Stakeholder Pensions

- Monday, 20th November 2000

 

The Programme seemed to suggest that I am still a Minister. Alas not. As a colleague once said: "You know when you are an ex-Minister ? when you get into the back of your car?and it fails to pull away from the kerb?.

However, I have spoken to the Pensions Minister, Jeff Rooker, and will endeavour to give an objective summary of the information you have asked for about recent government actions and plans for publicising stakeholder pensions.

RECENT GOVERNMENT ACTION ON STAKEHOLDER PENSIONS

The programme reminds us that on the 14th June this year Jeff Rooker said? "We have been talking and listening for almost 3 years, the time for talking is over, now is the time for action?.

As far as action is concerned, officials have indeed been busy since June ? though the talking continues as some of the action involves further consultation. [See Chart 2]

? In July, the Inland Revenue launched a further round of consultation on Individual Pension Account,

? a decision on Partial Concurrency which was unveiled in July and regulations were issued in August,

? final regulations on taxation appeared alongside these,

? the FSA issued in August Consultation Paper 61 on the Regulation of Stakeholder Pensions ? with the latest proposals on decision tress. Consultation ended on the 15th September,

? the Government Actuary has published new proposals for rebates for opting out of SERPS/SSP for the 5 years 2002 to 2007,

? FSA announces relaxation of polarisation rules for Stakeholder Pensions,

? following the pre-budget statement, the Treasury issued a Consultation Paper on the new Pension Credit.

? DSS announces change in rules to permit providers of Stakeholder Pensions to select members.

THE GOVERNMENT?S EDUCATION CAMPAIGN PLANS

I have also been asked to give details of the government?s education and publicity programmes and how it intends to market stakeholder pensions to consumers and employers.

There are three important dates for the implementation of stakeholder pensions [See Chart 3]

The dates are:

? 2nd October 2000 ? firms wishing to offer stakeholder pensions have been able to apply to register them with OPRA;

? 6th April 2001 ? investors may start to contribute to a stakeholder pension; and

? 8th October 2001 ? employers with five or more employees must provide access to a registered stakeholder scheme.

The government?s education and publicity campaigns appear to be designed around these.

On the 1st August 2000, OPRA launched its stakeholder pages on the internet which cover the definition of a stakeholder pension, the registration process, considerations for stakeholder providers and the employer access requirements . The register itself is also maintained on this site.

The government has also launched a new telephone help-line (0845 6012923) . This is run by OPAS, the Office of the Pensions Advisory Service, and will be funded by the DSS and the Financial Services Authority. Seventeen experts are being trained to talk callers through the stakeholder materials provided by the government and the FSA. The line does not provide specific financial advice and will not market stakeholder pensions or schemes.

The DSS has published two leaflets: Stakeholder Pensions ? a guide to registering as a stakeholder pension scheme provider and Stakeholder Pensions ? a guide for employers. The third leaflet Stakeholder Pensions ? your guide was due to be available in October, but is yet to be finalised .

The FSA is in the process of developing its decision trees which will form an important part of the selling process and the information provided to consumers. The latest versions for the decision trees are contained in FSA consultation document No 61 published in August 2000 .

By September "the government had sent its leaflet for employers to 400,000 companies as the opening mailshot in what will be a "multi-million pound publicity campaign? . It was reported that this will involve billboard advertising, television and cinema advertisements.

That there is a need for such a campaign is shown by the Axa/Sun Life survey that reported on the 15th November that 2/3rds of a sample of firms with 5 or more employees who currently have no pension scheme did not even realise that they will have to provide access to a pension scheme.

However, I can find little official information to date about the proposed campaign. A written answer in February confirmed that there would be a campaign "to communicate the benefits of stakeholder pensions? . And in the Standing Committee Debate on the main stakeholder regulations, Jeff Rooker, Pensions Minister, said that the government "will undertake a big advertising campaign on pension education at the end of this year or early next year which will cover not only stakeholder pensions but the whole issue of pensions? .

