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The Green Paper issued by the Department of Social Security

Comments from
The Association of Chartered Certified Accountants

Introduction

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to respond to the Green Paper on the future of pensions issued by the Department of Social Security. Our principal conclusions are set out in the following Executive Summary.

Executive Summary

• In view of the uncertainty that has surrounded pensions during the post-election period, the publication of the Green Paper was a welcome indication that the Government had concluded the internal deliberations over its future strategy on pensions. The subsequent, separate announcement from the Treasury that a new retirement saving product was to be launched from that source has, unfortunately, detracted from the impression of a concerted strategic approach on the part of the Government. We find this regrettable, since the opportunity may have been lost to resolve the complexity which surrounds pensions and which plays a large part in creating the difficulties that are associated with them.

• We concur with the conclusion reached in the Green Paper that the state will always be obliged to fund the basic pension needs of the low-paid, and agree that the focus of attention in respect of those individuals with disposable levels of income should be on helping them to join private, funded schemes. We also support the Government’s declared intention to build on the successful elements of the current framework rather than to replace them.

• The Green Paper is, however, flawed in the stress it places on the level of alienation and loss of trust supposedly felt towards pensions by the public. It is wrong for the Green Paper to suggest, as it does repeatedly, that the mis-selling scandal and the Maxwell affair have caused a general state of dissatisfaction with the industry and its products. The tone adopted is inconsistent with the fact that membership of occupational schemes continues to rise and also with the fact, acknowledged in the Paper, that overall levels of retirement benefit are higher now than they have ever been.

• Although the Green Paper emphasises the harm caused to public perceptions of the pensions industry by the aforementioned scandals, it fails to acknowledge that the ability of pension funds to satisfy their members’ retirement needs has been seriously damaged by factors such as the prevailing low annuity rates and by the discriminatory decision taken in 1997 to deny pension funds the right to reclaim ACT paid on dividend income. While the Government is right to address problems of accessibility to pension schemes, it is vital for it also to recognise the contribution that it can make to the preservation and enhancement of the value of fund assets and, consequently, of benefits.

• The UK’s system of occupational pension schemes has proved itself to be extremely successful, not least to the substantial extent that it removes future pension burdens from the state. There is, however, a concern that the increase in regulatory obligations imposed by recent, post-Maxwell legislation has caused many employers who run occupational schemes to question whether it is worth their while to continue to do so. Occupational schemes offer great value to employers, employees and Government alike, and any reforms which result from this review should be careful to avoid any further disincentive to run them. In targetting its proposed stakeholder pension, the Government needs to ensure that its effect is to supplement existing methods of provision and not to compete with or impinge on them.

• The Green Paper recognises that people need to be able to save for their retirement with confidence. For this goal to be achieved, people need to feel that there is a high measure of stability within the pensions system, a stability that is not likely to be disturbed by initiatives of a short-term, partisan character. We therefore urge the Government, in framing its reforms, to seek broad political consensus for them.

We set out our comments in more detail below.

1. The pensions framework

1.1

The Green Paper acknowledges that few people can truly claim to understand pensions. That this is so is, to a great extent, the fault of the extreme complexity of the rules that govern pensions and their administration. Individuals, especially those who are not able to join an occupational scheme, are confronted with a huge mass of information about pension options which, for most, is impossible to understand without expert professional help. While we accept that a significant cause of dissatisfaction with the current system has been the series of scandals affecting personal and occupational schemes alike, we feel it is important to recognise the part which administrative complexity has played in causing the problems which the Government’s review is trying to resolve.

1.2

We had hoped that the Government would have taken the opportunity provided by the review to make significant reductions in the complexity of the pensions system. Unfortunately, the commitment in the Green Paper does not suggest that this goal will be achieved. In fact, the proposal to change the basis of the payment of the proposed second state pension within five years of its introduction will add to the confusion that already exists. In addition, the announcement, subsequent to the publication of the Green Paper, and by the Treasury, of a new pension product not mentioned at all in the Green Paper suggests only that there remains a lack of coherence in the Government’s approach to retirement saving.

2. The state pension

2.1	It is reasonable for the Government to conclude that, for the low paid, private funded pensions will never be a feasible option and also that the state will always be obliged to provide for their retirement needs in one way or another.
2.2	We are concerned, however, at the long-term financial implications of the Government’s proposed commitment to the ‘minimum income guarantee’. The Green Paper states that, while the basic state pension will remain linked to prices, the Government’s aim is to link the minimum income guarantee, which is to include the second state pension, to earnings. Given the steadily widening gap between earnings and prices over the last 20 years, which the Government acknowledges will continue, it is inevitable that the state will acquire, through the earnings-linked guarantee, a financial liability which may prove difficult to control, particularly if the stakeholder initiative is not successful in funding good non-state pensions. It also needs to be clearly acknowledged that this substantial liability will need to be funded through direct taxation.
2.3	We find it surprising that the Government should be considering taking on such a liability at a time when other EU countries are having to face up to the serious consequences of the state having given very generous commitments to directly-funded pension payments.

