The UK pension reforms are going in the right direction, but it still has a long way to go says an architect of Australia’s compulsory system, Senator Nick Sherry. John Greenwood reports
With 20 years’ experience in Australia’s compulsory pensions system, Nick Sherry, Senator of Tasmania and former minister for Superannuation and Corporate Law is better positioned than most to comment on the reforms under way in this country.
While his overall verdict is generally positive, there are definitely things that could have been done differently, leaving us storing up potential problems as a result, he believes.
Topping that list is the enforcement of compliance. Sherry believes the UK would have been better off using HM Revenue & Customs to gather contributions, arguing that such a strategy would have made enforcement that much easier.
“It would have been better if the UK had gone down this route. Everyone already has to deal with the Revenue. In both Australia and New Zealand we use our tax office and firstly, it has an employer database, it has ongoing contact with employers, it has inspection teams to which they added compliance on superannuation,” he says.
It is a point made in a recent report published by Sherry, Challenges For UK Auto-Enrolment, From the Perspectives of Australia and New Zealand, which says: “Tax agencies have the authority, administrative capacity, personnel skills, on-going contact with employers on other tax payments and sophisticated software to maximise payments. In addition they are funded sufficiently to ensure on-going and specific targeting.”
He points out that The Pensions Regulator’s job will be that much more complicated than the task faced in Australia, because that system does not allow opt-outs.
He says: “Compliance is important in an opt out system. You have got to educate employers about the process and make sure not just that they are making contributions but also that they are complying genuinely with the opt-out provisions, so there is minimal coercion. It is a big challenge because not only are you dealing with English as a second language, but you have higher levels of illiteracy, and employers don’t like this ongoing system of asking employees to opt in or out. So there is a question over how effective compliance will be.
“In New Zealand the tax authority collects contributions and they have one admin provider so it is much simpler – here you have multiple providers, existing schemes and competitors to Nest. So that will be a challenge,” he adds.
So how easy would it be for the UK government to change tack if it found its current compliance approach wasn’t working?
“The jury is out. They have only just started, so it is something to keep a close eye on. But in New Zealand and Australia experience has shown that both the most cost-effective and effective compliance regime is through your revenue departments. But then you have a separate pensions regulator here, which Australia does not have,” he says.
Charges will also increase in significance politically as reforms bed in, he predicts, pointing to Australia where transparency is set to be lifted to new heights with a new initiative that are enough to make any but the best pension advisers have sleepless nights. Australia is planning to publish the returns of all individuals’ pension returns, net of advisory and other charges.
Sherry says: “Our regulator collects all this data but doesn’t publish it fund-by-fund. But once the structural changes are in place, the regulator is going to publish the outcome of all the investment options for every fund, including the return, on a five to seven year basis, and the breakdown of the fees, including the advisory costs, admin costs and fund management costs. That will give an overall management expense ratio.
“All this information will be made public on one day. The regulator has that data at the moment but under the secrecy provisions they do not have the right to publish it,” he says.
The idea of EBC or corporate IFA X performing on average several per cent lower than EBC or corporate IFA Y seems unimaginable in the UK. So what effect will that have on intermediaries on the day that such sensitive information hits the press?
“I think behaviours are going to adjust before that. We are moving commissions and going to flat fees. I think we will see significant behavioural change before we get to publication. We have got 14,000 investment options. The default options give overwhelmingly the best returns on anything I have seen. These exotic investment options are going to disappear, because they are not worth it,” he says.
Sherry, a naturalised Australian who was born in Kingston-on-Thames, believes predicting just how many people will opt out is incredibly difficult.
“We could get an opt out rate percentage in the mid-twenties, but it is really speculation,” he says. But he points out that opting into the New Zealand Kiwi Saver, which was introduced in 2007 with 2 plus 2 per cent employer/employee contributions has fared no better than that, even though it has been made more attractive by a NZ$1,000 initial lump sum contribution, as well as an annual government credit of up to NZ$521.43. Another attraction is the ability to access the fund for a first home deposit. Despite these relatively attractive features, opt outs stood at 34 per cent in 2009, although they had fallen to 28 per cent by 2011. For this reason, in the UK, where incentives are far less clear, compliance will be crucial, he argues.
“A lot will depend on compliance oversight because it is in the employers interest that an employee opt out. Compliance will be a challenge, particularly with smaller employers,” he says.
Australia’s experience on small pots has acted as a warning to the UK, with 30m pots now in existence for a workforce of almost 11m. Crucially there are now 7.3m ’lost pots’, defined as without a contribution for two years and with member statements returned, floating around the Australian system.
Sherry predicts a similar, if slightly smaller, problem will emerge in the UK, particularly if the transfer prohibition on Nest stays in place.
Even if the transfer prohibition is removed, the lack of IT administration compatibility between all funds and inertia will still lead to a substantial increase, he argues.
The lack of engagement with individuals means anything other than intervention to default individuals’ pots into other accounts would not be enough to solve the problem.
“Because people are in a system it does not mean they become actively involved or engaged with it. Even though in Australia there is a simple form of central register for multiple lost accounts, people don’t make any decisions. They fail to aggregate together their accounts and lose track of them. A website is useful information of itself but it does not solve the problem,” says Sherry.