Nonetheless, when my colleague, David Willetts, the Shadow Secretary of State for Social Security, tabled a question about when this campaign will begin and how much it would cost he was told recently that "the Department is not planning a specific campaign on Stakeholder Pensions. The Department will continue its pensions education marketing activity from January 2001. The campaign aims to communicate basic impartial information about pensions, and to explain the new wider range of pensions options available, so that people can make informed decisions about their pensions arrangements. The first wave of advertising is planned to run from January to March of next year. It will cost in the region of ?4.8 million.?

When I spoke informally to Jeff Rooker he indicated to me that the government will essentially look to the private sector i.e. the providers to publicise stakeholders.

An important element of the government?s drive to encourage people to take up private pension provision is the proposal for a new combined pension forecast. These forecasts are currently being piloted and provide individuals with details of how much they will have to live on in retirement based on current projections of state pensions and any private pensions held.

The government hopes that this information will encourage people to consider their retirement provision more carefully and take up occupational schemes where available, or some other form of private provision such as a stakeholder pension, if not.

CONTINUITY OF POLICY

One question companies contemplating the significant investment needed to prepare for stakeholder pensions often ask is, "will stakeholders survive a change of government??

Our adversarial mode of parliamentary government often gives the impression that when an opposition wins it will want to uproot everything it has been criticising.

In practice that does not happen. Oppositions oppose ? but governments rarely reverse.

They build on what they inherit.

(See Chart 4) Certainly in the field of pensions each radical reform has built on its predecessor.

So I would be more than surprised if a future Tory government even contemplated abolishing stakeholder pensions. The rules may need amending in the light of experience whoever is in power. But they will probably remain a building block of pension provision for the indefinite future.

THE ORIGINS OF STAKEHOLDER PENSIONS

The other reason stakeholder pensions are likely to survive is that they had their origins, at least in part, in work initiated by the last Conservative government.

We believed that Britain?s funded pension provision is a huge strength.

British pension funds are now worth more that ?1 trillion. (See Chart 5). That is not just more than in any other country in Europe. It?s worth more than all the rest of the EU put together have bothered to save and invest for future pensions.

We wanted to build on this success and encourage more people to opt out of SERPS and to save extra on top of their rebates.

The problem was that for those on low earnings and interrupted employment, the rebates they got were correspondingly small. And a disproportionate amount was eaten up by the fixed costs of setting up schemes. So it was not worth their while to leave SERPS.

We therefore set about looking for ways to reduce those costs to make it worthwhile.

(See Chart 6) (Elaborate on Chart)

(See Chart 7) Basic Pension Plus

(See Chart 8) Key Features of Stakeholder Pensions

(See Chart 9) HOW WILL STAKEHOLDER PENSIONS WORK OUT?

Will Stakeholder Pensions Benefit Savers?

Stakeholder pensions should give savers more ?bang? for their buck.

Savers should see less of their contributions absorbed by costs and more being invested in assets which, other things being equal, 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 up to 15 per cent.

However, 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.

He is also assuming a somewhat lower real rate of return on investment ? 4 per cent per annum against 4.25 percent over the previous quinquennium. The overall result of these changes is somewhat larger rebates ? typically 5.1 per cent against 4.6 per cent of earnings above the lower earnings limit.

So Will More People Opt Out Of SERPS/SSP into Stakeholder Pensions?

The government?s original target group was low earners ? with incomes between the Lower Earnings Limit and ?9,500.

There are around 5 million people in this group.

Nearly three quarters are women.

About half work part time.

And two thirds have no private pension provision at all.

For these low earners the SSP will be substantially more generous than SERPS.

Everyone earning between the LEL and ?9500 will be treated as if they are earning ?9500.

And the rate at which they will accrue pension entitlement will double.

So the pension entitlement accruing to people in this lower band will effectively be flat rate.

The government could therefore have given them a flat rate rebate if they opt out of the SSP as I proposed in the Basic Pension Plus.

I calculate that a rebate of about ?11 pw invested in a stakeholder pension would produce a pension equal to the SSP foregone.

A pension contribution of over ?40 pm should make these low earners tolerably attractive to stakeholder providers.

However the government has decided that anyone who opts out of SSP ? even in this low earnings band ? will get an earnings related rebate proportional to their actual earnings not to the notional ?9500 on which their SSP will accrue.

