With the nation grappling with the biggest cost of living crisis for decades, the industry will need a more pragmatic approach to supporting financial wellbeing and pensions saving.
That was the view of delegates at a recent Corporate Adviser round table, who noted the diverse and significant challenges facing individuals, employers and government, and who agreed creative solutions would be needed to educate and guide employees towards better financial wellbeing and adequate pension saving.
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Setting out the challenges, Aegon public affairs director Steven Cameron said: “Coming out of the Covid pandemic I am sure most of us expected the government’s focus would be on economic recovery, to the exclusion of everything else and that this would be the focus of the Chancellor’s recent Spring Statement.
“But now we have a number of other critical issues facing the country, which will impact both government policy and the regulator’s priorities when it comes to pensions.”
This includes the recent problems caused by spiralling inflation and a cost of living squeeze, both worsened by the war in Ukraine. Alongside this there are the longer-term issues of climate change, net zero targets, the levelling-up agenda and funding state pensions and social care for an ageing population.
Juggling short-term priorities with long-term factors like pension saving was a delicate balancing act, said delegates. Most of those attending the debate agreed that the key to improving financial wellbeing in retirement was reform of the auto-enrolment system, now approaching its tenth anniversary. However, while there was agreement that current AE contributions remained too low — opinions differed as to when and how these contribution levels should be increased.
Cameron said that recommendations made in 2017 to improve the AE regime were likely to be further delayed. He pointed out that the review’s recommendations — to bring down the AE age limit from 22 to 18, and to base contributions from the first pound of earnings — were widely accepted by those in government. But he predicted earlier plans to implement these changes in the middle of the 2020s would be postponed until the end of the decade at the earliest.
“At the time [of the 2017 review] the government was concerned that introducing these changes would be putting too much of a burden on employers, who were facing Brexit changes.”
Opt-out risk
But many businesses now are in a worse financial position, he said, given Covid losses in recent years. At the same time there is the risk that employees, particularly those on lower incomes, could opt out altogether if they face higher AE rates as other bills and taxes are rising.
Given these inevitable delays he says that the industry should now be starting to lobby those in power for further changes they would like to see, that can help improve financial wellbeing and resilience.
Michael Ambery a partner in Hymans Robertson’s DC consulting team said that the current 8 per cent contribution level is “not good enough” and may be actively mis-leading many people.
He pointed to research from the Pensions and Lifetime Savings Association (PLSA) that showed that six out of 10 people paying these minimum contribution levels are confident this will give them a reasonable standard of living in retirement, because these are levels are set by the government. The reality though is very different though — which the industry, regulators and government all recognise. However he says not enough is being done to address this central issue.
“We need lobbying from the industry again to say those total minimum standards aren’t good enough. The default levels need to increase and there needs to be better engagement on top of that to encourage people to save more.”
Punter Southall managing director, employee benefits Alan Morahan agreed and said more needs to be done to tackle the “government and corporate short-termism”. Financial wellbeing in retirement could decline sharply in the years ahead, he said, as we move from a world where many people retire with at least some DB benefits to a wholly DC environment.
“Our economy is currently funded by the so-called ‘silver parents’ and this is because they have these DB benefits. We’re moving to an environment that will be vastly different and this will affect the government’s ability to raise taxes in the future.” This he says could hit future state pension benefits, further exacerbating these problems.
Contribution reminder
Morahan pointed out that before DB pensions disappeared from the private sector a lot of companies were funding them with average contribution rates of 12 to 15 per cent. “They were funding at these levels then and bearing the risk. Now we should be saying if you are not bearing this risk then at least fund to a decent level.
“We have let corporates get away with this. It may not be the right time to make a dramatic change and significantly increase contribution levels. But the truth of the matter is we need to do something about it at some point. When will be the right time? We know that the 3 per cent that many employers are paying is wrong. It’s absolutely wrong. And we need to do something about it.”
However, some of those attending the event made a distinction between the academic and the pragmatic when it comes to improving pension provision.
Buck benefits consulting leader Mark Pemberthy said the contract between the employer and the employee is now very different to what it was 30 years ago. “People don’t work for the same employer for a lifetime, so I think there is a transfer not just of risk but of responsibility too from the employer. Many are catering for a multi-generational workforce and are looking to attract, upskill and engage employees across these different age bands, but with the knowledge that they are going to be in the business for maybe five years.”
As a consultant, he said he talks to employers about their wider benefits programmes and what they can do to address issues of financial wellbeing. He said that the vast majority of the employers Buck works with already have pension schemes, often offering more than minimum contributions.
“The challenge they have is that for big swathes of their employee population, and new hires, having a generous pension scheme is not having any value in those conversations about reward and retention.” He said that because the employees they are trying to keep don’t always value their pension, or the benefit of increased contributions, then employers are looking instead at other elements of their benefits packages — be it Isas or Lifetime Isas, student loan repayments or sidecar savings options. “Employers might have concerns about the long term, but that’s not where their priority lies. They are looking at the shorter-term wellbeing needs of the business, and their people.”
