected to be lower than at present.

So, savers should see less of their contributions absorbed by costs and more being invested in assets.

Other things being equal, that will mean higher pensions when they retire.

A reduction in annual costs of half a percent over a full working life could boost a final pension by as much as 15 per cent.

That assumes that the Government Actuary does not claw back the benefit of lower costs.

He could do that by assuming that a correspondingly lower rebate would now be sufficient to provide a pension equivalent to SERPS.

In fact, however, he does not appear to be doing that in his latest proposals. For the next five years he is assuming an annual charge of 1 per cent on all private pensions (whether or not they are stakeholders). Previously he assumed a 0.8 per cent reduction in rate of return and a 6 per cent charge on the initial invested rebate.

At first sight the 1% cap on charges compares favourably with the level of costs in Australia where there is no cap.

Administrative costs there are currently 1.29% of funds invested.

But by the time average balances reach US$30,000 administrative costs are expected to fall to ?% per annum.

Those figures exclude the cost of advice as, in practice, does the 1% Stakeholder cap.

Still less is there any provision in the UK for the cost of persuading people to take out a Stakeholder pension or to save more than the rebate.

There have recently been reports that the government has been making encouraging sounds to the pension providers and financial advisers that it may be prepared to relax the regime in some way.

However, it remains to be seen whether this is just reassuring mood music or whether it presages a substantive change in policy.

Chart 5(b)

(b) Will employers offer access and make contributions?

Although many employers, especially those with few employees, have been slow to designate a scheme, they will all do so in time.

It looks very unlikely that the government will defer the deadline now that it has come and gone.

The more important question in the long run is whether providing access alone will encourage a significant number of employees to save regularly in a Stakeholder pension.

This seems unlikely.

Chart 6

Likelihood of Take-Up if Employers Contribute

What would make an immense difference would be if employers decide to make contributions into their employees Stakeholder pension funds.

An ABI survey found that more than half of employees would be more likely o save via a Stakeholder pension if their employer made a contribution.

But will any employers do so?

A survey carried out by Axa/Sun Life a year ago found that 10% of employers with more than five employees expect to start making, or to increase, contributions on behalf of their employees.

None said they would stop existing contributions.

So there could be some modest improvement in pension provision where it is currently weakest ? among small, new and growing firms.

Chart 5 (c)

(c) Will Stakeholder Pensions increase saving among the target group?

In opposition the Labour Party ? rightly ? highlighted the lack of pension provision at the bottom end of income distribution.

So it is surprising that those with incomes between the Lower Earnings Limit and about ?10,000 are not included in the government?s target group.

Their state pension entitlement will be significantly boosted by the terms of the State Second Pension.

But they will be discouraged from opting out of that into an equivalent Stakeholder pension.

The target group is therefore the 5.3 million people with incomes between ?10 and ?20,000.

2.8million at present have no pension apart from the state pension.

Another 1 million who do have a personal pension are paying only their rebate from SERPS into it.

A significant proportion of people in this group at any point in time are women and part-time workers.

It should, however, be recalled that over a working life many individuals will move in and out of this band ? as their earnings fluctuate or they leave employment.

The early data suggests that the main effect (outside the construction industry) has been simply to change existing schemes from Approved Personal Pensions onto Stakeholder terms.

This involves no increase in saving ? except insofar as a slightly higher percentage of premia may be invested rather than absorbed by charges.

Many existing schemes are rebate only.

There is little evidence as yet that Stakeholder pensions will encourage anybody who already has a rebate only Approved Personal Pension to put aside additional money.

But some of those who opt out of the State PAYE scheme for the first time may choose to save a little on top of their rebates.

It has always been an axiom of the pensions industry that savings products are sold not bought.

Getting people to put money aside requires persuasion and that is costly.

The 1% cap makes it unattractive to devote effort to selling to people with the modest incomes of the target group.

There are strong indications that the providers are therefore focussing on relatively wealthy people who can purchase Stakeholder pensions, as a tax efficient savings plan for non-working wives and children.

For example, Legal & General, HSBC, the Halifax, Norwich Union, Scottish Widows and Virgin are all reported to have sold fewer Stakeholder pensions to people on incomes between ?10,000 and ?20,000 than they have sold to non-working wives and children.

In addition, the partial concurrency rule makes Stakeholder pensions attractive to some people who already have a company scheme, particularly those with high but volatile or manipulable earnings.

If their earnings from time to time fall below ?30,000, they can invest up to ?3,600 for five consecutive years in a stakeholder ? even if their earnings subsequently recover way above the ?30,000 ?ceiling?.

So Stakeholder pensions may mainly benefit the better off.

A study commissioned by the ABI paints a somewhat more optimistic picture.

They interviewed a representative sample of people between the 6th and 8th April just as Stakeholder pensions came into being.

Their responses suggest that 3 million people consider themselves ?very likely? to take out a Stakeholder pension in the coming 12 months and 6? million were either ?very? or ?at all likely? to take one out.

Charts 8 and 9 show the age and income distribution of those likely to take out Stakeholder pensions.

The key age group is the 25 to 35s.

But fewer than half of those likely to take out a Stakeholder pension appear to have incomes in the government?s target ?10,000 to ?20,000 band.

Chart 5 (d)

(d) Will Stakeholder Pensions increase the ratio of private funded pensions to PAYG from 40:60 to 60:40 by 2050?

