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The Actuary The magazine of the Institute & Faculty of Actuaries
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Pensions: Choosing to lose

If you asked a hundred people which single action in the last 25 years has done the most damage to pension saving in the UK, it is a safe bet that the most common answer would be the removal of the advance corporation tax (ACT) dividend credit by Gordon Brown in 1997. However, arguably far more damage to the nation’s pension savings flowed from the decision taken some 10 years earlier by Norman Fowler, the then secretary of state at the Department for Health and Social Security. This decision removed the rule that enabled employers to make membership of an occupational pension scheme a condition of employment and allowed the State Earnings Related Pension Scheme (SERPS) to be contracted out on a money purchase basis. To appreciate the significance of this legislative change, let us construct a ’compulsion timeline‘ starting in 1978.

1978 saw the introduction of SERPS, so at that time employees were building up a basic state pension and were either members of a defined benefit occupational pension scheme or were building benefits in SERPS. There was no choice in the matter, but either route promised benefits worth having. The ‘Fowler change’ meant that employees could elect not to join the pension scheme offered by their employer and could opt out of the alternative defined benefit provision offered by SERPS by effecting an appropriate personal pension. This latter move was encouraged by the generous rebates made available by the government.

Unintended consequences
By the late 1980s, the only form of compulsory pension saving for employees was the basic state pension plus membership of SERPS or an appropriate money purchase personal pension. As well as leading to many new employees electing not to join the pension scheme offered by their employer, the Fowler change also unwittingly paved the way for the pension mis-selling scandal of the late 1980s and early 1990s. This is because there could not have been ‘opt outs’ or ‘non-joiners’ if membership of an occupational pension scheme had remained a condition of employment.

The government at the time tried to repair some of the damage through the introduction of stakeholder pensions and, in particular, the stakeholder access requirements that came into effect in 2001. However, the government stopped short of requiring contributions to be made to the thousands of stakeholder schemes that were set up, so the stakeholder initiative effectively withered on the vine.

If at first you don’t succeed...
Undaunted, the government is having another attempt at improving pension savings through the introduction of personal accounts and auto-enrolment. This latest initiative is due to start in 2012 but once again the politically difficult decision to have compulsory membership and contributions has been sidestepped.

Instead, there will be a potentially messy compromise whereby employers will be required to auto-enrol their employees into personal accounts or another suitable workbased pension arrangement, into which the employer and employee will both be required to contribute. Crucially, however, employees will be able to opt out and there is a danger that many employees will do so in order to avoid a decrease in their take-home pay. This is despite the fact that opting out means forgoing the employer contribution, so the employee is effectively awarding himself a pay cut.

Furthermore, the procedural requirements for auto-enrolment and subsequent optingout will place a significant burden on employers if the proposals in the recently published draft regulations are enacted. There is also the thorny issue that, due to the interaction with our means-tested benefit system, saving through personal accounts will not be suitable for many individuals. To put this into context, 10 million people (1) could be auto-enrolled and, based on the Department for Work and Pensions’ (DWP) own figures (2), 5% of these individuals stand to receive less than full value for the contributions made by them and their employer. That equates to half a million people potentially auto-enrolled into an inappropriate pension arrangement.

So come 2012, our compulsion timeline will show the only compulsory pension provision as a further eroded basic state pension plus, for those employees who are not an active member of a defined benefit occupational scheme, a state second pension heading for a flat rate benefit structure.

Back in the 1980s, the Fowler changes were lauded as giving people choice, with the idea being that individuals could choose to save for their pension through a scheme run by their employer or they could choose to set up their own arrangement. In far too many cases the actual choice made was not to save at all. This means the choice Norman Fowler conferred was actually a choice to be poor in retirement. Despite the good intentions behind auto-enrolment, one way of viewing the opt-out facility is that the government is protecting an individual’s right to choose to be poor in retirement.

(1) See the DWP Report ‘Personal Accounts; a new way to save’ http://www.dwp.gov.uk/pensionsreform/pdfs/PA_PersonalAccountsFull.pdf
(2) DWP Research Report 558 http://www.dwp.gov.uk/asd/asd5/rports2009-2010/rrep558.pdf

Alan Smith is a director of the consultancy firm First Actuarial