The wait is over and auto-enrolment is now a reality. But what will it do to the UK pensions and benefits sector? John Lappin looks abroad for clues to what the future may hold
As the first employers’ staging dates strike, the reform of Britain’s pensions system is finally moving from the theoretical to the practical. It may be some years before a clear picture of just how auto-enrolment has taken off emerges, but we can at least anticipate some of the issues involved using examples from elsewhere in the world, countries from whom we have already borrowed many ideas. Two countries with similar systems of law and government – Australia and New Zealand – have experienced their own big reforms that give hints as to what to expect from this month’s historic launch.
It is well known that the Australian reform, which is well into its second decade, embraced full compulsion. This provides one significant source of comparison with the UK’s softer version.
New Zealand’s reforms however are the result of a very interesting political story. In 1997, with a big budget surplus, it asked its population if they wanted to adopt a system of compulsory pension savings, only to find it rejected by more than 90 per cent who favoured tax cuts instead.
Ten years later, in 2007, KiwiSaver launched, and embraced auto-enrolment. New Zealand’s version might be described as ‘softer’ than the UK’s, because it is only when Kiwis change jobs or enter the workforce that the auto-enrolment mechanism comes into play. It also offers early access to savings for those buying a home or where someone can demonstrate that they are in financial trouble.
Pensions expert Rachel Vahey believes the New Zealand system could give some indication of what may happen with opt outs here though she also notes key differences.
There is only one KiwiSaver per person with no ability to leave money with multiple schemes, the tax relief is more beneficial to someone earning the equivalent of around £32,000 or below and there is a £500 one off incentive to those taking a plan out.
She says: “On the one hand, you could argue UK’s opt out rates will be lower. KiwiSaver only auto-enrols people taking on a new job and 18-year-olds. Everyone else has had to opt in. If we assume new jobholders are generally younger, then we might also assume fewer will stick with saving. Auto-enrolling everyone, as the UK will do, may gather up the 30-somethings and 40-somethings who have been in their job for several years. These people may be more likely to want a pension. Interestingly, 63 per cent of the KiwiSaver total membership opted in – they actively chose to save – so current jobholders didn’t want to lose out. But on the other hand, if a current jobholder is automatically enrolled they will see an immediate pay cut, and there is less flexibility in UK, including access to their money. So may be the opt-out rate will be higher.”
Interestingly, the number of opts outs in New Zealand has fallen from 34 per cent to 28 per cent last year perhaps suggesting that more people could be encouraged to sign up over time in the UK, if initial take up is low.
However, as arguments continue in the UK about the creation of a universal state pension, New Zealand’s experience also suggests that political interference and the fear of it, can have an impact.
A survey of opters out in New Zealand found that one significant reason given for not joining KiwiSaver was a belief that the Government would interfere with the system. Indeed this has happened. The incentives are often the subject of political debate and minimum contributions have been moved up and down. Politicians also frequently return to the idea of full auto-enrolment or full compulsion.
Vahey also notes that 90 per cent of employers in New Zealand contribute the minimum 2 per cent. That could point to a levelling down by employers in the UK. She says the Kiwi experience also suggests that employees might stick to the minimum as well.
“If UK employers react in the same way, and just go for the bare minimum, then levelling down will be a certainty. Individuals also tend to start contributing at the minimum level – which started at 4 per cent but fell to 2 per cent for new joiners after April 2009 -and stayed there. However of those who started at 4 per cent, only 33 per cent have reduced to 2 per cent. The rest have mainly stuck at 4 per cent,” she says.
Vahey argues that it is vital to begin a conversation about increasing contributions in the UK early in the reform process.
“This suggests the current discussions about ‘auto-escalation’ or ‘Save More Tomorrow’are even more important. We have to get people to sign up on Day One to the idea that they will automatically up the contribution at some later date, because otherwise they will be stuck at 8 per cent of band earnings for ever more. And that will mean more of them don’t achieve a decent income in retirement,” she says.
The UK system has come under fire from Australian politicians and experts. A report for Tor Financial Consulting, written by Senator Nick Sherry and Peter Downes, respectively Australia’s former minister for Superannuation and Corporate Law and his chief of staff, published in April, was critical of the UK system on a number of counts.
Chief among these criticisms was the failure to use the taxation system to facilitate compliance. The report said: “The key lessons from Australia and New Zealand are that compliance is maximised by placing responsibility with respective Tax and Revenue central agencies. They 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 ongoing and specific targeting.”
Tor Financial Consulting managing director David Harris has harsh words for HMRC here. He says: “The tax systems in Australia and New Zealand are integral to the process. The Revenue here is not involved because of a missing computer CD rom or computer disk. They decided in the negotiations not to be involved. That was short-termism and departmentalism of the highest order and caused frustration. In New Zealand, Government officials, employees of the Inland Revenue, do the data matching, matching contributions to employers and financial services providers. In the US, the IRS plays an active role. The UK stands apart and that has added complexity when auto-enrolment already has complexity. It comes about not from well thought out policy, but bureaucratic petulance.”
However, despite this major difference, UK experts say that the Department for Work and Pensions did pay a lot of attention to both jurisdictions as it finalised the reforms.
Pensions Management Institute technical consultant Tim Middleton says that both the Australian system and KiwiSaver have been extremely influential in forging the UK’s system, but that hasn’t mean accepting all ideas. For example, he suggests that the DWP’s decision to pursue ‘pot follows member’ drew inspiration from Australia. New Zealand’s early access on the other hand was also considered, before being rejected.
