This article was originally commissioned for the October 2018 edition of the Investment Life & Pensions Moneyfacts Magazine. Tom Murray considers why the Government should examine the external view of auto-enrolment before considering the best way to raise contribution levels.
It is now six years since the introduction of auto-enrolment into the UK and there have been a number of reports assessing the impact of the project on the level of pension savings in the UK. On the whole, these have been primarily positive, with a large increase in the number of people saving and a lower level of opting out than was previously expected.
However, the general thrust of the reports have been to look at the amounts being saved and to assess what needs to be done to raise these amounts to a point that would have a significant impact on the levels of private pension provision in the future.
July’s report from the House of Commons Treasury Committee emphasised the need to increase the amount being saved. It urged the government to consider the options for raising the overall contribution beyond 8% of earnings, whilst making sure to keep the number of opt-outs as low as possible
Whilst the government is considering the best way to achieve this, one of the things it could do is examine the external view of the process. Ireland has decided to follow suit and has just released a consultation document, heavily referencing the UK experience, with a view to finalising a similar project and initiating it in 2022. Imitation is the sincerest form of flattery and the Irish proposals cite the success of the UK’s scheme in dramatically increasing the numbers saving for their retirement.
As part of their process, they have released a strawman proposal for comment by the industry and the general public. It is interesting to compare it to the UK system, to see what aspects the Irish are copying and, interestingly, where they are making changes to cover what they perceive to be weaknesses in the UK approach.
KEEP THE GOOD BITS
For a start, the Irish have copied the basic approach of an auto-enrolled system driven by employers, with an ability to opt-out and regular re-enrolments, just as the UK have done. They see this approach as having been extremely effective in overcoming the fact that the general public is heavily in favour of long-term saving but quite reluctant to actually do something about it; a deferral approach exemplified by St. Augustine with his prayer “Lord, Give me chastity and continence, but not yet”.
TAKE THE PAIN UPFRONT
However, there are a number of significant differences in the way that the Irish are going to achieve their goal. For example, the Irish propose starting at 1% of earnings for the employee, with a matching 1% from the employer, and then in addition, the government will contribute €1 for every €3 saved by the employee. This is escalated each year automatically for 5 years, until the contributions are 6% from the employer and employee respectively. With the government saving top-up, this effectively brings the savings to 14% of earnings for every employee.
This is a much higher level of contribution than is currently demanded in the UK and will bring the Irish population to a more appropriate level of saving quite quickly. The Irish feel that starting slowly is necessary for current workers but that the situation requires the level to rise quickly and for those who join later, pension saving at a level of 6% will just be the norm. It certainly will mean that it won’t be long before much of the population have significant amounts of savings in their pension pots and will therefore be far less likely to want to opt-out.
MAKING OPTING-OUT EXPENSIVE
When it comes to opting out, the Irish government have looked at the UK system and have proposed a noteworthy change for their scheme. Instead of being able to opt-out when initially enrolled, the ability to opt-out is reserved for a window from the start of the seventh month until the end of the eighth month after enrolment.
This is an ingenious approach. The idea is that those who wish to opt out will be faced with a real cost for doing so. For example, once the contributions are ramped up to 6%, an employee on €20,000 will have contributed €600 at the end of his or her first six months of work. The employee will have the option to opt out and get the €600 back but their personal account at that point, ignoring investment growth and charges, will have a minimum of €1,400 in it. Opting out will allow them to get their hands on their contributions, but at an obvious cost of €800, a high price for a €600 lump sum. This, it is believed, will be a far more effective deterrent than notional free money being missed. There’s nothing hypothetical about the disappearance of €800 of your own money into the ether.
Even in the first year of the scheme, when the contribution is only 1%, an employee on €20,000 wishing to opt out will be faced with a definite loss of €133 in order to get their hands on their €100 contributions to date. This is the kind of approach, i.e. making it mandatory for the first six months, that the UK should investigate to see whether it would work to keep opt-outs down as they raise the contribution rates.
