Pickering trades wider membership for lower employer costs
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Alan Pickering's recent report on the simplification of pensions contains a total of 52 recommendations.
The report proposes measures to allow employers to cut their pension costs, notably and controversially by removing the requirement for spouses' pensions and increases to pensions in payment.
Employers would be able to make scheme membership a condition of employment to promote higher take-up, and pensions would vest immediately to aid the build-up of pension rights.
Numerous recommendations for the simplification of contracting out are put forward, including easing the reference scheme test for defined-benefit schemes.
Other significant proposals concern the regulator, reducing the number of generic pension products, scheme modifications and disclosure.
The government plans to publish a Green Paper in the autumn responding to issues raised by the Pickering report, as well as the awaited tax simplification report and its consultation paper on annuities.
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Alan Pickering's task was always going to be impossible. When the then Secretary of State for Work and Pensions Alistair Darling asked him to produce a report on the simplification of pensions (See DWP launches simplification review of pensions ), expectations were unachievably high. Administrative complexity was to be cut at a stroke; pensions were suddenly to become straightforward for the average person; security was to be retained or increased while regulation was reduced; costs were to go down and membership up; and a political consensus was to be conjured up. Inevitably, those hopes have been dashed and reactions to the recently published report1 have been mixed. Indeed, Andrew Smith, the new Secretary of State at the Department for Work and Pensions (DWP), has already dubbed key elements of the report "not attractive". However, he also described the report as "radical, ambitious and pragmatic".
The executive summary of the report draws out three themes that emerged during the review. These are:
A proportionate regulatory environment: with non-prescriptive statutory requirements focusing on objectives rather than process, backed up by a small number of codes of practice.
A pension is a pension is a pension: an even-handed regulatory environment that treats occupational and personal pensions equally, and streamlined legislation and regulation that should lead to a reduction in the number of "generic pension products" to just three.
More pension/less prescription: measures to provide pensions for more people, through compulsory membership and immediate vesting, and to reduce prescription and "modernise" benefits, principally by dropping the requirement for schemes to increase pensions in payment and by setting easier thresholds for contracting out (including making spouses' pensions optional).
This feature sets out a summary of all of the report's 52 recommendations (see box), provides a selective list of reactions to the report (see box) and below examines the report's main proposals under four broad headings - cutting costs for employers; widening pension coverage; lighter, simpler regulation; and simplicity and flexibility. It concludes with a brief preview of what happens next.
CUTTING COSTS FOR EMPLOYERS
Controversially, the report makes two key proposals to allow employers to cut costs, in the hope that they will not abandon schemes completely. Alan Pickering chooses decent pensions for the many over excellent pensions for the few, saying: "We need to balance the interests of those who are in pension schemes and those who are not."
The two recommendations are, first, for the removal of the requirement to index-link pensions in payment and, second, for the changes to the terms on which defined-benefit schemes can contract out.
Limited price indexation
It is currently a requirement that all occupational pensions accrued since April 1997 must be increased once in payment in line with the retail prices index, up to a maximum of 5% per annum - limited price indexation (LPI). The Pickering report proposes that this requirement be scrapped. For defined-benefit (DB) schemes, this would mean that:
pensions already in payment would be unaffected;
schemes could remove LPI for pensions already accrued but not yet in payment, but the value of the pension would have to be protected; so, where LPI was withdrawn, members would receive a higher starting pension under a new "equivalence test"; and
schemes could amend their rules so that LPI was not applied to future accruals.
Members of defined-contribution (DC) occupational schemes would be able to choose whether to receive LPI (as now), or to opt for a higher starting pension with no subsequent increases. This would not represent any cost saving for the scheme. (In fact, personal pension policyholders are currently only required to purchase an index-linked annuity with the protected rights element of their fund, and most opt for a flat-rate annuity on the rest.)
The cost of providing LPI for DB schemes is substantial, typically an extra 2%-3% of payroll (OP, June 1990). The Pickering report points out that it is now disproportionately expensive because of a shortage of the index-linked gilts that schemes need to match their LPI liabilities. If increases were discretionary, the report says, and did not need to be covered by the minimum funding requirement, one of the drivers for employers to switch to DC schemes would be removed. On the other hand, a reason for introducing LPI for all occupational pensions in 1997 was that inflation can rapidly erode pensioners' income.
