Six thoughts on Labour’s pensions review from an ex-DWP adviser
Labour is placing significant hope on ‘unlocking’ more private funding in the UK. Our Head of Policy and resident pensions expert Jan Zeber shares his thoughts on the Pensions Review underway.
It’s only week 3 of the new Labour Government, but there is seemingly no rest in pensions policy. A review of the “pensions landscape to consider what further steps are needed to improve pension outcomes and increase investment in UK markets” was promised in the Labour manifesto which was duly announced this Saturday. The Pension Schemes Bill in the King’s Speech also gives the Government a locked-and-loaded legislative vehicle ready to implement the review’s findings.
Between 2021 and 2023, I worked for three successive DWP Secretaries of State as their specialist pensions policy adviser: Mansion House reforms, State Pension Age Review and management of the LDI crisis are just some of the highlights and lowlights I had the privilege to work and advise the Secretary of State on directly.
What follows is a collection of my thoughts on Labour’s review. They are based on my three years in the Department, and - perhaps more importantly - subsequent reflection on them. Most of these areas are within the scope of the Review, but some are not - in my opinion, they should. Finally, while I have always strived to ensure my opinions and advice are firmly rooted in facts and evidence, I have never worked for a pension fund and apologise for any mistaken assumptions should any subsequently be flagged.
3rd biggest pensions market, not a single top 20 fund
In 2023, the UK’s private pension assets stood at approximately £2.6 trillion, making it the world’s 3rd - and previously for a long time, 2nd - largest pensions market. Despite this, none of the world’s top 10 or top 20 funds by assets under management hail from the UK (in 2022, there weren’t even any UK funds in the top 30 - congratulations to the Universities’ Superannuation Scheme (USS) last year 36th!).
So the UK may have a lot of pension wealth, but it does not have large pension funds. Does it matter? Is bigger always better? Isn’t more competition a good thing?
As far as returns are concerned, the same survey of pension funds found in 2023 that the top 20 grew by 2.6% on average between 2017 and 2022, while top 21-50 grew by 3.6%, 51-100 by 2.1% and 100-300 by 1.9%. The year before, the rates stood at 8.8, 8.5, 8.2 and 8.1% respectively, showing clear returns to scale. This is even more stark when we look at average annual returns of large schemes by country - such schemes in Canada, Australia and the US deliver returns of 6.9% between 2018 and 2023, compared to 4.4% in the UK.
But perhaps more importantly for this Labour Government, scale is a requisite for complex investments into illiquids like infrastructure and early-stage companies. Minimum ticket sizes in these asset classes are large, while risk and liquidity management considerations mean illiquid allocations - particularly risky bets on private companies - should be small as a proportion of portfolio (although it is possible to ‘rent’ scale via pooling - more on this later).
Consolidation is therefore vitally important, and it is encouraging to see it prioritised in the Review. There are no silver arrows in pensions, but scale comes close. If the UK wants to take advantage of its vast pension assets, it needs globally competitive funds.
UK is an international outlier in not funding its public service schemes
Look at the list of top pension funds globally. Do you notice something? Maybe you’ve spotted it: they are overwhelmingly public service schemes.
Depending on how you count, the UK can be said to truly only have one: Local Government Pension Scheme (LGPS) which is subject to the Review.
But teachers, NHS workers, civil servants, police officers, firefighters and members of the armed forces are all in unfunded schemes. Meaning, the current generation of working age members pays for the current generation of retirees, in expectation of one day being on the other side of the fence, and so on. This is called Pay-As-You-Go.
Why? Unclear, so likely historical accident.
Yet, moving to a funded system - where a proportion of the contributions are invested - does not have to mean making the system less generous. Yes, there is a debate to be had about whether underpaying public sector workers but compensating them in future pension entitlements is optimal, especially when it comes to young teachers and junior doctors trying to buy houses and start families. But that is a separate matter.
UK’s public service schemes receive a lot in contributions from employers and employees alike. In 2019-20, members of four largest public service schemes were contributing 44% more in real terms than ten years prior, despite average pay decreasing 12%, while average public service employer contributions increased from 15.9% in 2009-10, to 24.3% in 2019-20.
At the very least, a proportion of these contributions can and should be invested. Countries with far less developed financial services sectors manage it just fine - we would too.
There is no way around DC contributions having to rise eventually, but there are ways to minimise the cost
Speaking of contributions, the defined contribution (DC) space suffers from the opposite problem - its contributions, while invested, are far too low to offer the sort of retirement old defined benefit (DB) schemes could.
Again, the primary reason why old-style DB pensions could be so generous had less to do with how these schemes invested or even with longevity risk pooling which you can do in these sorts of schemes (although that did help a bit) - rather, it was because contributions were much higher.
