If Association of Consulting Actuaries chairman Stuart Southall could have one wish for the pension reforms, it would be for the Government to act on its word when it comes to occupational pensions. He says: “The government has an oft-stated intention of reinvigorating quality occupational pension provision. But at the moment I cannot see any policy ideas which are likely to achieve it. If I had one wish, it would be for it to live up to the soundbites.”
Southall, who is also principal and chairman of actuarial firm Punter Southall, took over the role of ACA chairman in June and is steering the organisation at what he says, in a slight understatement, is a “potentially very interesting time” for pensions. He arrives as the Government is reviewing the state pension age, the default retirement age, pension tax relief, Nest and auto-enrolment.
Prime Minister David Cameron has made a great deal of the idea of fairness in his first months as Prime Minister and this is central to what Southall wants to see in the UK’s pension system.
Southall set out his intention in his speech at the annual ACA dinner earlier this month when he said: “Fairness always means different things to different people but, perhaps as a minimum, there should be widespread support for the notion of fairness across the generations.”
Southall says fairness in pensions is also about the fairest way to provide occupational pensions through the sharing of risk. The ACA has been lobbying for the last five years for a loosening of pension rules to allow the creation of occupational schemes that share the risk between employers and employees by sitting somewhere between the polar opposites of DB, where the employer carries all the risk, and DC, where all the risk is concentrated with the employee.
He says if the Government could pass such reforms, occupational schemes could be truly reinvigorated.
He says: “Our view is that under the current legislation, you are going to be treated as pure DC or pure DB so as soon as anyone tries to risk share to an extent you are going to be faced with the full panoply of the DB law, which can be deeply time-consuming and unappetising for sponsors.”
’Incentivising the middle ground’
Southall says the middle ground, utilising risk-sharing without the full DB law kicking in, would allow employers to create DC schemes where they controlled the whole process, guarantees up to retirement, providing an internal annuity through the scheme and also an ability to smooth out fluctuations. “This would be costly but that would be a hybrid where some of the risk is taken by the sponsor,” he says.
The Government’s solution to get more people into pensions is to create a nationwide DC scheme in the national employment savings trust.
But Southall warns that while Nest will benefit the millions of people without any pension provision, not having a middle way available could mean that millions of people’s existing provisions are reduced through employers levelling down.
He says: “If the Government does not do something about incentivising the middle ground for employers with more attractive risk-sharing occupational sch-emes, small and medium-sized employers will just go for the Nest minimum, so frankly the same level of contributions in the aggregate spread among more people might be fairer but it does not increase the sum total of pension provision. There is a real danger of levelling down taking place.”
’Joe Public is not likely to go into racier funds because they come with massive risk warnings’
Although many people will end up with pension savings they did not have before, Southall and the ACA are concerned that current DC schemes and Nest could leave people with significant risks of a shortfall in their retirement income.
In addition, Southall says the risks prevalent in DC schemes are not being addressed because those at the top have already been handsomely provided for with DB schemes ignoring the DC fears.
He says: “It is the baby boomers who were the major beneficiaries of these DB schemes. Many of them will be in management roles now and they are being shut down, they have super-protections and you could say that the boomers in Parliament have acted on their behalf because they are just protecting their golden egg.
“But frankly the cost of that golden egg is being borne by the 30-somethings and below and they are not getting adequate pension provision.”
This inequality between pension provision is central to the ACA’s call for fairness between the generations. Southall says pension reforms must take account of the children and grandchildren of baby boomers and means employers must not take the cheap route now.
He says: “It is possible to get higher returns from DC if you have the right investment consultants good at picking managers to get better returns.”
But Southall warns that the current fad of picking funds from a menu means that risk is not managed properly and returns are being missed. By investing in consultants, he says DC schemes would offer more to younger employees and help ensure they have the kind of provisions that DB scheme members are now enjoying.
