The government has a covert strategy to use pensions saving to improve Britain’s economic performance, but it may jeopardise the long-term interests of members
Between 2012 and 2017 around 10 million employees will be automatically enrolled into a workplace pension scheme – most of them for the first time. We are frequently told that this is to address the UK’s chronic under-saving crisis, exacerbated by population ageing. But this is, at most, only part of the story. It can also be explained with reference to the UK’s staggeringly poor record on investment, the so-called British investment strike.
The idea of automatic enrolment germinated in the boom years, but the reason it has been taken forward by the coalition government – despite the fact it represents an £11 billion increase in pensions tax relief expenditure – is to compensate for the government’s failure to rebalance the economy away from consumption and towards investment. The seemingly progressive move towards capping pension charges is a necessary corollary of this approach.
There is a very clear logic underpinning recent developments in pensions policy – or, more precisely, the justification for recent policy developments: increased longevity means individuals will live a greater portion of their life in retirement, so must save more during their working life.
However, this logic is fallacious for two main reasons. Firstly, generally speaking the coalition government does not want us saving more, insofar as it displaces consumption. This is why it has withdrawn the novel forms of fiscal support for saving introduced by the Labour government – the Child Trust Fund and the Saving Gateway – while delivering, largely intact, their predecessor’s plan to incentivise pensions saving through automatic enrolment.
The difference is that pensions saving is not really saving at all, but rather consumption deferred. And we know the government is very keen for us to consume more (despite the rhetoric of austerity). Despite the continuing stagnation in earnings, household consumption has risen by 3 per cent since the middle of 2009, largely fuelled by a resurgence in unsecured borrowing (confirmed by the Bank of England) and a housing market inflated by the Funding for Lending and Help to Buy schemes. In characteristically sober terms, the ONS has pointed out that ‘the change in household behaviour in the past year [i.e. additional consumption] may be associated with the performance of the housing market. House prices have been rising since 2011, and this in turn may have influenced household confidence and expenditure.’
Crucially, while general saving substitutes consumption, pensions saving only postpones it.
Secondly, if additional pensions saving was solely about retirement security in an ageing society, then the vehicles we are being asked to save in would need to look very different. A very important recent report by the House of Lords Committee on Public Service and Demographic Change on the challenge of population ageing, which unfortunately was overlooked by the mainstream media, argued that ‘defined contribution’ pensions were not fit for purpose because they involved too much risk-taking by individuals. If we need to save more, then we need to know this saving will actually provide a decent retirement income. Defined contribution pensions offer no such certainty.
What they do offer, however, is an opportunity to improve the UK’s investment rate, as part of economic rebalancing away from debt-fuelled growth.
We know that the coalition government has cut public investment dramatically, but it has also presided over a collapse in private investment. Across the G7, investment (that is, gross fixed capital formation) accounts for an average of 15 per cent of GDP. In the UK, in contrast, it represents around 10 per cent of GDP – and is still 25 per cent below its pre-recession peak, despite the apparent recovery.
The investment potential of the capital locked in pension schemes is enormous. Currently, pension funds hold capital worth 95 per cent of GDP. Yet only around 40 per cent of private sector workers are saving privately for a pension (most public sector schemes do not have actual funds, rather hypothetical ones). Clearly, this will increase substantially once the 10 million not saving are auto-enrolled.
Furthermore, auto-enrolees will generally be younger savers more able to make riskier long-term investments. We know the government is keen on pension investments in infrastructure, because it asked the National Association of Pension Funds to establish the Pension Infrastructure Platform (PIP). But the PIP has only £1 billion committed, with most of this from local government schemes (which do have actual funds) and the quasi-public Pension Protection Fund.
The new breed of private sector defined contribution schemes being used for automatic enrolment are the real pot of gold for infrastructure investment. But just how realistic is the government’s ambition? While in theory these schemes should be making riskier investments, the fact that investments are entirely individualised means that members face the prospect of an investment decision which goes catastrophically wrong wiping out most or all of their savings.
Traditionally, these risks would have been pooled or ‘collectivised’, allowing innovative investment strategies. Individualisation leads to risk-averse pensions savers.
Fortunately for the government, however, most people being automatically enrolled will have very little say in where their pensions savings end up being invested. This helps to explain why the government has been so reluctant to improve standards in defined contribution scheme governance. Schemes run by trustees are governed solely in members’ interests – yet the interests of each individual member might not add up to a common economic interest in large-scale investments that could (but probably won’t) fail to deliver a return.
So most people are being enrolled into schemes run by insurance companies, or ‘master trusts’ nominally independent of their parent companies, but in which the parent has undue influence over the composition of the trustee boards.
This, in turn, helps to explain the recent move towards capping charges in schemes used for automatic enrolment. It may look progressive, but the only reason a cap is needed is that we are entrusting the decisions about scheme governance to people who are not incentivised to consider the actual savers’ interests above all others.
It’s certainly not my intention to argue against long-term investments by pension funds in the real economy – not least because recent experience tells us that capital market investments can no longer be considered a safe haven. The point is, though, that it’s far from clear whether or not the schemes that will be used for automatic enrolment will be able to pick up the slack of a faltering economic strategy without putting the long-term welfare of individual members in jeopardy.