This one will run and run
The Pensions Regulator has its work cut out overseeing DC pensions says Teresa Hunter
Bang, the whole lot goes up in smoke. So it is understandable that veterans of previous regulatory wars are sucking their teeth nervously at signs that the Pensions Regulator has defined contribution pensions in its sights, and is planning a shake up. Behind the scenes it is already warning advisers and providers this will not be comfortable for them.
If anyone should be nervous, it should surely be the Government, Department for Work and Pensions and the various regulators. They are about to embark on a monumental coercion of the public into a pension scheme that they know to be essentially flawed.
Interference in investment strategy by regulators usually means only one thing - a wholesale switch into bonds. Lord preserve us.
The numbers are phenomenal. Currently 2.5 million employees are saving for a pension in some 46,000 DC occupational pensions. Of these, 43,000 schemes have fewer than twelve members, while the biggest 600 account for three-quarters of the market.
Once auto-enrolment is up and running, an extra five to eight million are expected to join similar arrangements. Before long, in excess of 13 million, more than half the private sector workforce, could be relying on DC pensions to fund their retirement.
But these pensions, as currently designed, are doomed to fail. While there is absolutely nothing wrong with money purchase arrangements, they only work if you pay enough in.
So you can see what is keeping the Regulator awake at night. If these pensions fail to deliver the income in retirement which many are expecting, the lynch mob heading in the Government’s direction will be very big and very angry.
So the Regulator has launched a debate, known otherwise as a consultation, about the appropriate level of contributions and charges, the design of default funds and investment strategy, security of the money and annuity decisions. The aim of the process is to come to some conclusions about what a good pension should look like. I thought we knew that. It’s called a final salary scheme.
The problem with DC pensions is that if only half the contribution goes in, compared with a final salary arrangement, then only half will come out. Even good DC schemes are unlikely to provide more than a third of salary on retirement. Do those staff who think they have a good pension appreciate this? I doubt it.
If these [new] pensions fail to deliver the income in retirement which many are expecting, the lynch mob heading in the Government’s direction will be very big and very angry
We don’t know what the current auto-enrolment 8 per cent contribution will provide. Lord Turner envisaged it replacing 20 per cent of earnings, but there is that rather alarming parliamentary question, revealing that someone on average earnings who contributes for 20 years, might only be a fiver better off a week than today. Government knows this, which is why the Regulator has initiated the debate. In the current economic climate this seems a rather futile exercise. Few companies or individuals are in a position to up their contributions sufficiently. But in the future they may not be given an option.
Next on the watchdog’s list are investment strategy and default funds. Lord preserve us. Interference in investment strategy by regulators usually means only one thing - a wholesale switch into bonds.
Which brings us to charges and remuneration. The consultation paper admits big schemes usually have low charges, often picked up by the employer and offer good value.
But the unspoken accusation is that advisers are paid too much and inappropriately. Up-front consultancy commissions, which can continue for group schemes after the advent of the Retail Distribution Review, can devour the first year’s premiums. Does the Regulator like that idea?
But what can the Regulator do about any or all of this? In the short term, not very much. However, this is the very start of a process which will run for years. And if you want to imagine where this might end, think of final salary schemes.
Teresa Hunter is personal finance editor of Scotland on Sunday