I am delighted that the government has set a target to increase the proportion of funded pensions.

When in opposition they used to attack the idea and argued that we should rely on state PAYG schemes like our continental partners.

The trouble is that nearly all pensions on the continent are financed by the taxpayer.

This year?s taxes pay for this year?s pensions.

Nothing is saved or invested for the future.

So with an ageing population and fewer people of working age they face an increasingly crippling burden of tax.

By contrast, in the UK we have encouraged people to opt out of the State Earnings Related Pension scheme into a private funded scheme.

When they do so their money is saved, it is invested, it goes into industry to pay for their pensions when they retire - without imposing a burden of tax on the economy and meanwhile strengthening the economy through a huge flow of committed long-term investment.

Chart 11

UK Funded Pensions exceed rest of EU combined

As a result Britain has more money invested to meet future pension liabilities, not just than any other European country, but more than all our EU partners combined!

I wanted to build on that success by encouraging more people to opt out of SERPs into private funded pensions.

The problem was that those on low earnings were entitled to correspondingly low rebates if they opted out: a disproportionate amount of which would be absorbed by the fixed costs of running a scheme. So it was not worth their while to opt out.

I resolved the problem by proposing a scheme called Basic Pension Plus.

All young people entering the labour market would be given a personal pension fund into which would be paid a flat rate rebate sufficient to fund their basic pension entitlement as well as their SERPs rebate.

Chart 12

Basic Pension Plus

Sadly the government has not stolen that radical solution to encourage more funded pensions (thought President Bush has!)

Instead they have tried to make it more attractive for those on lower earnings to opt out of SERPs by requiring Stakeholder pensions to charge a fixed percentage of assets to make opting out somewhat more attractive at lower earnings.

That will help a little.

But, in the absence of persuasion (which is not affordable within the 1% fee), or compulsion, I doubt there will be a big increase in opting out within the target group.

Chart 12 - Will the Government go for compulsion?

Will the government therefore go for compulsion to meet their target for an increased proportion of private funded pensions?

It is important to recognise that we already have a compulsory pension for employees on top of the basic state pension.

It is currently called SERPs and will be renamed the State Second Pension, with enhanced entitlements as from April 2002.

Employees earning above the Lower Earnings Limited either have to belong to SERPs/SSP or pay their rebate into a privately funded scheme offering an equivalent or better prospective pension.

Any additional compulsion could take three forms.

It could involve compelling people to opt out of SERPs/SSP into a private fund.

That clearly was envisaged by the government.

They failed to remove a reference to compulsion in their Green Paper on Stakeholder Pensions.

Indeed, the government has said that once the new system is bedded in it may make the SSP a flat rate benefit throughout its range.

But those who opt out will continue to get earnings related benefits based on the initial graduated structure.

It will therefore be in the interest of nearly everyone with a pension above the ?10,000 threshold to opt out into a stakeholder.

Indeed quite why the government plans to continue offering the SSP once it goes flat rate is not clear.

It will be guilty of fairly gratuitous misselling if it does!

The second possible element of compulsion would be to require the self-employed to take out Stakeholder pensions.

They include many with the greatest need for additional savings for retirement since they do not qualify for SERPs or SSP.

However, their true earnings are often difficult to assess and many are investing in their businesses to generate their pensions.

The third form of compulsion would be to require employers to make a contribution into their employees? pension schemes.

This must be a distinct possibility.

It would be the simplest way to boost the level of pension savings among those least likely to have a pension on top of the SERPs/SSP level.

Moreover, compulsion would overcome the disincentives created by the Minimum Income Guarantee and Pension Credit.

It would move the UK further towards the Australian system.

This involves a compulsory contribution of 9% of earnings and a means tested state pension.

Unfortunately, there is no gain without pain.

There are four problems:

First, a compulsory contribution of a percentage of an employee?s income into

their pension funds would feel like a tax to either employer or employee.

To misquote: If it looks like a tax, feels like a tax and hurts like a tax ? it is a tax!

Second, it raises the issue of why the state should require people to save ?

beyond the level necessary to ensure that they will not need means tested

benefits in retirement?

Third, once tertiary pension contributions are compulsory the case for tax

relief on pension provision would be weakened.

There would be no need to encourage people to do something that they would be compelled to do anyway!

There would be a case for tax incentives to contribute more than the minimum but that would further complicate a grotesquely complex system.

It is worth noting that In Australia, where contributions are compulsory, the state charges 15% tax on contributions, 15% on the yield of investments and 15% on pension payments for some people.

Finally, making employer contributions to Stakeholder pensions compulsory

would undermine existing defined benefit schemes.

It might accelerate the shift to money purchase schemes and the minimum compulsory level might become the norm.

Conclusion

Stakeholder pensions should succeed in reducing costs; they will make access via employer payroll systems easier and they may encourage some employers to make contributions into employees? funds.

But the impact of this will be modest and offset by the effect of the cap on costs in reducing providers? ability to afford much effort to persuade the target group to opt out of the unfunded State Second Pension, still less to save additional funds.

So the main marketing effort will be focussed on households wealthier than the government target group.

If the government is to meet its goal of increasing funded pensions it will certainly have to require people to opt out of the State Second Pension, a change which is more likely than not.

And it will have to consider making additional employer contributions compulsory but may well shrink from the likely political reaction to the effective tax increase involved.

 

 

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