Alternative models to a National Pensions Savings Scheme (NPSS) have not convinced the Pensions Commission they would deliver a set of benefits which would justify the extra cost.
In its third and final report, the Pensions Commission says the issue of the precise charges which can be achieved in the NPSS, or any of the alternative models, is less certain and to some extent less important, arguing what matters is relativity.
However in the 45-page document, the Commission says in its judgement the indicative target suggested in the Second Report, of 0.3%, “remains a reasonable ballpark figure for those members who choose investments in passive index-tracking funds”.
The third report responds to specific issues which have been raised over the recommendations of the Commission’s second report published in November.
It covers seven main areas of discussion, including the latest trends in pension provision, the proposals for state pension reform, auto-enrolment, employer contributions, the proposals for an NPSS, the objectives and trade-offs of the recommendations and also how to come to a consensus on pension reform.
However as employer contributions and the NPSS have sparked the most debate, they are the two issues, which the third report focuses most on. On employer contributions, Turner claims the issue has been “more contentious” than auto-enrolment, with several though not all business group arguing against it.
But he says although the cost impact on small businesses is a concern, the “minimum matching contribution is essential for the architecture of the whole package we have proposed”.
The report also criticises the Confederation of British Industry’s (CBI) proposals for an alternative to “contingent compulsion” by introducing a series of measures which will encourage employers to contribute, but allow them to opt-out.
The Commission claims the “possible impact of such measures is difficult to assess but they would almost certainly still leave a high incidence of non-contribution among small and medium-sized employers” and if this was not the case, the costs to business of the NPSS, about which the CBI is concerned, would not be reduced.
It says it therefore believes if contingent employer compulsion is removed the success of the NPSS would be put at risk, and if the NPSS is not a success then moderate income earners, particularly those employed by small and medium-sized employers, would be worse off as over time they would not enjoy any element of earnings-related provision either through the State Second Pension (S2P) or through the NPSS.
As a result, Turner says the focus of the attention should now be on measures which mitigate the cost impact on small businesses, adding “one appropriate source of additional government revenue which could fund a support package is that created by the declining level of contracted-out rebates which results from our proposals for the S2P.”
He says although the Commission did not illustrate the impact of this in the Second Report costings, Government cash flow could be increased by £0.8bn by 2015, and £1.9bn in 2020 as a result of the proposed freezing in cash terms of the upper limit for S2P accrual, with an even higher cash flow resulting from the abolishment of contracting-out in defined contribution schemes.
Meanwhile, on the issue of the NPSS, and its alternatives, the Commission still believes the NPSS is the best way forward as it could be described as a single Super Trust, as proposed by the National Association of Pension Funds (NAPF), and would offer the cheapest administration charge, with no danger competition to influence employer choice, as proposed by the Association of British Insurers’ (ABI) Partnership Pensions, would lead to increased expenditure on advertising.
On the contentious issue of the cost, which has been endlessly debated, Turner says it is important to understand there is a consensus that operating costs need to reduced by eliminating the need for regulated individual advice, and the debate is now where within a range of about 0.3% and 0.6% the costs should settle.
The report says all of the cost models presented have tended to assume that most members will and should invest in passive index funds, and have therefore assumed fund management costs of about 0.1%, but it points out if individuals are given freedom to choose actively managed funds, a possible option in both the NPSS and ABI models, fund management costs will be higher for those making that choice.
As a result, the Commission points out the crucial issue is how low operational costs can be driven. It says the NPSS estimate of 0.3% for total costs assumes operational costs of 0.2%, which it claims is a reasonable benchmark at which to aim given the Swedish Premium Pension System actually charged members 0.22% in 2005 with a forecast reduction to 0.19% in 2006 and to much lower rates in future.
Although the report admits since the Swedish system is fully compulsory, avoiding the complexities of automatic enrolment and opt-out, this will tend to result in lower costs relative to the NPSS, but adds the average Swedish account size has a lower contribution rate, at 2.5% of relevant earnings rather than the proposed minimum 8% for the NPSS.
The Commission also looks at the best ways of setting up a low cost savings scheme, and comes to the conclusion there is more risk to the Government through a multi provider system, particularly where individuals are not making their own choice of provider.
It argues within the NPSS model, either an individual makes his or her own conscious choice of portfolio, or has funds invested in the default fund alongside other NPSS members. But where individuals are allocated by employers or by a carousel between multiple providers, individuals could, at least retrospectively, claim that they had been encouraged to save and automatically assigned to funds which had performed relatively poorly.
However, the Commission claims there is no “nil risk” solution, and it is inevitable individuals will have to bear some investment risk return, adding “the challenge is therefore to ensure these risks are clearly explained in the literature provided, and make it clear the only fund whose return the government can guarantee is one invested in real indexed government bonds held to maturity”, but which offer low returns.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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