Interestingly, on announcing publication of the Pickering report, Andrew Smith did not mention removing LPI as one of the "unattractive" provisions. However, the government wants individuals to save for their own retirement so they do not become a drain on state benefits. Without LPI, pensioners with modest levels of occupational pension at retirement could find that in time they come within the scope of social security benefits, especially if inflation takes off. Furthermore, the state second pension benefits that members of contracted-out DB schemes have given up are linked to national average earnings, and the guaranteed minimum pensions built up in place of the state earnings related pension scheme has to be increased in payment. To remove all increases now would appear to be politically very difficult.
Even if this recommendation were implemented, there seems little reason to suppose that employers would seek to remove LPI from DB schemes in preference to other cost-cutting measures, such as reducing the accrual rate for future service, a step already open to them, or replacing the scheme with a DC alternative. Indeed, a snapshot survey by the National Association of Pension Funds of 100 of its members reveals that 76% would keep index-linking, and that number would no doubt increase when hard decisions had to be made.
Reference scheme test
The report makes a series of proposals for changes to contracting-out. Some of these, dealt with below under "Simplifying contracting-out", are intended to reduce administrative complexity and therefore administration costs. Changes to the reference scheme test, however, are at least partly measures intended to allow employers to offer contracted-out DB schemes, but at a lower funding cost.
Currently, for a DB scheme to contract out, the scheme actuary has to certify that no more than 10% of the members will receive worse benefits than under the reference scheme. The report proposes that the rules be changed so that:
up to 20% of members could be worse off;
the test uses an accrual rate of 1/100th rather than 1/80th;
schemes are no longer required to provide a spouse's pension of at least 50% of the reference scheme pension; and
the revised test is based on all earnings, not just 90% of earnings between the upper and lower national insurance limits.
The first three changes would be to the disadvantage of members. In addition, it is proposed that the government should explore using career-average earnings rather than earnings in the final three tax years for the purposes of pensionable salary.
WIDENING PENSION COVERAGE
The report makes proposals aimed at widening scheme membership that have little to do with simplification - in particular, compulsory membership and immediate vesting. It also encourages multi-employer schemes (Alan Pickering was closely involved with the Plumbing and Mechanical Services (UK) Industry Scheme).
Compulsory membership
Since 1988, employers have not been able to make scheme membership compulsory (see Factfile: August 2002), except in limited circumstances (notably non-contributory schemes offering only death benefits). The evidence suggests that this has a significant effect on take-up: the 2000 general household survey: living in Britain found that 16% of full-time employees with access to an occupational scheme choose not to join.
The report proposes that employers should be able to compel employees to join their scheme. The same provision would apply to group personal pensions and stakeholder schemes provided the employer paid a minimum contribution, which the report says might be 4%. No minimum level of contribution is mentioned for occupational schemes, though one would presumably need to be applied. The argument in favour of setting a minimum standard would be less strong if individuals could enjoy concurrent membership of a personal or stakeholder scheme, which is possible but only in limited circumstances at present.
Despite support from the TUC, some trade unions are opposed to this recommendation. They do not regard it as acceptable for employees to be required to contribute to schemes because of the lack of security for their benefits, given that there is no guarantee that if a scheme is wound up full benefits can be paid.
Immediate vesting
Though compulsion was floated in the Green Paper A new contract for welfare: partnership in pensions (OP, February 1999), it was not pursued. This was partly because the circumstances in which concurrent membership was permitted then were even more restricted than they now are, and it was claimed that compulsion would disadvantage employees serving short periods of employment who receive a refund of contributions on leaving rather than a preserved pension. They would not have been able to make alternative pension provision.
As a result of this concern, the Pickering report recommends "immediate vesting". This would entitle members leaving with under two years' service to a preserved pension. It would ensure that those workers who hop from job to job build up a pension, and would benefit young workers in particular.
Under the current law, occupational schemes can refuse to preserve the pension of a member leaving with less than two years' service, and most do, though some offer to transfer the benefits to another scheme. A few, however, insist on preserving all pensions. A rarely used provision also allows schemes to buy out, with an insurance company, the benefits of leavers who have between two and five years' service (after they have been left for a year and provided there are no protected rights involved), though the report seems to overlook this.