It follows that while the Mansion House reforms are necessary from an overall economic growth and investment perspective, they won’t by themselves give us a better retirement. For that to happen, we simply need to save more.
But it is notable just how difficult it was for the previous Government to pass the primary legislation necessary for the 2017 Automatic Enrolment Review (only done last year through a Private Members’ Bill) despite the fact they are relatively small and have been arrived at by a painstaking process of consensus-building with industry and employers, both of which expected them for years.
Why was it so difficult? Because higher pension contributions mean not just lower pay-cheques, but also higher cost of employment, neither of which was appealing during the fragile economic recovery from the Covid-19 pandemic and cost of living crisis. If passing relatively insignificant changes was so difficult, how optimistic can we be about the prospect of more fundamental reform?
It is therefore good to see ‘adequacy’ falling specifically within the remit of the Review (scheduled for the second phase) since a specific, high-profile policy development process means most opportunity to build consensus.
And luckily, there are a number of niche ideas out there for how to ‘soften the blow’. Automatic increases linked to life events like paying off the student loan, paying off the mortgage or simply higher default contributions linked to different levels of pay are just some of them. Might the Government be tempted to seriously look at the work undertaken by Nest on “Sidecar Savings”?
For schemes to get comfortable with more risk, they need to be in charge of the investments
Much has been made of cultural factors when it comes to the risk appetite of UK pension schemes. While I do think this is a significant factor, I also think this sometimes can be confused with wariness of undue political interference. The dreaded situation is something going wrong as a result of an action that looks like has been taken not as a result of usual risk management processes, but as a result of political inducement which resulted in those processes being deprioritised - whether that is what actually happened or not.
It is important to remember that trustees can be personally liable for scheme losses where breach of trust is ruled. While, of course, this situation is highly theoretical, the historical purpose of trusts is the protection of those who manage property and assets for the benefit of others from undue internal AND external influence.
This is one of the reasons why I continue to believe that Australia (which, as a common law jurisdiction, has trusts) is an under-appreciated model of how to get pension schemes comfortable with riskier investments. There, pressure from the trade unions to invest in Australia resulted in schemes coming together to establish their own not-for-profit, scheme-owned asset manager today known as IFM Investors.
Initially intended as a pooled vehicle for Australian infrastructure investment - since Australian schemes back then were too small to do it themselves - today it is an international giant with several private and public markets specialist funds (including private and listed equity). Schemes are fully in control of it meaning no question of undue influence, while lack of shareholders means fees can be kept relatively low.
If there is a proven model of how to reliably boost productive pension investment when many schemes are still relatively small, this is it.
We don’t yet have an advice crisis, but…
People think they have pensions, but they don’t - in DC, it would be more accurate to say they have pots of money. Those pots have to then be turned into sources of income, whether through an annuity, flexible drawdown, cashing out, or a mixture of all three, and that income has to last for the remainder of their life.
How this is achieved is a topic that is complicated, boring, uncomfortable (who wants to think about death?) and - since pension freedoms - eventually necessary for every DC member, i.e. these days the great majority of the working age population.
Just how reluctant people are to think about these things will surprise no one. More worrying is the fact that there is also reluctance to seek regulated (and therefore expensive) advice or even free guidance from the Government’s own guidance service PensionWise. Boosting the rock-bottom take up of it was a DWP priority when I was there.
While the DC market is still maturing, this isn’t a huge problem - most DC pots being accessed are small and supplemental, since new retirees just about still had access to old DB schemes, and those do not come with these decisions.
But this will change eventually.
“Pensions landscape” should include the State Pension and pensioner benefits
If you’re rolling your eyes right now, hear me out: pensions policy should be thought of as a system - you turn one dial, it’ll affect all the others. It is therefore crucial that any big review of the area at the very least includes consideration of the usually neglected dials, i.e. the state pension and pensioner benefits.
Not doing so risks unintended consequences like the risk that Automatic Enrolment will result in enough income to render someone ineligible for pension credit and housing benefit, but not much more.
It also risks the system drifting by inertia in an unintended direction. For example, I would argue that the combination of Triple Lock, generous pension tax relief and restraint on minimum private pension contributions is turning the UK’s pension system “European” - we are more reliant on the Government for support in old age, not less. Was that the intention?
And if there is such a thing as a ‘good time’ to look at the Triple Lock (which Labour does not want to do, but let’s entertain a hypothetical for a minute) it has to be at the point of considering the entire pensions landscape. After all, we can only know the appropriate level for state-supported ‘foundation’ of retirement income once we know how much we think people should be compelled to save, and vice versa.