So someone with earnings of ?6000 will receive a rebate sufficient to generate a pension equal to 40% of the difference between the LEL and ?6000.

And they will continue to accrue an element of SSP related to the difference between ?6000 and ?9500.

Got that?!

Even though their rebates will be worth twice as big as those they would get under SERPS I doubt if stakeholder providers will be targeting them as customers.

So there will probably be little increase in opting out at the bottom end of the earnings spectrum.

The government?s rhetoric tacitly accepts this and now focuses mainly on those with incomes between ?10k and ?20k.

People in this range who opt out of SSP into a personal stakeholder will get a rebate equivalent to their full SSP.

So at the bottom end of the range it will be double the previous SERPS rebate and at the top it will be the same as for SERPS.

People at the bottom end of this range will therefore be more attractive to stakeholder providers than before.

But initially the balance of advantage to employees between staying in SSP and opting for a stakeholder will not change and will remain fairly even.

However 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 nearly the interest of everyone with a pension above the ?9500 (indexed) 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!

Will Those Who Opt Out Save More?

Some of those who opt out into a stakeholder who would not otherwise have had a private fund may choose to save more than just their rebates.

That is one of the main purposes of the exercise.

But the advent of low cost Stakeholder pensions is less likely to persuade people who would have opted out any way to increase the amount they save.

If there is any increase it is likely to be at the top end of the earnings spectrum.

In particular some of those who can benefit from partial concurrency may take out a stakeholder pension while remaining members of a company scheme.

That would be particularly attractive to those who have high but volatile 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?.

What About Saving By Those On Lower Earnings?

This is because the main factor holding back those on low earnings from saving more is simply that there are more pressing demands on their household budgets.

They are not put off saving by the level of costs in personal pensions.

So they are unlikely to decide to save more just because a vehicle with a lower cost ratio becomes available.

What Would Make More Low Earners Save or Save More?

Most people on modest incomes would only save more if they were persuaded or compelled to do so.

Yet the stakeholder scheme removes the scope for rewarding financial advisers for persuasion without replacing it by compulsion.

Won?t The Minimum Income Guarantee Render Saving Pointless For Low Earners Anyway?

The Minimum Income Guarantee (MIG) is simply Income Support writ large.

As such, it penalises any modest saver whose retirement income falls below the level of the MIG in retirement.

They lose ?1 of benefit for every ?1 of pension or saving income up to the MIG level.

In his pre-budget statement, Gordon Brown announced that the MIG will be raised to ?100 per week for a single pensioner (?154 for a couple) by April 2003 by which time the single state pension will be ?77 per week (?127 per week for a couple).

On its own that would mean that single pensioners who have saved for a pension or other retirement income of up to ?23 per week might as well not have bothered. They would not be a penny better off in retirement than someone who had not saved anything.

Moreover, the government is committed to raising the MIG in line with earnings while the state pension will only rise with prices.

So in less than 20 years time the gap between the MIG and basic pension would be equivalent to ?55 (at 2003/4 prices).

That is the average occupational pension of men retiring now.

So, if nothing were done, a majority of pensioners would be caught in the MIG trap.

Won?t The Pensions Credit Eliminate This Problem?

Clearly that situation would destroy the incentive to save for retirement for the majority of the working population.

The government recognised that and is therefore proposing to introduce a Pension Credit to offset the disincentive effect.

The proposal will work as follows.

Pensioners will be guaranteed an income of at least the MIG: ?100 per week in 2003.

If they have any income from savings, state second pension or earnings, they will get an extra 60 pence for every ?1 of such income on top of the MIG.

The government will give pensioners credits sufficient to ensure that their total income, including the credit, is equal to the MIG plus 60 per cent of their savings.

The effect of this is shown in the chart.

Clearly this means that no pensioners will any longer lose ?1 of benefit for every ?1 of savings income.

That confiscatory withdrawal rate would otherwise apply to pensioner incomes falling in the gap between the basic pension and the MIG.

But instead of fewer pensioners facing 100 percent withdrawal of every extra ?1 of pension income they saved for, many more will now face an effective marginal tax rate of 40 percent over a far wider range of pension income.

