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Is compulsion the right way ahead?

The talking sheepdogs are back on our television screens, showing how keen the Government is to see more people with private pensions. But increasingly we hear it said that encouragement will not be enough and some form of compulsion will be necessary.

At its most simplistic, the argument is that voluntary take-up will be too low, so compulsion is inevitable. But this conveniently ignores a great many important issues that would need to be considered before any plans for increased private sector compulsion could be contemplated.

Before I consider some of these elements, let us take a look at Australia, one of the examples most often quoted as a success by those in the pro-compulsion camp.

Certainly, there has been rapid growth in private pension coverage in Australia. Until the 1980s, employer-sponsored schemes only covered public sector workers and white-collar employees of big firms. A compulsory employer contribution was introduced in 1993, starting at 3 per cent. It currently stands at 8 per cent and is set to rise to 9 per cent in July.

Membership of a scheme is mandatory for almost all employees, with the result that 91 per cent of permanent full-time employees are now covered. But coverage for casual and part-time employees is lower at 62 per cent. Among the self-employed, the figure is lower still, with only 39 per cent having taken out the Australian equivalent of personal pensions.

A key feature of the Australian system is the trend away from stand-alone funds, with many employees having moved to master-trust, multi-employer or industrywide plans.

Another clear trend is a move from defined-benefit towards defined-contribution schemes. Currently, there are around 3,700 schemes of which the majority, approximately 2,800, are defined-contribution schemes while the remaining schemes are split roughly evenly between pure defined-benefit and hybrid defined-benefit/defined-contribution schemes.

What can we learn from the Australian experience? It is far from clear that this model would work in the UK. Many in the UK would not want to see our existing trend from defined-benefit to defined-contribution schemes end in the same situation we see in Australia.

Other parts of the picture look more positive. The coverage of full-time employees at 91 per cent is an impressive figure. But the figure for the self-employed is depressingly low. In a UK context, it is probably the self-employed for whom there is the best argument for compulsion, since they are not part of the state second pension system and therefore have the greatest need for additional provision.

Other issues also emerge. I understand that a compulsory employee contribution was to be introduced in the original plans for the Australian system. This appears to have been quietly forgotten about. Could it be that Australian politicians felt that a compulsory employee contribution would be viewed by voters as a tax by any other name? Would such a proposition smell any more sweet to British politicians?

The state would need to convince people that it had the right to tell them what to do with their own money. Perhaps that argument does hold water because those who can afford to save have a moral duty to ensure that they will not be a burden on the state in later years.

Even if we accept the moral argument, what about the practicalities? For example, what about those who can afford to make only small and prob-ably irregular contributions? Would their compulsory savings be worth making?

In Australia, a problem which rapidly became obvious was that high job mobility created lots of small pension pots. It is certainly possible to cope with this situation but any solution is almost bound to be expensive and complex. In the UK, a great deal of effort is being made to drive down pension costs and to make pensions simpler. We do not want to move backwards.

At an industry level, it is often assumed that the increased level of contributions would be of benefit. But would this pose dangers for our system of pension taxation, regarded by many as an incentive to make pension saving? What need would there be to encourage in a compulsory world?

On an economic level, the theory goes that since compulsory contributions would increase overall saving, the economy would benefit. Unfortunately, there is evidence that where one form of saving is compulsory, other forms of voluntary savings fall. We should therefore be wary of making overly bold predictions about increased savings and economic benefits.

In the last few years, we have seen a huge amount of change in UK pensions. Two things are very important at this point. First, we should not be too eager to conclude that stakeholder has failed. Stakeholder has not yet seen its first birthday. In any case, the measure of success is not only about stakeholder but about increased private sector pensions across the board.

Consider the fact that group personal pension business more than doubled between 1998 and 2001.

Second, we should beware of jumping to the conclusion that compulsion is the only answer. Is there perhaps a third middle way for UK pensions? All the evidence shows that an employer contribution to a scheme is the key to unlock the door as far as employees are concerned. Incentives for executive pension planning could be linked to employer scheme contribution levels and/or employee take-up rates. Tax credits or National Insurance credits could also be used to encourage employers to make that crucial contribution.

More needs to be done to consider how pension incentives could be restructured and improved before we conclude that compulsion is the only way. We live in an increasingly sophisticated world where black and white choices are not always the best option.


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