As the UK puts a comprehensive set of pension reforms into motion, Helen Morrissey questions how prepared the industry will be to cope with the pace of change
When the Coalition government came to power in the UK in May it faced many major challenges, not least the reform of the pension regime. While the previous Labour government had made attempts to simplify the system, most notably streamlining tax regimes in 2006, subsequent policy changes had resulted in the system remaining as complicated as ever. Cost savings were also high on the agenda for the new government faced with reducing a sizeable budget deficit.
Over the past six months pension minister Steve Webb has remained true to his word as he moves to “reinvigorate” the pension system and has set several key processes in motion. The proposed reforms include:
• Scrapping of the default retirement age
• Proposing increasing State Pension Age to 66 by 2020 – a full six years earlier than that proposed by the Labour government
• Simplifying the State Pension system by proposing a flat rate of £140 ($217) per week per pensioner and scrapping the complicated system of means-tested benefits. However, these changes are not expected to apply until at least 2015.
• Deciding to proceed with the auto-enrolment of all employees earning more than £7,475 from 2012. Employees will have the opportunity to opt out of the system if they wish but they will be re-enrolled every three years.
• The launching of a review into the viability of public sector pensions. The review, which will be published in 2011, is headed by previous Labour secretary of State for work and pensions Lord John Hutton.
• A change in how pension increases are indexed from the retail price index to the historically less generous consumer price index. While the move is expected to result in smaller pension increases for pensioners, it will prove welcome news for cash strapped employers battling against growing defined benefit scheme liabilities. Potential savings from these changes have been estimated at anything between £25bn-£100bn.
The most recent change came in October when Webb announced wide scale change to how pension tax relief will be calculated. Annual allowances have been decreased from £255,000 to £50,000 while the lifetime allowance has been reduced from £1.8m to £1.5m. These rules are subject to a three year carry forward rule whereby any unused allowance can be included in any of the following three tax years and tax relief was set at the full marginal rate. It is expected these changes will amount to a £4bn cost saving for the Treasury.
While the reduction in these allowances may not sound like a good idea in theory, in practice this system replaces the previous proposals which tapered tax relief so that those on gross salaries of £180,000 only received pension tax relief at the basic level of 20% (rather than 50%) on contributions. When these rules were announced in 2009, it led to widespread criticism of government policy and the concern that higher earners would turn their backs on pension provision.
PricewaterhouseCooper’s pensions partner and chief actuary, Raj Mody believed these changes are a welcome simplification to the rules previously in place.
“The new regime is significantly more welcome than that of the Labour government,” he said. “They (the Coalition government) managed expectations very well in that they slashed the annual allowance yet people welcomed it.”
Indeed, the government’s proposals for pension reform have by and large been welcomed across the industry. “I think it’s too early to say if all of these changes fit together in a cohesive fashion as yet but I will say the government has hit the ground running,” said AWD Chase de Vere technical director, Param Basi. “They have done a lot to tackle the mistakes of the last administration but they have been blighted by cost issues. However, I’m quietly positive about how things are progressing. I’m pleased they have addressed a lot of the key issues and moving away from a regime which was turning people away from pensions.”
Another major reform given the green light was auto-enrolment. This was a policy put in place by the previous government which aimed to enrol workers earning over a certain amount (initially £5,035 a year but since increased to £7,475) into a pensions scheme. This scheme could either be the state run National Employment Savings Trust (NEST) or a similar pension vehicle provided by the employer. Under the NEST structure an 8% contribution would be taken comprising 3% employer, 4% employee and 1% tax relief.
When pensions minister Webb announced the process would be put on hold while a thorough review was carried out there were concerns that the project could either be significantly curtailed or else derailed completely. However, in October it was announced that the scheme would proceed as planned.
“It’s been a difficult time for the pension industry as we’ve had a lot of planning blight as we waited for decisions to be made on NEST. There’s still a lot of detail to be crunched through but the government decision to move forward with auto-enrolment and NEST was significant,” said National Association of Pension Funds chief executive Joanne Segars. “We were always confident that NEST would go ahead as we had gone a long way down the path to creating it but we were concerned that there could be some shrinkage in the number of people who could be auto-enrolled.”
However, the decision to proceed with NEST was not welcomed so warmly in all sectors of the industry. Telegraph pension scheme manager James Churcher expressed some concern over how NEST would work.
“I am doubtful about NEST but I’m hoping to be proven wrong,” he said. “I feel it is overly bureaucratic. I think the wrong people will opt out so not everyone who will be in it should be in it. I also have concerns that the government put together a service department to do work that providers in the UK such as Standard Life and Legal & General already do perfectly well. I think we shouldn’t have built this huge NEST framework when we could have tweaked the employer duties to make the mass market viable for products already being offered by pension providers. However, the decision has been made now and it is for us to make it work.”
The need for clarity
While much of the changes have been welcomed by the industry as bringing much needed clarity it’s also fair to say that we are still waiting for much of the detail as to how these changes will work together in practice. Will the government succeed in finally simplifying the pension industry or tying the industry up in knots for years to come?
“My concern is in the detail rather than the design,” said Mody. “For instance if the annual allowance is not increased over the next four or five years then it may not look so generous once you’ve allowed for inflation.”
He continued: “If you look at the change from RPI to CPI when calculating pension increases the details are again far from clear and that’s a concern. Is it a practical approach or will it conflict with the protection of people’s accrued rights? On the one hand it’s welcome that the government took early steps to address this issue but the following detail has yet to come through so people can’t work on it.”
It would seem that the industry is very much caught in the middle of knowing that changes are coming but as yet lacking the detail to be able to do anything about them. However, as the reform schedule continues to move forward quickly will the government be able to cope with its own workload? There is also a concern that this bottleneck of work will also affect scheme managers and advisers who will struggle to cope with the regulatory demands being placed on them.
“We are at risk of exhausting the industry’s capacity to deal with these changes,” said Mody. “Company agendas aren’t dictated by regulatory change – they have a day job to do. In totality there are a lot of issues out there to be dealt with and we run the risk that companies will be so overloaded that they take the easy decision rather than the right one. We are looking at a very intensive time for the industry as the timetable for change stretches beyond 2013. Of course we will see innovation and good advice but the pace of change will be relentless.”
So the UK pension industry has a great deal of change to contend with over the coming years and pension scheme managers will need to brace themselves if they are to cope with demands being placed upon them. However, there is a positive sense that the results will be worth it.
“As an industry I feel we are coming out of the doldrums associated with the large scale closure of DB schemes,” said Churcher. “We have accepted the increasing trend not only towards the establishment of DC, but also alternative schemes like career average. We in the pensions industry are now keen to meet the challenge of how to make sure these changes and new schemes work really well and I feel we have every reason to be positive in the future.”
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