GPPs – a whole other level…
Sorry to be boring, but I’m writing about the National Pension Savings Scheme (NPSS) idea again. You know, the one that was proposed by the Pensions Commission late last year. I know I’ve gone on about it a lot, but I think it’s pretty important we all know just what it is that’s being talked about by the people who know what’s best for us.
The idea behind this proposed state-run throwback to the 1940s is that the 10 or 12 million people in the UK workforce who do not currently benefit from employer contributions towards their pensions will be able to impose compulsory contributions on their employers by joining the NPSS. To do that they may have to turn their backs on the current voluntary pensions markets, but that seems a small price to pay for pushing their erstwhile feet-dragging employers into making pension contributions for them doesn’t it? It’s a modern form of compulsion really. It’s available to any employees not already in a ‘high quality pension scheme’ who want it and their employer has no choice in the matter. If an employee is happy to commit 4% of their band earnings to the NPSS, then the employer has to pay 3% like it or not. Put that in your pipe and smoke it, sort of thing. The taxman will also chip in 1% for good measure to make the total pension contribution up to 8% with only 4% payable by employees. Brilliant; some say.
I suppose there’ll be more than a few employers out there who’ll be horrified by all this, but if it goes through as proposed they’ll just have to get used to it or hope they’re lucky and their employees don’t stay in the NPSS (all employees not getting pension contributions from their employers will be put in the NPSS, but they don’t have to stay in it if they don’t want to, or if employers can talk them out of it). With any luck there will be some sort of rudimentary consumer protection built into all this to make sure that employers don’t put people in a position where they could stand to lose out financially, but that’s not really what I want to write about in this BeeLine; that’s something I’ve done to death already.
No, what’s concerning me most at the moment isn’t the employers who so far have done nothing to help their employees save for the future, but rather those who have. We’re all of us in the financial services community well aware that there is a shift from final-salary pension provision to money-purchase pension provision going down at the moment. The stats make it look pretty much like employers are switching from pension schemes they can’t control to ones that they can.
In a final-salary pension scheme the employer typically promises a fixed pension based on an employees’ length of service and earnings levels at or near to retirement. Employees have the benefit of knowing where they stand and can even calculate the level of the pension their employer is promising them. Employers, on the other hand, take all the risks associated with the investment returns and also the likely longevity of their employees. The pensions, once in payment, are payable for life.
When an employer switches from a final-salary scheme to a money-purchase scheme the two main risks are transferred to the employees. The employer commits just to an agreed monetary input to the cost of pension benefits; the employee runs the risk of investment returns and, through the eventual annuity cost, the risk of general increases in longevity. The modern way in UK pensions is for employers to lump the real risks associated with pension provision onto their employees.
That’s bad enough I guess, but there’s plenty of evidence to suggest that employers do a bit more than simply transfer the risks to their employees when they restructure pension schemes in this way. A typical final-salary pension scheme providing a 60th of final salary as a pension for each year of pensionable service would cost something like 22%1 of payroll to fund these days. Usually only 5 or 6% would be levied as a cost on the employees with the employer picking up the other 17 or 18%. Where employers switch to money-purchase schemes they appear to also take the opportunity to reduce their financial input to their employees’ pensions at the same time. It’s not to say that all employers do this, but it is a sad fact that the funding levels for typical money-purchase schemes are much nearer 10% than 22%. It’s only anecdotal I guess, but I’m sure we’ve all seen examples of this.
Without being able to be too precise or anything I suppose I’m saying that employers in the main appear to have earned a track record recently for levelling down their pension schemes at the same time as they restructure them to shift the burden of risk.
The NPSS, it seems to me, offers employers who have already shown a predilection for levelling down their commitment a further opportunity to do so once again, this time with the help of the Government. Once the NPSS arrives on the scene it will set what to the uninitiated will look like a benchmark for ‘good’ pension schemes. Indeed, existing schemes that will be deemed to be ‘good’ and therefore exempt the employees from being swept into the NPSS will be defined in the legislation if this stuff ever gets off the ground. It looks likely to me that ‘good’ schemes will be those where employers pay at least a 3% contribution. There has to be a very real risk that existing money-purchase schemes will be levelled down with the advent of the NPSS.
In real life it’s not too hard to see why that might happen. Think of a typical employer who just a few years ago was running a final-salary scheme for all employees. In the last few years they would, if they are typical, have closed the final-salary scheme to new entrants and be running a money-purchase scheme (almost certainly a grouping of personal or stakeholder pensions rather than a trust-based occupational money-purchase scheme) for their more recent employees. The employer will today have three types of employee working for them; those longer serving employees in the closed off final-salary scheme; those more recent employees in the money-purchase scheme; and, a group of people who have decided not to join the employer’s pension arrangements and are therefore not covered by any pension scheme.
If the NPSS ever comes along the people in the final-salary scheme would not be swept into it as that scheme would almost certainly be regarded as a ‘good’ scheme by the legislation. For those in the money-purchase scheme, if the employer is paying more than a 3% contribution already, the same will probably apply. But for the existing Refusniks who have previously shunned pension scheme membership things would be different. As far as I can tell from my reading of the Pensions Commission’s report the current Refusniks would be automatically enrolled into either a ‘good’ pension scheme run by their employer, or the NPSS. Employers aren’t likely to let people get automatically enrolled into their closed final-salary schemes, but may not mind if people are plopped into the money-purchase scheme I suppose, as long as the scheme allows that (they might not have enough service, or be too young, to join, or they may be too close to retirement to be allowed in, or the scheme may not allow people to join if they’ve previously opted-out). Either way, if the employer’s got nowhere else to put them then they’ll just get auto-enrolled into the NPSS I guess where they’ll have to pay 4% and the employer will have to pay 3% in contributions. They will, however, have the right to opt-out of whatever scheme they’re forced into if that’s what they want to do.
At the end of the day, when all this palaver is over, the employer will still have some people who are not in any pension scheme, but may end up with some who are in the state-run NPSS. They’ll also have a load of older people in the final-salary scheme and maybe even more people than before in their Grouped Personal Pension scheme. Now, unless the employer likes the idea of spending most of the working week fiddling around with pensions rather than getting on with making widgets or whatever else they do to bring home the bacon, such a muddled outcome looks to me like it will be ripe for rationalisation. It might be easier from the employer’s point of view just to put everyone with a money-purchase pension in the NPSS and leave it at that. It’d save a lot of fuss and bother, especially if the Government runs it through payroll deductions, and probably be cheaper too if it only ‘costs’ 0.3%. In fact, why leave it at that? I mean, it would save a small fortune if the people in the final-salary scheme were put into the NPSS for their future service too wouldn’t it? There’d be big savings to be made there. That’s the sort of thinking that will go alongside this idea that cheap is good, rather than the old-fashioned idea that good pensions have got more to do with the actual amount saved each year. Like I said in my BeeLine yesterday, if we think pensions are difficult these days, things are likely to get even worse if the NPSS, yet another product-based solution with a strong message that cheap is good, is ever thrown in with the rest of it. Don’t say I didn’t warn you…..
9 February, 2006
1. Association of Consulting Actuaries - UK Pension Trends Survey Report 2, May 2005.
Any research and analysis included has been provided by us for our own purposes and the results of it are being made available only incidentally. This document is based on Scottish Life's current understanding of the Pensions Commission Second Report published on 30 November 2005.