Nigel Waterson, Chairman, NOW: Pensions
Twelve months after the very first companies started automatically enrolling employees into pensions, the project to get the nation saving has earned a positive first year report.
‘Solid progress thanks to lots of hard work’ would probably sum up this initial phase in the vast auto enrolment project. With more than a million more people now saving for their retirement than a year ago, and opt-out rates far lower than most had predicted, there is much to applaud.
But this early success is no reason for the government, regulators or pensions industry to rest on their laurels. Many challenges lie in the months and years ahead and much work remains to be done.
Beginning this month, organisations with as few as 500 employees will reach their staging date and consequently, the number of employers needing to find a pension scheme will increase exponentially.
Last year fewer than a hundred employers reached their staging date between October and December. More than 3,000 will do so in the same period this year, while May 2014 will see more than 12,000 employers required to stage in a single month.
One report from Towers Watson has calculated that pension providers will typically be working at seven times normal capacity by December, while pension advisers are likely to be similarly stretched. Fears around capacity could yet prompt some providers to withdraw from the market leaving some firms with a last minute scramble to meet their obligations within the required timescales.
At the same time, some providers are taking the view that smaller employers are too expensive to serve and have chosen to withdraw from the corporate pensions market altogether.
Rising opt-out rates?
While it is widely anticipated that opt-out rates will increase as smaller companies stage, it’s by no means a certainty. Many smaller companies take a much more paternalistic approach towards their employees and due to their size, communicating to staff is easier than in larger firms.
But, the economic climate remains challenging and in the coming years, as minimum employee contributions increase from 1 to 4 per cent of band earnings, some workers will undoubtedly feel the squeeze and opt-out.
Recent research we conducted revealed that more than one in four Britons (28%) have stopped saving in light of the recession and haven’t saved since. While one in three has less than £500 in savings and as many as one in five (15%) has no savings at all.
Lack of trust in the industry
Another potential barrier to the success of auto enrolment is the fundamental lack of trust and confidence in the financial services industry.
As auto enrolment continues, scheme members will need to be continually reassured that their pension is delivering value for money and remaining enrolled in the pension scheme is worthwhile.
Savers will quickly become disillusioned if their hard earned pension savings are being eaten up by high charges. Similarly, if the performance of their fund is volatile, the motivation to stay enrolled will be sorely tested.
The government therefore has a duty to tackle high charges and ensure that default funds, which 90-97% of members will end up in, are fit for purpose.
At the moment, the typical default fund in the UK is highly weighted towards equities, with an allocation of nearly 80%. This exposes members to a high degree of volatility. Anecdotal evidence suggests that if members see their fund value drop by more than 16%, opt-out rates will increase. As such, default funds need to be structured in such a way that they do not expose members to excessive risk.
The NAPF’s consultation around including default funds in its assessment of the Pension Quality Mark is a definite step in the right direction as employers need a way of easily identifying good quality pension schemes. By including default funds in the PQM benchmark, employers will have greater assurance that the default fund is going to do what it says on the tin.
Communicating a difficult message
Auto enrolment will go a long way to helping people get into the savings habit, but if they just contribute the minimum, the reality is they won’t have enough saved for a comfortable retirement.
In order to achieve their retirement ambitions, a combined contribution of at least 12% is needed.
While auto escalation is in place to ensure that contributions rise over time, the maximum combined contribution from October 2018 onwards is 8% which experts agree isn’t high enough.
Communicating this message is going to be difficult and there is a fine line to be trodden between ensuring people remain opted-in and encouraging them to increase their contribution levels. But, there is a real danger that people will assume that auto enrolment will provide for them in retirement and this simply isn’t the case.
Employers also need to be encouraged to contribute above the minimum. As time goes on and pensions become part of the culture at work, job hunters will demand to know more about the pension provision and pensions will once again become a more valued part of the overall compensation and benefits package. This will hopefully encourage employers to make their pension a selling point and not just view it as a regulatory burden.
The government might consider increasing the minimum contributions to tackle this problem. Nonetheless, employers and pension providers need to focus on this sooner rather than later to prevent employees receiving a nasty shock when they come to buy their annuity.
What are the threats to long term success?
Pensions need to be part of the culture at work but right now, consumers don’t trust pension providers to give them low cost, good value, honest schemes. The OFT, DWP, TPR and NAPF are all working on various initiatives to address the issues of quality and value for money in the UK pensions market but this work will take a long time to filter down to consumers.
In addition, providing low cost schemes suitable for auto enrolment is all about scale and much more work needs to be done to consolidate smaller, poor quality schemes that don’t offer value for money.
Auto enrolment has got off to a good start but the industry, government and regulators need to continue to work together to safeguard its future success and ensure that the progress made to date does not ebb away over time.