“Joe Public is not likely to go into racier funds because they come with massive risk warnings. But an investment consultant who can be nimble on their feet and knows how markets act can make those moves and can control the risks – they can explore emerging markets, dynamic asset allocation funds and, dare I say it, hedge funds. There are a whole panoply of funds the sophisticated DB scheme uses but the masses in DC are never likely to use them unless the benefits and the risks are dressed up and communicated properly.”
One area that is ripe for a good quality risk-sharing approach is public sector pensions.
Southall says incoming reforms will be made as part of the biggest swathe of spending cuts enacted by a modern Government, meaning that
any changes to public pensions will not be positive for scheme members. But despite the wilder predictions, Southall says there will not be wholesale move to DC.
“We are categorically not about a wholesale switch to DC in the public sector, so risk sharing is where we get to.”
Southall says any talk from the Government to move the public sector from DB to DC is dangerous and only recommended by politicians who “have a lot of pension in the bag already.
“It is easy for them to say that all public schemes should go DC, it is less easy for your low-paid worker to take the risks with DC. We think this is an opportunity though. They have to do something with the public sector and that might be a risk-sharing option and you may have to make them less generous but let’s not throw them out completely. We think the public space would be a good place to trial a risk-sharing DB scheme that we are proposing, it would be a good advert to say that it works.”
As the name suggests, the ACA is an organisation run by and in the interests of consulting actuaries and critics could suggest that the move to DC, whether in the private sector or public sector, would be potentially very damaging for pension consultants but Southall says their arguments in favour of hybrid schemes are genuine and the fairest solution.
’Some people say the ACA is putting forward the risk-sharing mantra because there is more in it for actuaries but it paints us as a very selfish beast’
“Some people say the ACA is putting forward the risk-sharing mantra because there is more in it for actuaries but that paints us as a very selfish beast. We genuinely believe that for people in the public sector, pure DC is very much the wrong solution.”
Another point where the ACA thinks the principle of fairness needs to be addressed is around the idea of inheritance. Southall says the Government should be exploring ideas of passing down assets, maybe through pension funds. He says people who started working after the decline of final-salary schemes will almost certainly find their savings inadequate and one option would be to recycle some of the assets that are already in pension savings down to future generations of pensioners
“Creating a plan to pass down assets would mean there is money for a rainy day. It would come with strings attached, of course, it isn’t spending money but this goes to the heart of this generational thing. As it stands, there will be lots and lots of people who have inadequate pensions in the future.”
Southall says that the pension industry must understand the idea of inter-generational provisions if the pension system is to be sustainable in the long term. He says some of the recent ideas around merging pensions and Isas is a step towards this, as is pension minister Steve Webb’s comments around early access.
But like any pension reforms, striking the right balance is always going to be very difficult. Southall says: “If you make reforms too stringent, you are not introducing any new flexibilities for most people and it is a pointless exercise.
“If you make it too flexible, it may be open to abuse. There are good ideas out there. It is just that finding a workable solution might be more difficult than stating the idea in the first place.” ’Joe Public is not likely to go into racier funds because they come with massive risk warnings’
’Some people say the ACA is putting forward the risk-sharing mantra bec-ause there is more in it for actuaries but it paints us as a very selfish beast’
- He is chairman and principal of pension consultants Punter Southall
- Was elected chairman of the Association of Consulting Actuaries in June after nine years on the board
- Currently an investigating actuary under the Institute of Actuaries’ disciplinary scheme, a non-executive director of Neptune Investment Management and serves as trustee of a number of pension arrangements and an educational trust
- An early editor of The Actuary magazine and an author of a prize-winning actuarial paper on scheme wind-ups
Association of Consulting Actuaries’ aims
- A more holistic approach to the consid-eration of financial needs in retirement and the implications of ever-improving life expectancies
- Reinvigoration of occupational pension schemes through tax incentives and investment management to avoid levelling down to Nest and sponsor migration
- Creation of a system for inter-generational transfer of pension assets or assets which could be used for long-term care being made easier and better incentivised
- Softening of the defined-benefit rules to allow for the creation of a ’middle ground’ between defined-benefit and defined-contribution schemes, where both the employer and the employee share any risk burdens