While Government proposals to introduce lifetime provider models may help to tackle the growing number of small pension pots, they risk undermining the success of automatic enrolment. The proposals could fundamentally change the role of the employer and could have a negative impact on outcomes for savers, the Association of British Insurers (ABI) has cautioned.
To tackle the growing number of small pension pots and engage more people in pension saving earlier on, the Government has suggested introducing lifetime provider models through two methods: member choice and pot for life.
In order to understand the real-world impact of the proposals, we commissioned WPI Economics to poll employers on how they would respond to the reforms and to examine the impact of the proposals on different groups of savers.
Savers staying put could miss out - and there are risks for switchers too
Under automatic enrolment, charges mainly take the form of a very small percentage of the value of the pension pot. Because it is a percentage, this means that people with smaller pension pots benefit from lower charges than those with larger pots. Firms recoup the lower charges for small pots by charging more for larger pots – known as cross-subsidisation.
However, under member choice people would be encouraged to switch providers and firms – creating a retail or individualised pricing model, similar to banks. With this model, pension firms are likely to seek to attract savers with bigger pots out of workplace pension schemes, leaving smaller pension pots behind.
Based on analysis of international and UK markets, those with lower savings could end up with lower performing defaults, while also potentially being hit with increased charges as they would lose the cross-subsidies from larger pots. This could cause existing inequalities in pensions to deepen further, as it’s more likely to impact those who are younger, on lower incomes, women, and people from ethnic minority backgrounds.
While member choice may not support good outcomes for lower-income savers, it also may not support good outcomes for savers as a whole. International evidence from Mexico shows that 40% of consumers switched to schemes which had both lower returns and higher fees after a member choice model was introduced.
Fundamental shift to role of the employer and concerns for savers
Employers play a significant role in workplace Defined Contribution (DC) pension saving by selecting an appropriate pension that meets their employees’ needs. This role could significantly change under either of the proposed reforms.
With choice and switching providers being a key part of the Government’s proposals, the onus would shift from employers securing the best deal for their employees, to individuals taking more control of their pension pot.
In a survey of over a thousand employers, 65% said it would be more difficult to assess the quality and value of a pension scheme for employees under the proposed reforms. And over half (57%) said they would take less interest in the quality of the scheme that they would choose for the employees who remain with their workplace provider.
The focus on switching poses a further challenge, as WPI Economics estimate that just 5% - 8% of savers will exercise choice in the initial years of the reforms, based on evidence from other markets.
For those who do decide to act, insights from WPI’s employer poll reveal concerns about the outcomes for savers. Over half of employers (59%) said that they would worry that their staff would make bad pensions decisions if they had to choose for themselves. Likewise, 62% of employers expressed concerns that the reforms would lead to their employees getting worse pension outcomes compared to just 10% who disagreed that there would be a negative impact.
Increased burden on employers
Results from the poll also revealed that the reforms are likely to create a significant admin burden on employers. 63% of employers said that they’re worried the proposed reforms will increase their payroll provider costs, while 28% estimate that the reforms will require an additional five hours of staff time per month. Modelling based on the findings suggests that this admin burden could cost £550 million per year across the economy.
Yvonne Braun, Director of Long-Term Savings Policy at the ABI, said:
“Tackling the challenge of the rapidly growing number of small, inactive pension pots is vital so that it’s easier for people to keep track of their money. However, automatic enrolment through the workplace was primarily set up to help those who were not saving into a pension, many of whom were lower paid people, and we must not reverse its success. As this evidence shows, member choice would deliver few benefits, but risk throwing away the gains from auto-enrolment.
“Pensions dashboards will bring key improvements in data quality which could help to make more efficient, cheaper pension transfers a universal reality. It is important that this work is completed, and the impact understood, before any further reforms are added to the mix.”
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Notes for Editors
Definitions:
- Member choice would give employees the right to ask their employer to pay their contributions into a pension pot of their choice.
- Pot for life would mean employees stay in the first pension scheme that they started saving into at the beginning of their career, unless they proactively opt to move.
The report ‘Understanding the impact of ‘pot for life’ proposals’ can be found here.