Comments on the Proposal for a
National Pension Savings Scheme
by Stephen Wynn

1. Eight problems

In my opinion, there are eight main problems with the National Pension Savings Scheme proposed in the Second Report of the Pensions Commission:

1) Instead of "8% of earnings above the 'primary threshold'" (page 7 of the Second Report ^x), I suggest that there should be compulsory flat-rate contributions in the region 25-50 pence per hour.

The Pensions Commission proposes a 3% employer contribution. This has not been agreed with employers. They may therefore encourage employees to opt out of NPSS so that they do not have to pay this 3%.

The Pensions Commission proposes that people should be able to opt out of NPSS. The DWP is consulting on whether or not membership should be compulsory:

"Do you think people should not have the choice to opt-out of the National Pension Saving Scheme?" ^x

2) "All employees not covered by a high-quality pension scheme" (page 133) will be auto-enrolled into NPSS. What is a "high-quality pension scheme"? This does not seem to be defined in the Second Report.

Perhaps all employees who are not members of a defined benefit pension scheme guaranteed by the Pension Protection Fund, should be members of the new scheme. It can then be viewed as a counterpart to PPF for defined contribution schemes.

It is proposed that members of defined contribution pension schemes should no longer be allowed to contract out of S2P. But they are being allowed to opt out of NPSS. This seems inconsistent.

3) Many people may be discouraged from being members by a probable loss of means-tested benefits.

4) NPSS will become tangled with personal and stakeholder pensions, financial advice and the RU64 rule, ^x because membership is optional - at least for individual employees, though not for employers who have to pay the 3% contribution for employees who choose to be members.

5) NPSS is required to "bulk negotiate" with fund management companies without having its own in-house funds. This puts it in a weak negotiating position, because it is then obliged to accept offers from these companies.

Although the Second Report often refers to "fund manager", this term is not defined in the Glossary at the end. On this website "fund managers" are people. The Pensions Commission is using the term "fund manager" to mean a fund management company.

6) It is proposed that there should be a choice of 6 - 10 funds. This does not seem much of a choice, when all the funds are managed by the industry which has brought us so many scandals and which hides stockbroker's commission and other charges. It also seems like an unhelpful dilemma. What criteria are there for choosing between these funds? "Attitude to risk" does not seem meaningful for someone aged 30 saving towards a pension. What kind of risk? What about the risk of inflation?

7) When people retire they are being left to negotiate a "product" in the market - probably an annuity. Complicated rules apply to these "products", which are summarised in Figure 10.16. It asks:

"How and by whom should annuities be provided? Is there a necessary government role in providing annuities or in supporting the market in other ways?" (page 380)

A new scheme should itself provide annuities. But the Pensions Commission recommends:

"NPSS should not in general be a direct provider of annuities." (page 384)

8) NPSS gives hostages to fortune. The number of funds may increase - like the stakeholder cap on charges. The 0.3% "target" for expenses may not be achieved.

2. Wrong directions

An article in the Financial Times Turner hails 'big shift' in debate on pension management charges (February 3rd, 2006), says:

"The argument that pension savers need a scheme that offers radically lower management charges, which leads to a much bigger pension, has been won, according to Lord Turner, chairman of the Pensions Commission."

I agree. But this is a second bite at the cherry. We have been here before. Exactly the same was said before stakeholder pensions were introduced. They were described as "low cost" because of "low management charges". They were intended to solve the problem of the high charges of personal pensions. The Pensions Commission says that NPSS will be "cost efficient" because of "bulk purchases" and "bulk negotiations" with the financial industry. The word "bulk" is used 28 times in the Second Report. But the same was said of stakeholder pensions. The green paper Partnership in Pensions (1998) said that stakeholder schemes would:

"use a collective structure, like occupational schemes, to get the best value-for-money for scheme members" (chapter 7, paragraph 15)

"As collective schemes with bargaining power, we would expect stakeholder pension schemes to be able to offer good value access to other arrangements, such as life insurance cover" (chapter 7, paragraph 70)

In this area there is a long history of governments requesting the industry to propose reforms for the industry. Of course the industry suggests "reforms" to suit itself, with the result that nothing much happens. Therefore I have misgivings about the fact that Lord Turner is the Vice President of Merrill Lynch Europe. The government seems to making a mistake:

Direction 1. Seeking guidance about general pensions policy from the industry regulated by the FSA.

