Pensions
Interview with Mr. Alan Pickering
Partner, Watson Wyatt Worldwide / News Release
December 16, 2005
In 2002, an independent body was commissioned by the UK government to assess the challenges associated with the UK pension system and to make recommendations for its reform. The Pensions Commission published an initial report in October 2004, which presented an analysis of the adequacy of the pension system and personal savings in the UK. The final report, which provided recommendations for reform and the likely results if policy is unchanged, was released on November 30, 2005. This long awaited final report sparks the beginning of a national debate on pension reform, which is expected to conclude with wide-scale pension reform legislation.
The AARP Global Aging Program spoke with Mr. Alan Pickering about his reactions to the recently released Pensions Report. Mr. Pickering is a Partner at Watson Wyatt Worldwide and is one the UK’s foremost pension experts.
GAP: The current British pension system has been criticized for being the most complicated in the world. Adair Turner’s recommendations include a universal flat-rate basic state pension, a second pension based on contributions/credits, and a National Pension Savings Scheme, which will allow people to invest in multiple savings options.
Does the Pensions Commission Report make the pension system any less complicated? What more needs to be done to simplify the system?
AP: The British system is complicated because of the layer cake way in which it has been created over the decades and the way that state and private provision has interacted. I had hoped the commission would recommend a sweeping away of complexity and replacing it with a more simple system. To make sure the proposal is politically acceptable, Adair Turner has erred on the way of caution. Balancing simplicity against cost efficiency he has proposed something that is way too complicated.
I have a 3 fold solution. The first element must be to create a labor market which is blind to age and the Pension Commission deserves credit in acknowledging that unless we create the wealth, we cannot distribute wealth through the pension system. The Pensions Commission has acknowledged the current waste of older workers and it has made recommendations to take advantage of the productive capacity of older workers.
The second element is to create a single state pension which is big enough to provide a guarantee against absolute poverty in old age. To make a simpler, bigger pension affordable, I would be willing to pay the price of a higher eligibility age. The Pensions Commission has shied away from a higher state pension age in order to eliminate hostility among those affected by such a change. I would have said this is a price to be paid for a bigger state pension during the 2020 decade.
The third element necessary to make the system simple is to say to employees and employers, commercial providers and customers, that if you want to contribute you can do so in unrestricted unregulated fashion. The only regulation we need is to save more sophisticated people from stealing from less sophisticated people.
GAP: Industry groups have voiced strong opposition to the report’s recommendation to introduce compulsory employer contributions to the National Pension Savings Scheme. They claim that it will stifle productivity, it will force them to hire less, and it will make UK businesses less competitive.
In reality, how damaging would a 3% compulsory contribution be to small businesses?
AP: I don’t think it is a 3% contribution rate that would be damaging to British industry, but the complex policing method that would be required to ensure that every employer contributed the right amount, for the right work, at the right time, and that the money ends up in the right funds. In my mind it is the bureaucratic burden that would have a bigger impact on industry than the 3% contribution rate.
That is another reason why I believe in a simpler system. We should pay for a basic state pension through taxation on both business and individuals. To many people, compulsory contributions to a private scheme will be viewed as taxation, but it’s very complex taxation. If we have to pay tax, let’s keep it simple.
GAP: In your opinion, will industry groups compromise?
AP: There is a real danger that an adverse reaction from industry to some of these proposals will result in the loss of many of the positive aspects of the Pensions Commission’s recommendations. Two of the most positive aspects of the recommendations are the recognition of the economic contributions that older workers can make and recognition that a bigger state pension has a role to play.
If business does make a compromise, such a compromise might be made by excluding very small firms (5 or fewer employees) from any national pension scheme that might be established.
GAP: The Confederation of British Industry has been quoting a survey they conducted that suggests compulsory contributions will force them to “level down” on more generous pension benefits or even drop employees from more generous employer-based plans.
Do you foresee this as being a potential consequence of the reform proposed by Adair Turner?