Academic or pragmatic
Cameron agreed this distinction between the academic and pragmatic is very pertinent to the current pensions landscape. “We know what the numbers are and what they should be. But equally we know that individuals don’t always follow the numbers. A lot of people argue that 8 per cent is not enough and it should increase to 12 per cent. I can see the merits of that, but there are also downsides, particularly for someone on low earnings.
“Perhaps in the meantime we need to encourage both employers and employees not to wait for the government to move on this issue, but to take voluntary steps that go above and beyond the minimum requirement for auto enrolment.”
Aegon UK managing director Linda Whorlow added that this needed to be supported by effective education and engagement with workplace pensions. Given the current financial difficulties many individuals are facing, this becomes more important than ever, she said.
Cameron pointed out that AE reforms are not the only regulatory initiative currently impacting the workplace pensions industry. One of the other big changes is what he describes as the government’s “obsession” with using DC schemes “as a superpower to invest more in productive finance and illiquid assets.”
Cameron said: “This is very much about helping Britain build back better as it comes out of the pandemic, but at times this is dressed up as improving value for money for members. There is an element of that, but let’s not kid ourselves: a lot of this is about getting more money into productive finance to boost the economy.”
There have been a number of recent regulatory changes to support this initiative he said. This includes legislation to allow new Long Term Assets Funds (LTAFs), steps by the Department of Work and Pension to encourage more consolidation within the industry, and proposals to exclude performance fees from the AE charge cap. Cameron said he does not think all of these will necessarily support the financial wellbeing of members. “I am particularly concerned that changes to the charge cap will reduce confidence among members.”
Alongside this is consultation on extending trustees disclosures so they have to state their policy on investing in illiquids. This would complement current legislation which requires trustees to disclose ESG policies to members in their Statement of Investment Principles.
Cameron said: “I expect this to continue to evolve. We have started to see demand from members for ESG-linked or sustainable investments within their pension. But I’m not sure if they are demanding their schemes invest more in productive finance. I don’t think they will engage on this issue in the same way.”
Barnett Waddingham national DC consultant Andy Parker argued large workplace schemes should be investing in illiquids. “It is absolutely the right thing to do. But we keep hearing that this is what employees want. No they don’t. Most of them don’t know what they want to invest in at all. They just want a pension that is going to give them a decent retirement at the end of the day.”
He pointed out that discussions about illiquids can easily get bogged down in the details. “There’s a lot of discussion about how you can work on daily priced funds if you’ve got illiquids in there. But these are members who are investing for 40 years. Why should they be worried about
whether they can or can’t get their money out tomorrow.”
He added that providers have a “massive challenge” delivering on this. The regulatory landscape had changed significantly in recent years he said. “These are not minor changes, they are absolutely huge. I would like to see the government give the industry time to get these things right, not just keep adding one massive change after another.”
Parker pointed out that the UK was moving considerably faster on many of these issues than those providing pensions in other comparable jurisdictions, particularly the US. Conversations with US fund managers suggested that they are concerned about including significant exposure to ESG funds or illiquids as this may lead to litigation at a later date if these funds don’t perform as well as the ‘non-responsible’ versions.
Lane Clark & Peacock senior consultant Heidi Allan said that it was clear the regulatory push in recent years has been towards more sustainable pensions and investments, a trend she expected to continue. Allan said this may help employees engage more with pensions, and so help improve financial wellbeing. However she added that there remains considerable work to be done on this issue.
ESG perspective
“When looking at the latest research it is clear that when it comes to everyday spending and saving, ESG is part of parcel of people’s decisions. In the short-term they don’t want to put money in companies that invest in child labour and manufacture from fossil fuels and so on. This perhaps reflects their shopping decisions, what to buy, where to socialise and how they travel.
“These ESG issues are less of a consideration though when people were asked to think about the decisions they make regarding their medium term savings, although some of them still say it’s a factor, albeit less of a one.
“But when it comes to retirement this all but disappears. There’s a disconnect, especially if they are in a default fund. The future seems a long way off and the money is seen as sitting in a pot outside of their day-to-day finances. People perhaps don’t really have a sense of ownership over these savings, the money comes out of their salary and then seems to sit in the ether. They don’t have a massive amount to do with it, or control over where it is invested.
“One of the biggest challenges is how we get people engaged about these issues and these savings. How do we encourage people to take ownership of these longer term savings, to make them see them as an essential part of their overall financial wellbeing?”
She said that while this isn’t an easy conundrum to solve, it may be an important issue when it comes to addressing long-term financial wellbeing. “If people start to see how valuable their pensions are, when it comes to making day-to-day financial decisions they may be less likely to reduce or cease pension contributions. This is going to be harder decision to make if they see pensions as a valuable resource.”
Engagement and education will remain an important part of this she said, as will future regulation. Cameron added that the new ‘value for money’ regulations will also have a key part to play, as will the FCA’s new Consumer Duty.
“Thankfully there is a growing acceptance that this is not just about charges but also investments, customer service and good consumer communications. This will be key if we are to improve engagement, which is critical to planning ahead and improving financial wellbeing.