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The Actuary The magazine of the Institute & Faculty of Actuaries

NPSS : the flaws exposed and rectified?

n May’s issue, Seamus Creedon reviewed the final report of the Pensions Commission, in which he noted that Lord Turner believed that auto-enrolment, with the right to opt out, had apparently attracted universal support. I find this extraordinary, and wonder if the TUC, Which?, and consumer groups can really be grasping all the implications.

Flaws in current proposals
The proposed contribution split of 3% employer/5% employee (gross) is unappealing to employees, and markedly different from the more prevalent 2:1 split or, at the very least, equal matching of employee contributions. Moreover, the absolute level of 5% required from employees, regardless of age, constitutes a serious barrier.
While auto-enrolment is a reasonable idea, it seems quite wrong for the employer contribution to be lost if the employee chooses to opt out, whether on grounds of affordability or for other reasons. Clearly, this could lead to unscrupulous employers presenting matters in a misleading way aimed at encouraging employees to opt out solely in order to save the employer money.
Also, the proposed flat-rate contribution scale would result in unduly low benefits at older ages, and correspondingly high at younger ages. Moreover, money purchase (or defined contribution) involves a significant degree of risk being borne directly by employees, and hence requires some form of indexed (or smoothed) pension investment vehicle.

A suggested remedy
My earlier ‘blueprint’ presented at Staple Inn in May last year (see The Actuary July 2005), was of course put forward for discussion before Lord Turner’s NPSS proposals of November, so I have now modified my earlier suggestions to fit in with Turner, and to rectify its worst flaws.
My new proposal starts with a compulsory (no opt out) core employer contribution of 2% of pay above the earnings threshold (£5,044pa for 200607), with no employee contribution requirement. In addition, there would be an optional age-related contribution scale from employees, which would be matched £ for £ by employers (see table 1).
I believe this would ensure that all employees not already in an appropriate pension scheme would be given a modest start towards a pension, on which they can then build, as and when they can afford it, with further matching contributions by their employers. Table 2 shows illustrative pension results at various ages, based on core contributions only, and also with maximum matching. It will be seen that the latter is equivalent to about 1/2 x 1/60th at all ages, with the final outcome depending on the pattern of contribution saving chosen by each individual throughout his/her working life.

Concluding thoughts
For a typical workforce, compulsory employer contributions of 2% of pay above £5,044pa are equivalent to about 1.5% of total payroll and, with full matching, about 6% of payroll. So, the midway cost of 3.75% of payroll, given 50% of full matching, would therefore seem reasonably affordable for the provision of a worthwhile level of pension benefit. Moreover, this proposed structure should serve to overcome most of the perceived objections to, and disadvantages of, compulsion and of the current NPSS proposal.
And finally, despite the sales pitches of interested parties such as the ABI and the NAPF, I believe that, if we are to avoid repeating the ‘empty boxes’ of stakeholder, it is employees (and not employers) who must be allowed to choose their own NPSS provider. In this regard, let us not forget that the NI system already deducts NICs from all employees, and has since 1988 been remitting contracted-out rebates direct to the personal pension provider chosen by each individual employee. Surely that process could readily be extended?