AP: There is a real danger that this package will result in a leveling down of existing arrangements. One countervailing argument is that many employers who choose to offer pension schemes find themselves at a competitive disadvantage when competing with companies that don’t have pension costs. Some firms may see compulsory pension costs paid by competitors as leveling the playing field.
GAP: Are subsidies an option to create incentive for employers not to drop existing plans?
AP: I’m not a big fan of tax payer financed subsidies. You have to remember that in the UK only half the working population is covered by workplace pension schemes and they tend to be the better off half of the workforce. I would rather remove disincentives to good quality provision rather than throw money at those employers who may be persuaded.
GAP: Given the aging population, many countries are looking to make public pension systems less generous. The report recommends linking benefit increases to earnings, rather than prices, which would create a more generous state benefit.
Is this good policy? Is this affordable?
AP: Yes. In Britain, the problem has not been generosity of public provision, but inadequacy of a universal public provision. Basic state pension in Britain falls way behind the level which Parliament has determined as the poverty line. In order to bridge the gap between the basic state pension and the poverty line, we have created a complex system of means tested benefits, which are difficult to claim and expensive to administer.
Means testing acts as a disincentive for people to save for retirement. I look at this from an efficiency, rather than ideological standpoint and I think it is far more efficient for the state to provide a guarantee that people don’t fall below the poverty line in old age, than it is for the private sector to offer such a guarantee.
Once we get the level of state pensions right, once we get the qualifying age right, it is then legitimate to have a debate from time to time about whether the state pension should be increased in line with prices or earnings.
GAP: The British press has been suggesting that Gordon Brown is concerned about the cost of a pension system that is linked to earnings. How legitimate is this concern?
AP: I think Gordon Brown has two concerns. One is cost and the other is the question of targeting public expenditure. He has argued, with some justification, that a means tested approach to boosting state pensions is the best way of dealing with absolute poverty in this decade; however, for reasons I mentioned before, I think he’s wrong if he thinks mean testing and targeting is a way of dealing with the pensioning needs of the future. And like him, I want a system to be affordable, which is why I said the level of state pension starting age and mechanism for subsequent increases should be subject to political debate. In an AARP context, it’s worth saying that when such issues are subject to political debate, we shouldn’t underestimate the voting power of older people.
GAP: In the UK and US there is a serious concern about individual’s ability to make sound financial decisions. Many people do not participate in employer-based savings plans and when they do, they often make poor investments.
Do you think this will pose a challenge to a National Pension Savings Scheme where people will be allowed to opt-out or choose from a number of investment options?
AP: I think that the one choice that most of us should be capable of making is the one about work-life balance. Do we live now and pay later, or save now and work a little less later on? Once we get beyond this basic choice, we are expecting people to make sophisticated decisions many of them have not made before. Indeed, the time scales associated with pension provision are such that it is very difficult for most people to make the right decisions all the time. I’m a big fan of financial education, but I think we should start with the low hanging fruit first, which means that we educate people how to handle debt and savings accounts before we move them on to mutual funds and pension planning.
GAP: The Pensions Report suggests that administrative charges can remain low, no higher than .3%, in a National Pension Savings Scheme.
How can this be ensured?
AP: I believe that the laborer is always worthy of higher. We shouldn’t drive all costs out of the system if that means that the system is sub-optimal. The Pensions Report, in suggesting a switch from a retailer approach to wholesaler approach, shows how some marketing costs might be avoided. However, some of those marketing costs involve helping people make the right choices. If we take advice out of the system completely, we increase the chance that people will make the wrong decisions. The other thing that one has to be careful about when making cost comparisons is ignoring those costs that are born on the public purse, rather than the private system. There may well be some additional costs to government if we switch from a private retail model to a publicly sponsored wholesaler approach. Marketing, administrating and policing may have to be done by the government.
