Astrong faith in nudge and a deep focus on conflicts of interest are the two themes that emerge when talking to Baroness Jeannie Drake, the Labour peer who was one of the original architects of pensions auto-enrolment.
To this day she remains one of the most effective parliamentarians on pension issues in either of the Houses of Parliament – her latest intervention being her recent amendment to the Pensions Bill, calling for commercial providers to be excluded from a new pensions dashboard for the first year of operation. Taking the time to examine the behavioural responses to a dashboard and tailoring the member journey in light of this behaviour is, for Drake, key to avoiding repeating problems of the past.
“We know there are behavioural biases, what the FCA calls ‘taking the path of least resistance’. We know the consumer side is weak and the information architecture supports the providers. But we don’t know what the behavioural response to the dashboard will be, so we need to give ourselves a year of experience before we open it up,” she says. “There is also a hope that the pension dashboard will build a momentum to bring small pots together. But we need to see how it evolves. We need to review the landscape, particularly in light of Covid. We don’t yet know who is going to be worst affected. It could be younger people, or women, or certain sectors.”
The dashboard has to complement the Government’s overall strategy to support savers. “When you know more about what the consumer response will be to the dashboard you can understand more the activities and policies that should come off the back of the dashboard. Do you offer access to innovative defaults? Do you offer efficient routes to guidance? Set requirements on data presentation? Pension freedoms came in at speed with no consumer impact analysis. The consumer protections in that instance have been built up after the event,” she adds.
She rejects the idea that an open finance approach will supersede a centralised dashboard.
“There are big questions about verification and security around a person’s ID. It will be the state mandating access to the data – this is not like open banking, it is different. There are vulnerable customers. Issues such as how do you stop scamming and misselling,” she says.
Looking back at the state of the UK pensions system at the turn of the millennium and you can see just how influential the reforms proposed by Lord Turner and his Pensions Commission co- authors, Baroness Drake and Professor John Hills, have been. By 2004, 54 per cent of private sector workers weren’t saving in a private pension, relying on the state to fund their retirement. Since then around 10 million workers have been brought into pension saving.
The trio of reforms that flowed from the Pensions Commission were all adopted by government, leading to a raising of the state pension age, the introduction of a single-tier pension and the launch of auto-enrolment.
Auto-enrolment has been generally accepted as a huge success. Drake sees many positives but also unfinished business. “Pension freedoms changed the retirement market fundamentally, although this came after the Commission’s report. We did flag the emerging issue with the self-employed and the gig economy. And we had identified the consequences of too many entrants into the market in response to auto- enrolment. There were so many market entrants that it created inefficiencies and new risks for the savers and this needed to be addressed. The new master trust authorisation and supervision regime was a response to those risks.
“The big prize was auto-enrolment which was the only way to reverse the decline in pension saving and employee engagement with workplace schemes. We could see inefficiencies in the market and with so many small employers to service, establishing Nest was essential. We still have the small pot problem, and it is growing. Hopefully consolidation will reduce this to an extent,” she says. “I was very pleased to see the Chancellor’s continuing support for autoenrolment in the job protection measures he has introduced.
While she was part of the team that created Nest, she is now a trustee of its biggest competitor, The People’s Pension. She declines to comment of potential conflicts of interest within rival vertically- integrated providers, but says: “The regulator is setting up the authorisation scheme to be clear about the discretion and duties trustees have and to make clear they can make changes where they feel there are conflicts. Managing conflicts of interest is well rooted into the operation of master trust regulation.
Pension trustees are under pressure from regulators in how they interpret their fiduciary duty towards their members and their investments. Does it extend to simply maximising returns, or should broader issues, such as the environmental condition of the world the member will retire into be taken into account? Similarly, should the impact of infrastructure investments on the economy in which the member lives be taken into account? On both points she is cautiously flexible.
“What is good practice is changing, as is the case with ESG,” she says. “And when it comes to infrastructure, pension investments are long-term and generally speaking this makes them good for pensions.
But when it comes to how that is implemented, the devil is in the detail. Charges are key and we have a consultation on this. Governance is absolutely key.
“If there is £1trillion to invest in the country the members work in there can be a virtuous circle, but it needs to be governed in an absolutely robust way. It is inevitable that any government will say that infrastructure is key. But it is for those with a fiduciary duty to assess whether particular investments are in the interests of the scheme members.
“On ESG, I am in the school that says if you don’t mainstream ESG issues the return on investment will be lower longer term. You can’t ignore climate change or pandemics. Also, this idea that shareholder interests are dominant is being increasingly challenged – social impact is going to come to the fore,” she says.
“I think the government is moving from enabling ESG factors in investing to expecting it. You can see that in the wording of the Pensions Bill. The issue is how do you do it, how do you deal with charges for members and how do asset managers respond.”
She doesn’t see a stellar future for collective DC (CDC) any time soon.
“Now is a difficult time for employers to go into a novel form of pension. The first CDC is a modest venture. To have a scale multi-employer CDC scheme where employers are unconnected would require new secondary legislation. The government are starting modestly with an authorisation regime for CDC schemes used by a single or connected employers. We have yet to see how collective risk sharing between scheme members will evolve under the new regime.