However, one very significant difference is the economic environment. As Vahey has noted, in the UK auto-enrolment could mean cuts in take home pay. In Australia, the reform was introduced during a time of wage inflation so it was easier to divert some of that to the pension.
Friends Life head of corporate benefits marketing Martin Palmer says: “One of the key differences is timing. When Australia did it, it was a lot more opportune. The investment market boomed when they kicked auto-enrolment off. People were almost complaining about contributions not being high enough. It was also at reasonable levels of salary inflation. Three per cent out of a pay rise wasn’t so massive. We are trying to bring it in at a time of recession. The problem is that even with 1, 2 or 3 per cent contributions, people will have net reductions in their salaries.”
Even in New Zealand’s more recent reform in 2007, it was devised partly because the country had a budget surplus, though such benign conditions did not last for long, given the financial crisis.
Palmer says another big difference is engagement. This is obviously helped by the fact that people have now accumulated sums into five figures in Australia. He notes that the slow start in the UK does work against us.
But he says trade unions played a key role in Australia and could do so here too.
“They got the buy in of the trade unions, and recognition that it was going to come out of the pay increases. I think the trade unions have more of a role in the DC world to get behind pensions and extoll them to the workforce. If we could get employees to focus on the value of the pensions benefits, that would help to encourage employers to put more money in.”
One issue often discussed in the UK is the idea that contributions must inevitably rise.
Harris, who worked as a civil servant involved in setting up Australia’s scheme, says that this is always a struggle. He says the trade body for small businesses in Australia brought enormous pressure to bear saying they couldn’t afford it. The way in which the contributions were staged may remind advisers of what is happening here.
“We went from 3 to 9 over a ten year cycle for the smaller employers, 3 per cent, 4 per cent, pause, 5 per cent, 6 per cent pause. The increase curve was more gradual. To increase contributions is not easy,” he says.
He notes that Australia will now push contributions from 9 per cent to 12 per cent, funded by a mining tax. This has bi-partisan support, though it is being resisted by the mining industry. The UK does not have a resources boom.
However some debates that are only happening in Australia many years into the reform are already being thrashed out in the UK.
With around 80 per cent of Australian’s in default funds, the country is launching its MySuper Account reforms next year. The accounts will have a single investment strategy and standard set of fees and will aim to increase transparency, adding to trustees duties and making them considering outcomes for income. There have also been debates about the relative high costs of fund management.
Arguably, in the UK The Pensions Regulator and FSA are already setting out better standards for default schemes and employer and trustee duties.
However, Harris notes that the UK is very much alone in using price capping to any extent and that it is through consolidation and economies of scale that Australia and other countries will get a more competitive system.
Harris also notes that Australia’s multi-employer system is a big difference. In the UK arguably only B&CE with the People’s Pension, offers something akin an industry specific solution. In Australia, Harris notes, not only are there multi-employer schemes, but a journalist could for example choose the scheme marketed to another sector such as construction.
He sees no particular reason why these multi-employer schemes could not be developed in the UK.
One issue for corporate advisers to take note of is the fact that compulsion in Australia has helped increase the focus on adviser remuneration. Australia’s Future of Financial Advice reform is banning commission and giving advisers a fiduciary duty to their clients. Part of the justification for the change has been the compulsory nature of pension saving. Arguably the UK has got there first for other reasons, but it shows that big pension reforms can increase scrutiny and political pressure.
Another feature of the Australian experience is that the huge success of the reform has driven a lot of consolidation in terms of employee benefits advice. Harris says realistically there are only two big players – Mercers, which is also a provider though its master trust, and Towers Watson, which is more focused on investment consultancy.
However, there are a large number of smaller advisers which are arguably closer to the retail IFAs here, though of course remuneration is under scrutiny in both jurisdictions.
The final big change in Australia is that banks have bought up the wrap providers which has, among other things, seen them buying up large insurance firms, with AMP the last surviving significant independent. This could prove to be one trend to watch as corporate and workplace wraps look to gain market share in the UK, though once again it probably depends on the speed of accumulation.
In terms of spotting trends and borrowing ideas, it may not all be one way traffic. UK wrap and pension consultant Mark Poison, of The Lang Cat, says the recent launch by Aegon of a workplace scheme linked to its retirement platform has attracted attention in Australia. The provider of the underlying technology used by Aegon, GBST, is doubtless reporting back to its Australian parent on how Aegon Retirement Choices takes off.
“No one has gone down the round of integrating a leaver proposition in Australia. It is the first time I have seen Australia look to the UK, rather the UK look to Australia.”
However, Polson says most lessons still move in the other direction. He notes that the golden ratio for corporate schemes is about 4,000 members to one administrator, and notes that Australian BT Westpac scheme has 24,000 members to one administrator.
“What is stopping this market getting there and what would that do to prices?” he asks.
However as advisers grapple with auto-enrolment, one final important difference may give them pause for thought.
In Australia, politicians such as Bob Hawke as PM and Paul Keating as finance minister and then PM drove through the reform. Harris, who was a civil servant at the time, says implementation took an astonishingly fast 18 months. In New Zealand, PM Helen Clark was closely associated with the reform. Corporate advisers may note that Britain’s two most senior office holders, PM and Chancellor, do not seem in such a rush to associate their names with pension reform here.
Harris adds: “You need trade unions and leaders in government and an industry that is savvy and pragmatic.”