3. The Stakeholder Pension

3.1

Any measure that expands overall levels of retirement provision by making pension saving a more attractive proposition for more people is, in principle, helpful. The proposed stakeholder pension is, therefore, a welcome innovation to the extent that it aims to make second pensions available to individuals who currently do not have access to a non-state pension or who are, for whatever reason, dissuaded from joining one. The commitment to match the new pension to flexible working patterns is also very welcome.

3.2

We agree with the Green Paper’s analysis that the process of construction of the stakeholder pension needs to involve the identification of the target market and of the factors that currently prevent or dissuade them from investing in a second pension. In considering the Government’s analysis of the problems that exist within the current system, we would like to make the following observations:

	i.	Complexity of personal pensions The Green Paper suggests that the ‘complexity’ of personal pensions deters potential consumers. We do not support unnecessary complexity: indeed, as previously stated, we would have preferred the Green Paper to do more to tackle this issue. It must be accepted that much of the complexity associated with personal schemes is the result of regulation that is imposed directly or indirectly by the Government. In general terms, the Green Paper’s account of the shortcomings of personal pensions is somewhat misleading. For example, it is alleged at one point that personal schemes levy high up-front charges, which ‘typically’ account for a quarter of a member’s savings. There is, we understand, a trend away from up front charges within the industry; we also find it difficult to accept that such very high charge levels are ‘typical’.
	ii.	Costs of regulation It is stated that one of the major problems with the current system is the sheer cost of regulation, a cost that invariably has to be passed on to the consumer in the form of charges. It must be acknowledged at the outset that regulation exists for a purpose, which is to ensure that schemes are properly run in the interests of their members. As long as regulation is considered to be desirable, it will always have a cost. The Government suggests, however, that it can minimise regulatory costs by reducing the need for potential members to obtain financial advice before joining a stakeholder scheme. It will achieve this, it hopes, partly through the proposed system of minimum standards and partly by assuring potential members that the schemes will be run in their members’ interests. Given that the ultimate objective of second pensions is to enable individuals to accumulate an independent source of income that is sufficient to satisfy their basic retirement needs, we believe it is unhelpful at this stage to play down the importance of proper financial advice prior to starting a pension. It will help neither the member nor the Government if an individual, through lack of or inadequate advice, takes out a pension which is inappropriate to his needs or does not invest sufficiently to produce a satisfactory supplementary pension on retirement (which would result in claims being made on the state). Also, given the concern that the Government has rightly expressed about the predicament of the victims of faulty advice on pensions, it seems surprising that it is now suggesting that individuals be encouraged to invest in new pension schemes on the strength of no advice at all.

The minimum standards

3.3

The minimum standards set out in paragraphs 31-33 set out what the Government hopes will be the core characteristics of stakeholder schemes. The characteristics listed are all admirable as aspirations but we are not convinced that, as they stand, they are all achievable in practice. We note that a separate consultation is to take place on the final form of the minimum standards, but we have the following comments on the outline standards as they are presented here.

Limits on charges

3.4

The Green Paper proposes to place limits on the charges that operators of stakeholder schemes will be able to levy on scheme members. Since charge levels in personal schemes have been widely criticised, it is understandable that the Government wishes to emphasise the affordability of stakeholder schemes.

3.5

We see practical difficulties, however, in setting a rigid limit on charges. Firstly, since there is usually a link between cost and quality, it may turn out to be a false economy to stipulate that all stakeholder schemes should operate in accordance with fixed maximum rates. Secondly, stakeholder schemes will be required to invest their funds in the best interests of their members. This will invariably mean making investments in different markets, the costs of which will vary. If funds are to be deterred from investing in particular markets because of the associated costs (which would need to be passed on to members), then this may result in a scheme failing to get the best return for its members. Thirdly, if the Government is committed, as it must surely be, to ensure that stakeholder schemes are subjected to a comparable degree of regulatory control as exists in relation to occupational schemes, then it must be accepted that this regulation will be achieved at a cost. In view of these factors, we suggest that there will have to be some flexibility in the limitation of charges.

Charging structure

3.6

It is proposed that charging structures should be kept simple in the interests of comprehensibility and comparability. As a guiding principle, this is welcome. We do, however, foresee problems with the suggestion that, so as not to impose proportionately higher charges on those with lower levels of savings, charges would be levied on some form of percentage basis rather than by way of a flat rate charge.

3.7

All stakeholder schemes would be required to operate in the best interests of all members of the scheme and would have a number of central responsibilities, including the obligations to appoint professional advisers and to produce an annual report. These regulatory obligations would continue however much and however regularly an individual member chose to contribute to his fund. They would even continue if an individual decided to take a contribution holiday for a period. It does not seem fair for an individual to derive benefit from membership of a collective scheme and not be required to pay an equal share of the scheme’s regulatory cost. We would therefore prefer to see charges imposed on a per capita basis.