Without credits, the 100 per cent rate would apply to savings incomes (on top of the basic state pension of up to ?23 per week for a single pensioner and ?31 per week for a couple. With credits, the new 40 per cent withdrawal rte will apply on savings incomes (on top of the basic state pension) of up to ?42 per week for a single pensioner and ?78 per week for a couple.

So a wider range of pensioners will face quite severe disincentives against saving more than before.

For those entitled to Housing Benefit and Council Tax Benefit the effective marginal tax rate could be much higher than 40 per cent. The government?s consultation recognises this but does not propose any concrete way of dealing with it.

Instead there is a rather pathetic plea for "views on how this can best be achieved?.

Will Many People Take Out Stakeholder Pensions?

The take-up may well be quite high.

But there is a danger that few of those doing so will be new savers.

Most would otherwise have saved in personal pensions or even in company pension schemes.

Allowing people to have stakeholders as well as being members of an occupational pension scheme (partial concurrency) is welcome.

But in practice only better off savers are likely to take advantage of it.

Less well off people may still be tempted ? in the absence of advice ? to leave their company scheme and mis-buy a stakeholder.

Won?t Decision Trees Prevent That?

I think decision trees, if properly designed, can be helpful.

They will stop some people mis-buying stakeholders at the expense of leaving a scheme to which the employer contributes.

But as they stand at present they leave some questions unanswered.

For example, does the minimum ?20 contribution include the rebate for opting out of SERPS?

In any case, decision trees will not remove the need which many people will have for advice.

For many people the decision process requires more than a guide down a pathway of options.

They need to talk it through with someone knowledgeable, to get a subjective as well as an objective feel as to how they should value the alternatives before them.

Most providers believe the 1 per cent charge simply will not leave leeway for giving advice.

Theoretically savers can pay for that advice separately.

But in practice, very few people are willing to pay for advice on a fee basis.

So Will Many Providers Offer Stakeholder Pensions?

So far only eight firms have registered stakeholder schemes.

More will undoubtedly do so in the months ahead,

But at least one company has said they will require a 20 percent market share to give sufficient economies of scale to profit in this market place.

That suggests that eventually there will be only a handful of major providers with perhaps a few niche operators as well.

I understand that in Australia the initial field of 20 providers was whittled down to a couple of major players.

Relaxation of polarisation to allow direct sales forces, banks and building

societies market other firms? stakeholders may help the government meet its

objectives but could well result in misselling.

Will Providers Be Able to Offer Stakeholder Pensions Within The 1% Charge?

The 1 per cent charge is not as tight as some suggest ? taken over the lifetime of a pension scheme.

But it does restrict reward early in a contract which may discourage entrants without deep pockets.

It is clear that e-commerce and related technology will be essential to keep costs to a minimum.

Some providers have said they will only deal with customers over the net. Unfortunately the Axa/Sun Life survey shows resistance to this. 70 per cent of firms of all sizes said they would not carry out day to day administration of a stakeholder pension scheme over the internet. Indeed, less than 15 per cent of employers do currently use e-commerce.

We must hope that will change rapidly since it is the key to keeping costs down.

A key factor will be software to link employers? payroll data to providers and/or Independent Financial Advisers.

This could cut out a lot of otherwise expensive data collection.

Such software is being developed.

But security aspects will be paramount.

So The Employer?s Role Will Be The Key To Success?

I have emphasised the danger that the introduction of stakeholder pensions may undermine existing company-defined benefit schemes, accelerate the pace of closures and lead to mis-buying by former members of such schemes.

There could even be a reduction in overall pension provision as a result.

That is a serious risk.

But there is also a positive prospect.

The greatest upside arising from the whole stakeholder project is that employers who currently have no schemes may decide to set up stakeholder based schemes and pay in an employer?s contribution.

The recent Axa Sunlife survey showed that 10 per cent of employers with 5 or more employees expect to start making or to increase contributions on behalf of their employees. None said they would reduce or stop existing contributions.

That could extend pension provision where it is currently weakest ? among small, new and growing firms.

 

 

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