“Will it take off in the next 3 to 4 years? Probably not. When leaving the EU has been addressed and resolving the consequences of Covid and the economy is more settled, maybe.”
But is she convinced by the theoretical gains to be had from a CDC model?
“Yes, though it does depend how many employers and members you have using such a scheme. You need scale and a reliable supply of active contributing members into the scheme to sustain the collective risk sharing across the members, although some supporters of CDC may disagree with me,” she says.
She accepts that the speed with which state pension reform was introduced has created winners and losers. She challenges the suggestion that for many years to come many of the contracted-in working poor will be worse off as a result of a combination of auto enrolment and the removal of state second pension in favour of the single-tier state pension, because they will never recoup the state pension they have lost through their AE savings.
“That assessment depends on how you think the second pension was going to develop. The Pensions Commission proposal was for the state second pension to be flattened by 2030. But that timescale had already been accelerated by successive governments and could have been accelerated further. But with the rapid move to flat rate in 2016 there were winners and losers. Significant numbers of women and the self-employed were better off. But there is no doubt there were people in DB schemes who were given the opportunity to build a higher state pension than they might have got otherwise.
“Any movement to flat rate comes with complexities. When the commission looked at the problem we identified the decline in the value of the state pension taking place which together with the decline in private pension saving meant pensioners would become poorer and more and more would come into means tested benefits. But I was surprised at the speed at which they did the change. I did not see that coming so quickly,” she says.
“I was also very unhappy when the earnings trigger for autoenrolment was raised so significantly so excluding so many women from the eligible population. I also think carers eligible for credits towards their state pension should be given a credit into their private pension pot.”
With the government having to incur massive spending in responding to the consequences of Covid at some point in the future, the question of tax relief is inevitable. Drake expects change, and says for her this became apparent as soon as pension freedoms were introduced.
“The super-advantaged tax relief structure was to support an income stream in retirement. If it was no longer compulsory for pension savings to have to do that then questions on tax relief would emerge. My first thought when pension freedoms happened was that tax relief would be vulnerable. It is a difficult area because the lion’s share of the relief goes to defined benefit pensions. There is lots of complexity here, whether it is the higher paid consultants in the NHS or employers supporting contributions into DB schemes. But the Treasury must be looking at it.
“At the moment most of the tax relief goes to the higher paid. But a public policy interest in having tax relief is to achieve adequate pensions among the 80 per cent or so of people with low to moderate earnings to ensure they do not have to rely so heavily on the public purse. That would suggest a flat rating of tax relief to achieve a fairer distribution of the tax incentive to save as between lower and higher earners.
“I do favour staying exempt, exempt, taxed, rather than taxed, exempt, exempt. This is because you want the benefit of the tax relief going in at front. If you didn’t get it up front you would have to be absolutely sure you would get it at the other end, relying on future governments to honour the promise. There would be a risk of intergenerational unfairness” she says.
“You also have people who pay no or less tax, because they are low income earners. To them the value of tax relief can be quite high which is why it is important to deal with the issue that Baroness Altmann has been campaigning on that low earners get tax relief at source or comparable treatment. I wouldn’t be surprised if they did review all this but it is going to be complicated,” she says.
So what lessons has she learnt having played such a pivotal role in the world of pensions? “Public policy chose to harness inertia to get millions more to save. If it had relied on active decision-making none of this would have happened. We can’t lose sight of the huge success we have had
from harnessing inertia for the public good. Engaging people and choice are really important but they don’t deliver the scale of change needed to deliver good outcomes. So how you harness inertia and create pathways to better choices and outcomes for savers is really important. I do worry that individual choice is getting more attention than effective pathways and defaults that will give better outcomes for many people in the retirement market,” she says.
And how does she reflect on the huge policy decisions she has been a part of? “The decision was taken to deliver the second tier pension provision through private savings and autoenrolment was a game changer. Providers in the marketplace play an important role but we have to be careful that we do not lose sight of the public policy outcomes we are trying to achieve. A pension system is intended to deliver outcomes in terms of securing income streams rather than just pots. We need to think if we look back in 30 years’ time and ask has the system delivered good outcomes for pensions, what would today’s and tomorrow’s policy decisions contribute to that answer.”
And what future areas for policy intervention does she see?
“The Pensions Commission made the observation that dealing with increasing longevity involved looking both at health and social care systems. We were only looking at one part of it, pensions, but we can’t neglect social care any longer. If ever you wanted evidence of the need to sort out social care, you just have to look at what Covid exposed.”
And should here be another Pensions Commission? “Delivering a sustainable state and private pension systems are long term projects which cannot be delivered in the lifetime of any one Government. There needs to be consensus over the long term policy framework and core principles, outcomes can take decades to come through. But securing and maintaining a consensus is not easy and pension policy will and should be subject to continuing debate over time, in the light of new information becoming available.
“I would support the creation of a permanent Pensions Advisory Commission charged with assessing developments and laying before Parliament every three to four years a report which could include describing key trends in demography, pension provision, employment and retirement patterns, and their implication for public decision making.”