The report recognises that the administration of large numbers of small preserved pensions could be costly. As a quid pro quo for immediate vesting, it therefore proposes allowing trustees to transfer benefits valued at below some specified amount (it suggests £10,000) to a "safe harbour" of the scheme's choosing if the member does not nominate where the transfer should go. It is envisaged that this would probably be a stakeholder pension.
LIGHTER, SIMPLER REGULATION
The report favours a number of changes aimed at reducing the amount of prescription included in legislation, transforming the way legislation is applied and modifying how the pensions industry is regulated.
Principles and codes
The horrendously complex Member-Nominated Trustees Regulations are cited to support Alan Pickering's case for much less detailed legislation. Statutes would be mainly purposive - that is, concerned primarily with the purpose to be achieved rather than the detail of how it is achieved.
Schemes would be left to decide how to implement the overall purpose. A small number of codes of practice would be produced, by government, the regulator and professional bodies (whose codes would need endorsement by the regulator). More reliance would then be placed on professional advisers "exercising and backing their judgment" and, though the report does not say so, on their integrity.
Critics maintain that disputes over the correct application of legislation would then more often have to be resolved by the courts, or the Pensions Ombudsman, and that much of the existing detail was introduced to prevent the type of abuse perpetrated by Robert Maxwell.
"New Kind of Regulator"
Alan Pickering wants to see what he calls a "New Kind of Regulator" (NKR) to replace the Occupational Pensions Regulatory Authority (OPRA). It would take on an advisory role, both for government and for professional advisers, and would be much less concerned with minor breaches of the law. The report wants to see a risk-based approach to regulation, similar to that adopted by the Financial Services Authority (FSA), and anticipates a cost saving as a result of not following up trivial matters.
Even-handed regulation for schemes of all sizes is sought. The review considered, but rejected, a "lighter regulatory touch" for small schemes. Somewhat worryingly, the report states that fully insured occupational schemes are currently not regulated by OPRA or the FSA.
It seems unlikely that the government will scrap OPRA and set up an entirely new regulator. Any change is more likely to be evolutionary, and will no doubt partly depend on the quinquennial review of OPRA currently being undertaken (OP, March and June 2002).
SIMPLICITY AND FLEXIBILITY
Reflecting his desire to cut down on prescription, Alan Pickering sets out a series of recommendations that leave existing regulation in a number of areas broadly in place, but cut out much of the detail, simplify the requirements or seek to encourage good practice. These cover statements of investment principles, "over-cumbersome" internal disputes resolution procedures, the use of standardised terminology, reviews of scheme documentation and the treatment of pension rights shared on divorce. In addition, the report approves the government's intention of scrapping the opt-out from the obligation for one-third of trustees to be nominated by members (OP, February and November 2000), but wants to see virtually no detail in the legislation.
Rather more significant changes are proposed on contracting-out, scheme modifications, disclosure and reducing the number of different generic pension types. These are discussed briefly below.
Simplifying contracting-out
In addition to the changes to the reference scheme test outlined above, there are a number of other proposed amendments concerning contracting-out. Some of these, such as the recommendation to remove the restriction on the date from which contracted-out rights are payable, are intended to give members more flexibility. Some offer administrative convenience for schemes; for example, it is proposed that schemes would be allowed to convert guaranteed minimum pension rights to reference scheme test benefits, using an actuarial basis.
One recommendation, at least, offers advantages both to schemes and members: this is the proposal that all scheme benefits, including contracted-out rights (and presumably additional voluntary contribution benefits, though the report does not say so), could be used to calculate the retirement lump sum. This would allow some members a greater lump sum, and ease the calculation for schemes. It would be subject to Inland Revenue rules.
Scheme modifications
Section 67 of the Pensions Act 1995 has been troublesome and the report proposes a means of easing its operation. This provision prevents changes to schemes which could be detrimental to members' accrued rights. Often, employers wish to modify schemes in such a way that accrued rights are affected, but are prevented from doing so even though the change is likely to yield equivalent or better benefits.
The report recommends changing the section so that modifications can be made if accrued benefits are "expected" to be equivalent.
Communications not disclosure
Alan Pickering wants to see changes to the Disclosure Regulations. The thrust of his argument is that schemes should be communicating with members so they have the information they need to make informed decisions, rather than disclosing information.