That, he argues, means more drastic action is required, action that the Australian government has finally taken, with reforms that include ’auto-consolidation’ set to take effect from 2013.
“In Australia after 20 years of debate on this we have decided that if you fail to notify the revenue website and aggregate then after two years it will be done automatically for you. We are going to start with account balances of less than A$1,000 – interestingly that is about half of the lost accounts. And they are going to increase that to A$10,000 over a number of years. Whatever the process, you need a default solution to reunite people with their money in the system,” he says.
This does, of course, ride roughshod over contract law, impacting business that life insurers and other pension providers might feel they have spent good money attracting. Sherry has little sympathy for such arguments. Because governments, whether in Australia or the UK, are responsible for the increase in inflows, the relationship between providers and government, and how contracts can be broken, changes fundamentally, he argues.
“It is clearly in the providers best interests to have soft compulsion because they get more business. But at the same time they have got to accept the downside of a soft compulsory system is lots of accounts. And it is inefficient from a system perspective. The simple truth is if you aggregate and transfer, providers will have a smaller number of actual pots but with higher balances.
“But you need to make sure you get the technology to be able to make it all work. Some providers are only designed as one way streets to bring funds into them, ’one way street syndrome’, I call it. We need two-way streets, because that is in the best interests of the member for whom the system is designed. And it is also in the best interests of the providers because when they looked at what this has meant in Australia they will find that the cross flow did not really affect total funds overall.”
But surely some providers with old books of business will lose out. Again, Sherry’s sympathy is in short supply.
“There were a few providers who had been around a long time who when they first heard about it were not happy. It was pointed out they have benefited from compulsion, tax relief, the 9 per cent Super guarantee, which is increasing, and so they have to deal with it,” he says.
Another consequence of compulsion in Australia that he predicts being replicated over here is an increased focus on governance.
“Governance of trustees and funds in Australia has become much more important. Funds have to be licensed in Australia. They have merged. You have got 51,000 here. I find that staggering.
“In Australia trustees have to go through a proper training course. The regulator is looking at the diversity of trustee boards, asking whether they have the required mix of background and skills as a board.
“And a lot of my friends who are trustees don’t understand this but they are interestingly introducing an Act to make trustees individually and severally liable. It is a very significant change,” he says.
Another issue for trustees is what to do with all these assets that are gathered, he says, although government’s have stayed away from directing investment, beyond requiring diversification and suitable long-term strategies.
“The other major responsibility is economic, which is not only seeing the trustee charged with maximising the return for the member. The sheer size of the system, it is now the size of the Australian economy after 20 years of compulsion, is immense. The UK’s will be much bigger. And the economic and savings investment decisions of trustees become very important on a macro level,” he says.
Sherry says there was a public debate at the time compulsion was introduced, with people saying do not invest in low labout cost overseas to take jobs away from our people.
“People were saying ’don’t invest it overseas. Invest it in infrastructure or houses, or new IT’ – it has been widely debated over the last 20 years. But all governments have decided it is best left to trustees. Increasingly it is predominantly equity based in Australia, because that gives the best prospects for return, but that is now increasingly flowing into infrastructure, as they are going overseas, for the rates of return.
But socially responsible investment is becoming increasingly important for trustees,” he says.
He also points out that the economic backdrop at the time of launch will certainly impact on auto enrolment.
“Clearly the attitude to the financial sector is sceptical, and we launched during a period when returns were going backwards. It is hard to explain the concept of long-term returns. There is no doubt of the impact, as the research in New Zealand showed, which was launched in 2007. And so that does impact on confidence. I went through it as minister, when I got thousands of complaints from people saying ’my account’s gone backwards, why is that’. Well there has been a global financial crisis, ’yes, but why has it gone backwards?’ It’s hard to explain the concept of long term return,” he said.
Sherry displays amusement at the pace of the reforms in the UK, but believes the US is far worse. “It could have been done quicker, but the UK is still getting there. It is maybe 20 years behind Australia, but it is still happening. If you look at the US, they are still debating all of this and have done nothing. Europe has got a crisis because of its DB liabilities, so from that point of view I should not be overly critical. And I am a compulsion man but soft compulsion will give, say, 70 to 80 per cent coverage. That is a lot better than what you have got,” he says.
He does see full compulsion coming back on the menu in future, however.
“At some point in time the debate will be revisited, but soft compulsion is a good second best. You sent all your convicts out to Australia, so we understand authority. But given the background and the need for the political consensus I can understand why the way you have chosen is the way forward,” he says. And it is much better than the alternative, which is a collapsing DB system and nothing at all to replace it. That is what is happening in the US, collapsing DB, discussion about social security, but no reform. The UK has been slow but the US is like a glacier.”
The Hon. Nick Sherry
- Labor Senator for Tasmania
- Has 20 years’ experience of the Australian superannuation system.
- Was Shadow Minister responsible for superannuation before becoming Minister for Superannuation and Corporate Law.
- Became the first minister of any Australian Government to have exclusive responsibility for superannuation. Resigned from the Australian Parliament in May 2012.