The Pensions Commission seems to be lining up a "bonanza for fund managers". ^x For example increasing retirement ages is beneficial for fund management companies, as is government policy in general such as "informed choice" and "building trust in the market", which is a heading in the green paper on pensions Simplicity, security and choice (2002). ^{x x}

The ABI and NAPF are submitting alternative proposals for a NPSS. These were requested by the government. I have been informed by the Pensions Commission:

"The Pensions Minister Stephen Timms did set out a challenge to the Pensions industry to present alternatives to our National Pensions Saving Scheme in a speech to the ABI on 5 December."

The funds of both the ABI and NAPF proposals are managed by fund management companies. In the case of the ABI this is understandable since it represents the insurance industry, which is largely the same as the fund management industry. An organisation ABC is commonly composed of different companies such as: ABC Assurance Limited, ABC Fund Managers Limited, ABC Marketing Ltd. For example in additon to the Prudential Assurance Company Limited there is Prudential Fund Managers Limited. Some of the members of NAPF are fund management companies. Its website says:

"NAPF also has more than 400 members who offer services to pension schemes, from investment banks and insurance companies to software houses and solicitors." ^x

Direction 2. Having funds controlled by companies whose profitability depends on the charges they make, so that they have an incentive to make these as high as possible.

The Pensions Commission proposes a choice of funds possibly 6-10 funds. Under the NAPF proposals there will apparently also be a choice of "super trusts".

Direction 3. Allowing too many choices.

The Pensions Commission considers that stakeholder pensions are a poor deal because charges are unacceptably high, which is the reason it is proposing the NPSS. I thought they were a poor deal even before they were introduced, ^x which initiated this website. The FSA considers that they are a fair deal and encourages people to buy them as part of its programme to "help retail consumers achieve a fair deal". They were welcomed by many people such as the Consumers' Association:

"The introduction of stakeholder pensions - with strict control on access and charges - not only offers consumers an excellent deal but have forced down charges on older style personal pensions." (page 4 ^x)

The Consumers Association promoted the creation of stakeholder pensions:

"We argued that the government should introduce a new type of stakeholder pension where charges would be capped and features regulated." ^x

But not all charges are within stakeholder cap, and it was increased from 1% to 1.5%. Which? is now advocating or agreeing with a cap on the number of funds offered by NPSS. The same seems likely to happen. There could be "access to a wider range of funds". The Second Report says: "NPSS to bulk negotiate a range of 6-10 funds and to allow access to a wider range of funds" (page 37) The 6-10 funds cover "major asset classes" (page 376). The Glossary says "major asset classes" are bonds and equities. But that is only two classes. What about property? The Thrift Savings Plan is investing in five "specific asset classes" (page 375). The 6-10 funds of NPSS must refer to specific asset classes.

The Consumers' Association welcomed mortgage endowment policies and for example the formation of the FSA, on the grounds that they were improvements. Improvements are necessary, but not sufficient. They may leave a job half-finished. It is now welcoming the NPSS because of "low management charges" ^x which is the same reason why it welcomed stakeholder pensions.

Direction 4. Welcoming work before it has been completed.

Aon Consulting say that:

"Turner was asked to report on whether compulsory private pensions contributions should be introduced, but his report is actually a wholesale review of the entire pensions system, and most of the recommendations relate to State Pensions rather than private pensions. ^x

Important topics about the private sector have been left unresearch by the Pensions Commission. I requested that it should research the cost of annuities and the compulsory Danish ATP scheme, but it has not done so in its Second Report.

The discussion of "implicit costs" in the First Report of the Pension Commission is inadequate in view of the importance of the topic. "Further research" was promised:

"We intend to conduct further research and to request information from fund managers on this issue." (page 219)

I was looking forward to this, but cannot see it in the Second Report. It is proposed that the funds of NPSS should be invested by fund management companies using "mandates". But such mandates to manage pension funds, is apparently a topic discussed by the Pensions Commission. How successful are they?

A correspondent has criticised the proposed NPSS on the grounds: "It will be an unaccountable quango. It will involve a concentration of too much market power in a Government controlled institution." I agree that accountability for a new scheme is a problem. How to make it accountable is a research project. It should not be "Government controlled". The board should be appointed by outside organisations. In the case of the Danish ATP scheme this is organisations representing "parties to the labour market", like our CBI and TUC.

Direction 5. Leaving important topics unresearched.

3. A case for compulsion

An article in the Financial Times (30th October 2006) Cazalet fears huge losses for provider reports:

"Lord Turners's proposed national pensions savings scheme could generate huge losses for any public or private sector body that tried to operate it."