He would like to see the information that schemes must provide to members, especially when they are considering joining, drastically cut back and the time limits removed from legislation. The NKR would adjudicate on disputes. Other information would be available as now, except that it would normally be free - schemes can currently make a reasonable charge, though the infrequency of requests ensures this is not an issue.
To aid effective communication, the report urges discussions with the FSA aimed at allowing employers more flexibility to promote their schemes to members.
Fewer types of pensions
One of the most far-reaching proposals in the report is for the reduction in the number of generic types of pension, which, it says, amounts to 15 money-purchase types alone, though it does not specify them. This has attracted surprisingly little comment. The report contains sparse detail of what is envisaged, perhaps because the issue is so closely allied with taxation, which is being considered by the separate tax review, the report of which is still awaited.
The report recommends that the number of generic pension types should be reduced to three: defined-benefit occupational schemes; employer-sponsored money-purchase arrangements; and individual pensions (including top-ups for occupational plans). Additional voluntary contribution (AVC) arrangements would stay for the time being. However, if the existing rules on the concurrent membership of different types of scheme were extended and all members of occupational schemes could also contribute to stakeholder pensions, the obligation on schemes to offer an AVC option might be removed.
Included on the report's wish list is the desire that commercial providers cease trying to differentiate between products that are not generically different. However, it accepts that a stakeholder provider that has a product which beats the minimum standard should be able to advertise the fact.
WHAT NOW?
In his statement to the Commons, announcing publication of the report, Andrew Smith said that, subject to responses received, the government planned, at the very least, to take forward the recommendations that:
improve the way in which contracting out is administered;
streamline procedures and reduce general administrative burdens;
look at better ways to provide advice through the workplace; and
improve information to scheme members.
It seems unlikely that some of the more controversial proposals will see the light of day in legislation, at least in their current form. Others, however, could foreshadow important changes in the nature of pension provision in the UK.
The government is now committed to producing a Green Paper in the autumn, taking a radical look at the issues raised by the Pickering report, the forthcoming report of the tax simplification review (OP, May 2001) and its consultation exercise on annuities (OP, March 2002). Mr Smith says: "The acid tests for the Green Paper must be increasing the level of savings for retirement and making a secure occupational pension accessible to as many people as possible." Neither of these were set as aims for Mr Pickering.
Three other key issues may be addressed in the Green Paper: (a) compulsory contributions; (b) raising the basic state pension and the whole future of contracting-out; and (c) raising retirement ages.
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When the review was announced, Alan Pickering was widely seen as an ideal candidate to undertake the work. He had a long career as a trade union official before joining the consultancy firm Watson Wyatt, and has served as a board member of the Occupational Pensions Board, the former regulator. He has also recently chaired the National Association of Pension Funds. The main terms of reference for the review team (See DWP launches simplification review ) were "to identify a package of options for simplification" of Department for Work and Pensions (DWP) private pensions legislation and for the "reduction of compliance costs", to consider whether "the law is proportionate to the policy purpose" and to report by July 2002. In essence, the review's task was to find ways of removing barriers to the provision of pensions by employers. Alan Pickering was not asked to find ways of encouraging higher levels of private pension scheme membership, higher levels of pension saving or more people to contract out of the second-tier state pension, but these considerations were part of the sub-text for the review. Although the review had to have regard for the impact of its recommendations on tax rules, it had to steer clear of making proposals in that area given the separate tax simplification review under way. Alan Pickering led the review with the help of a team of nine, made up of DWP officials and professional advisers. A consultation paper was issued (See Consultation paper on pensions simplification ) and 90 organisations made submissions (See Submissions to Pickering simplification review - for a summary of some of the main ones). In addition, meetings were held with a total of 32 mostly representative bodies in the UK. The resulting report was delivered on time! |
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This feature is based on Alan
Pickering's report, on our previous analysis of submissions to the inquiry
and on numerous immediate responses to the report from a range of
organisations. |
1"A simpler way to better pensions: an independent report by Alan Pickering", available on the internet (at www.dwp.gov.uk/publications/dwp/2002/pickering/report.pdf ), and from the Stationery Office, tel: 0870 600 5522 (enquiries), price £14.25 plus £3 p&p.