GAP: Why couldn’t fees remain low under the current system of private accounts, which are estimated to average 3.2% per year for people investing over a ten year period? (1)
AP: I think that if private arrangements can benefit from automatic entry, then the costs will reduce significantly. I think it is wrong to compare costs of the proposed system, which relies on auto-enrollment, to the costs of the present system, which has not traditionally made it easy for such an approach to be adopted.
GAP: One of the challenges with encouraging people to save in the UK has been distrust in the pensions system caused by the “mis-selling scandal” and losses incurred from the personal account system.(2)
What steps must be taken to regain trust in the government’s and the financial service industry’s ability to provide adequate retirement savings options?
AP: As far as the government is concerned, it would help if any new infrastructure had the support of all of the major political parties. This, together with the increased tendency of older people to cast their vote on the elections, should provide a greater degree of trust in government than there has been before. What is more, a simpler state pension system would be much more difficult for the government to renege on than is the case with the present arrangement.
As far as the private sector is concerned, all the surveys suggest that working people trust their employers more than government and more than the financial services industry. The Pensions Report seems to ignore this and suggests that the employer only acts as a collecting mechanism for the financial services industry. I think that a much more powerful combination is the expertise of the financial services industry, to be headed by those employers that people trust.
GAP: What are your predictions for pension reform?
AP: If I’m allowed 2 predictions -- My pessimistic prediction is that this report, like many of its predecessors, will be shelved and nothing will happen. My optimistic prediction is that the government will now realize that something has to be done and that government will come forward with its own proposals influenced by, but not necessarily reflecting the recommendations of the Pensions Commission, and that these proposals will set out in the early spring a vision of where the government wants our pension system to end up in the 2020 decade. The rest of us will then work hard with the government to produce a road map on how we get from where we are today to where we all want to end up in 2025.
GAP: So, either way, you expect the Pensions Report to be merely recommendations, rather than realistic reform?
AP: Yes, if I were advising a university student, I would tell them not to spend too much time studying the report of the Pensions Commission. Wait until they can judge the government’s reaction to the recommendations.
In itself, the report is a major achievement because government has been in denial for 30 years that no major reform is needed. The Pensions Commission has convinced government that wide-scale reform is needed, and that can be considered a job well done.
The piece that government will want to take forward in its entirety is the proposal surrounding a labor market blind to age. I think that most of the other elements, which deal with the wealth distribution part of the pension equation, will be amended by the government.
(1) Since 1987, the UK has allowed employees to withdraw part of their social security contributions in exchange for making contributions to an individual account system. The reduced contributions are matched by reduced social security benefits.
(2) The “mis-selling scandal” was a widely publicized scandal in the 1980s, in which employees were wrongly persuaded to abandon their occupational pension plans for less generous investments in the UK’s individual account system. Over 1 million investors filed complaints against the financial services industry when they discovered that they would have been better off remaining in their occupational pension plans. The financial services industry was forced to pay over $20 billion in compensation for misleading investors.
The views expressed in this article do not necessarily represent the views or policies of AARP
Alan Pickering is a Partner with Watson Wyatt. He joined the firm in June 1992 having spent the previous twenty years with the EETPU, where he gained considerable experience in many aspects of employee relations, pensions and personal finance. He is chairman of the Plumbing Industry Pension Scheme and has been closely involved with the development of many other industry-wide schemes. Alan was a member of the Occupational Pensions Board from April 1991 until April 1997 serving as its Deputy Chairman from October to December 1993. He was Chairman of the National Association of Pensions Funds between May 1999 and May 2001. In October 2001, Alan became Chairman of the European Federation for Retirement Provision (EFRP). On 26 September 2001, he was asked by Alistair Darling, Secretary of State for Work and Pensions, to lead a review into the possible simplification of the rules governing the operation of all forms of private pension provision. His report "A Simpler Way to Better Pensions" was published on 11 July 2002. In January 2004, Alan was awarded a CBE for services to occupational pension schemes.