This says that it would generate "huge losses" with the proposed charge of 0.3 per cent of capital per annum. The 2005 accounts of the Universities Superannuation Scheme ^x gives: administration costs £9.1 m, investment expenses £15.9 m, assets at start of year £19,446.1 m, assets at the end of the year £21,739.7 m. Therefore the expense ratio is 100 x 2 x (9.1 + 15.9)/(19,446.1+21,739.7) = 0.12%. The Danish ATP scheme is much less. For the year 2004:

"Pension activity expenses amounted to DKK 32 for each member, while investment activity expenses were DKK 16 per member."^x

A charge for administration of (DKK 32) less than £ 3 per annum is quite a contrast to the stakeholder 1 - 1.5% of capital per annum, or even the 0.3% proposed for the NPSS. An expense ratio in the accounts is 1.4% of premiums rather than of capital. So how do they do it in Denmark yet according to Ned Cazalet we cannot do it in England? ATP is compulsory for employees, whereas it is possible to opt out of NPSS. He suggests that there will be many opt-outs because:

"Mr Cazalet's own analysis, showed that about 1.8 per cent of regular premium pensions lapsed each year."

This is therefore an argument in favour of compulsion. In my submission to the Pensions Commission following its First Report, I recommended that it should study the Danish ATP scheme. But it has not done so in its Second Report, where the ATP scheme is mentioned only twice; on page 106 where it is referred to as "the Danish example", and on page 385 where it says that in the event of death before retirement there is a "Single capital equivalent to 35% of fund paid to spouse."

4. An alternative to compulsion

If there is not compulsion, there will need to be an incentive for people to remain in the scheme. Who pays for this? The Pensions Commission proposes a 3% employer contribution. In the Financial Times 28th January 2006 Pensions aid for businesses proposed. Lord Turner suggests that there could be government subsidies towards NPSS:

"The government could pay a subsidy for the contribution. That would help small firms at little cost to the Exchequer as there are cash flow savings to the government from the commission's proposed reform of the state second pension."

The Second Report of the Pensions Commission discusses the Thrift Savings Plan in the US. This has considerable employer contributions.

"First, when you become eligible for agency contributions, your agency will automatically contribute to your TSP account an amount equal to 1 percent of your basic pay each pay period. .. .

Second, if you are contributing to your TSP account, your agency also makes Agency Matching Contributions once you are eligible for them. If you do not contribute your own money, you will not receive Agency Matching Contributions. Matching contributions apply to the first 5 percent of pay that you contribute each pay period. Your contributions are matched dollar-for-dollar on the first 3 percent of pay you contribute each pay period and 50 cents on the dollar for the next 2 percent of pay. Your agency will not match the contributions that you make above 5 percent of your pay. However, you will still benefit from before-tax savings and tax-deferred earnings on those contributions." ^x

These matching contributions are part of the contract of employment and pay negotiations. This is not the case with the 3% employer contribution proposed for NPSS. As a result some employers may persuade their employees to opt out of the scheme, so that they do not have to pay the 3%.

5. The NAPF proposal

The chief executive of the NAPF, Christine Farnish, said in an article in the Financial Times.

"The Commission's NPSS, is little more than an umbrella structure for millions of individual defined-contribution pension contracts." (8th February 2006)

I agree. The proposed NPSS does not even provide pensions. A choice of funds is not beneficial, at least for younger members. She says: "Experience suggests that nine out of ten consumers would end up in the default fund." I agree with the NAPF that NPSS would be too "monolithic". The NAPF proposes a system of competing "super trusts".

"Competitive tensions in the market have to be better than a single NPSS." ^x

There will apparently be a choice of trusts:

"Employees would eventually be able to choose a trust to provide their retirement income, although initially Ms Farnish envisages employers directing their workers to a trust they have selected."

So that in addition to a choice of funds, we now have a choice of trusts. More confusion! However I like "provide their retirement income". Details of the NAPF scheme are expected at the end of February.

The NPSS would be less powerful if contributions were smaller. The Swedish PPM scheme has contributions of only 2.5% of income. The sudden introduction of NPSS with the proposed 7% of income contribution (4% employee + 3% employer) will have a rather drastic effect:

"The existing individual pension markets for people who were basic rate taxpayers would cease to exist overnight with most transferring to the NPSS." ^x

It seems preferable to introduce a new scheme into the UK gradually, with only small contributions initially.

6. "A new independent pensions body"