Another difference is the administrative arrangements. The Irish strawman proposal posits a centralised processing authority (CPA) for enrolment and contribution handling, and only allows for a limited number of approved pension providers. The reason for restricting the number of pension providers is related to the specifics of the Irish market; it is relatively small and too many providers would prevent economies of scale being able to deliver the pension products at low cost. This is not an issue that would pertain in the UK, a market 14 times the size of Ireland.
The idea of the CPA is to set up a governmental or quasi-governmental body to collect and distribute the contributions, as well as to provide information and act as a consumer portal for communications between the provider and the employee. Essentially, it will be a one-stop shop for communications between all parties – employer, employee and pension providers.
This achieves a number of quite specific aims. The CPA will tender for a number of providers from the private sector by tender to provide products and will assess the products provided to make sure that a minimum level of benefits is provided. The employee themselves can then select the provider/product to which their savings are to be allocated. Those who don’t actively make a choice will be allocated a provider on a carousel basis.
The Irish have come up with a number of reasons for this. Their hope is that trust in the system will be higher with government involvement. They also believe that it will help to keep costs down, if payroll systems only have to create one new single interface to remit the money and information on AE pensions to the providers, leaving the distribution of that money, along with the government top-up, to the CPA.
ONE EMPLOYEE / ONE POT
Another feature of the strawman proposal is that by using the CPA, each employee’s personal public service number (PPSN), the Irish equivalent of the NINO, can be used as the unique identifier because it is a publicly operated service. This obviates any possible issue with data protection in the use of these numbers, as the CPA is proposed to be a government body.
The primary advantage here is that the use of this system will facilitate the pot-follows-member approach, ensuring that even intermittent workers should have no difficulty in maintaining a single savings pot from all their work periods, irrespective of the number of different employers they have. All the employer will have to do is remit the amounts linked to the PPSN, an activity they already do via payroll for tax and national insurance, and the CPA will direct it to the correct plan in the correct provider. There is no need for employers to get involved at all in the details of where their employees actually save for their pensions.
Indeed, the approach lightens the burden for employers, who have no role in the selection or vetting of the products/providers, this being carried out centrally by the CPA. Their sole role is to enrol employees with the CPA and transmit, via payroll, the contributions deducted along with their matching monies. This will make it much easier for smaller employers, particularly those with high numbers of casual labour or high turnovers of staff.
Ireland clearly has been examining the successes of the UK’s auto-enrolment project quite closely and have made significant changes to try to achieve all the best aspects of that system whilst improving some of the approaches that didn’t work so well.
Whilst admiring the success that the UK has achieved in massively extending the number of those saving for retirement, the system has created a large number of under-savers, whose savings will definitely not be sufficient for their retirement. If the system doesn’t deliver sufficient amounts for retirement it will soon lose the confidence of the public and will fail to deliver the benefits the government is counting on.
The danger of increasing the amounts now is the fear that some who are happily saving at the current rates will be minded to opt-out once the saving rates are increased. Also, those now joining the system are joining at a higher contribution rate, making opting out ‘for a few years’ more attractive at the start. This could be usefully offset by the delayed opt-out approach being proposed by the Irish.
In particular, the use of the PPSN to eliminate the problem of multiple pots, the straight move to the final levels of contributions that should be sufficient to produce significant pension pots and the ingenious approach to reducing opt-outs by making potential opt-outers relinquish large amounts of money already in their retirement account are issues that could usefully be examined by the UK authorities.
There’s no doubt that auto-enrolment has been one of the most successful public policy initiatives in the last few decades. It took on what seemed to be an impossible task; making the general public save for their own retirement rather than rely on the state for support. Given the increasing dependency ratio in the UK, this was a much-needed reform. Yet while it has achieved the breadth of saving the UK required, it hasn’t achieved the depth. As other countries learn from us, we would be wise to see what they were doing and how it might best be adapted to make auto-enrolment even better.