Other issues relating to the stakeholder pension

Contributions

3.8	The Department proposes that contributions to a stakeholder scheme will be limited to £3,600 pa or 100% of the member’s earnings, whichever is the lower. Clearly, the adoption of a fixed limit, rather than the established percentage of earnings-based limit, would mean that, for those members whose remuneration is below a certain level, it will be possible to make higher contributions to a stakeholder scheme than to an occupational scheme. The contribution limits applicable to a stakeholder scheme might, therefore, make a stakeholder pension more attractive than a company scheme to an individual earning under £24,000 pa.
3.9	This difference in permitted contribution levels could have important consequences for traditional funded schemes. Maintaining an occupational pension scheme requires a substantial investment in terms of time, effort and finance on the part of an employer. Many companies are, however, prepared to make this investment because the provision of an occupational scheme has come to be seen as a valuable tool for use by companies in the recruitment and retention of good quality staff. This particular motivational factor may be lost if employees are encouraged to believe that they can derive greater benefit from a stakeholder pension than from an occupational scheme. Since the Government is not suggesting that a stakeholder pension will be a better quality investment than an occupational pension, it needs to avoid providing any incentive or encouragement to employers to wind up their schemes in favour of stakeholder schemes.
3.10	Separately, the Green Paper suggests that scheme members who are not working will be able to continue making contributions to their scheme and obtain tax relief on those contributions. It is not clear how a member could qualify for tax relief if he was not working.

Clearing House

3.11	The proposal to set up a clearing house mechanism, through which employers could pay their contributions to stakeholder schemes, seems attractive.

Providers of stakeholder pensions

3.12

The Government hopes that representative and membership organisations will be among those bodies that provide stakeholder pensions. Clearly, organisations that are not currently pension providers should be made to satisfy stringent requirements regarding capital assets and fund management before being allowed to become a provider.

Compliance costs

3.13	In Appendix 1, it is stated that the on-going costs to an employer of complying with its new obligations regarding stakeholder schemes will be between £10 and £25 pa. We suspect that this will turn out to be an under-estimate, particularly in the case of smaller firms.

Investment

3.14

There is little discussion in the Green Paper of how stakeholder funds would be invested, save to say that each scheme will be free to decide on its investment strategy. The suggestion made, in paragraph 78, that schemes may allow their members a measure of choice over investment strategy, is, we believe, impractical. If stakeholder schemes are to be supervised by trustees, as is proposed in the Paper, it will be the responsibility of the trustees, or their properly delegated agents, to invest the scheme assets in the best interests of the scheme’s members.

Annuities

3.15	It is proposed that members of a stakeholder scheme should be subject to the benefit restrictions currently imposed on members of personal schemes. This will include the requirement for an individual to purchase an annuity by the age of 75.
3.16	We believe that this is a good time to review the continuing appropriateness of the existing rules on compulsory purchase annuities. These currently suffer from two principal problems. Firstly, rates have tended to fluctuate dramatically by reference to prevailing economic conditions. This means that those who are fortunate enough to be retiring at a time when rates are high will be able to secure for themselves a better pension than those unfortunate enough to be retiring at a time, such as now, when rates are low. Because of the dependence on market rates, therefore, an individual in the former group with a modest accumulated fund can end up with a significantly higher pension than a person from the latter group who retired with a bigger fund. We believe that it is fundamentally unfair that a person’s prospects for financial security in retirement are subject to external factors as discrete as prevailing annuity rates. Ultimately, we would favour breaking the link between an accumulated fund and the compulsory purchase of an annuity. If it is to be retained, however, then at least the age at which the annuity has to be purchased should be upgraded to 80 or, preferably, deleted altogether. Either of these alternatives would at least enable the individual to buy his annuity at a time that suited him.
3.17	The second defect of annuities is that, on death, the benefit of the accumulated fund is usually lost to the pensioner. It would be more equitable if, instead of seeing annuity investments retained by the provider, the residual funds could be transferred to the pension fund of the deceased’s next-of-kin.

4. Other issues raised in the Green Paper

Bankruptcy

4.1

We welcome the proposal to reform the law so as to end the relative disadvantage suffered by members of personal pension schemes when they are made bankrupt. As well as being equitable, this reform is consistent with the moves being made within the DTI to remove the unwarranted stigma that is still associated with insolvency.

Increasing the level of savings

4.2

Chapter Nine of the document addresses the position of the self-employed vis-a-vis the second state pension. The self-employed sector, in particular at the lower end of the income scale, has proved difficult to reach in pension terms. In principle, the proposed innovation of the second state pension represents a good opportunity to bring the self-employed into secondary pensions and we would encourage the Department to consider how this can be effected.

Conclusion

The commitment on the part of the Government to expand the range of individuals who invest in private, funded pensions is a welcome and necessary step. This expansion needs to take place, however, within the framework of the Green Paper’s acknowledgement that reform should build on, rather than compete with, the successful elements of the current system. Stakeholder pensions need to be targetted in such a way as not to destabilise the highly successful occupational scheme sector, and should focus on attracting those in that market who have disposable income levels and who are not currently served by the secondary pensions system. If the stakeholder initiative is not properly targetted and does not offer the necessary incentives to potential consumers, then the Government’s commitment to a minimum income guarantee linked to earnings will not be feasible.

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