Pensions - Articles - Politician’s syllogism preventing analysis of auto-enrolment

 by Tom Murray Head of Product Strategy for Exaxe

 When politicians finally concluded that something had to be done about the low level of pension savings, the government bit the bullet with auto-enrolment. However, the question remains; ‘Has enough consideration really been given to the effectiveness of the solution?’

  

 The politician’s syllogism from Sir Humphrey, in Yes, Minister sums ups the auto-enrolment dilemma quite aptly in the phrase: “We must do something, this is something, therefore we must do this”. In a similar way, when auto-enrolment came along, all parties leapt on the band-wagon seeing it as a feasible solution. By adopting it as a policy, they could be seen to be tackling the problem. However, the fact of the matter is that not enough analysis has been given to whether the solution is going to fix the problem or whether something more dramatic is required.

  

 The efficacy of auto-enrolment as a solution to the lack of pension saving in the UK deserves closer consideration than it is getting, as does the approach of providing the National Employee Savings Trust (NEST) as a vehicle for it.

  

 Since the original idea of auto-enrolment was mooted, the idea that the main reason individuals have not been saving for their pension was down to inertia has been transmuted from a theory into an unquestionable fact. It appears to be impossible for anyone to even countenance the prospect of failure of auto-enrolment to dramatically raise the number of people saving for their retirement in the UK.

  

 So the opt-out clause- where individuals can decline to be forced to save- was assumed to be a feature that would preserve individual rights, but hopefully wouldn’t be used much. After all, with all the media discussions about the future pensions’ time bomb being endlessly churned out, why would anyone want to opt out?

  

 What if auto-enrolment fails?

  

 Worryingly, no one seems to be considering what should happen if the opt-out rate is significantly above the government’s assumption of twenty five per cent. How is the government going to react if people respond by deciding that money in their pocket today far outweighs the benefits of money in their pocket in thirty or forty years time? How likely is this to happen?

  

 The problem is that most assessments of the system concentrate on looking at it from a societal point of view. But the individuals that will be auto-enrolled into the pension schemes only look at it from a personal point of viewand from that angle, the prospect is starkly different.

  

 The level of sacrifice by the low-paid is disproportionally greater than for those on high salaries. So even though the initial contributions are set quite low – too low in the view of many – auto-enrolment will still require specific and immediate sacrifice by the low-paid in the form of an adjusted lifestyle.

  

 Based on the contribution limits currently in place, projections of the final pension pot are unlikely to be very impressive. Without emphasis on the role that state pensions will play in the future, the question is how much it will decline compared to the level of the state pension today, it is hard to get the ‘fear factor’ going amongst those on low and medium wages. Without fear of the future, the main driver to sacrifice spending today for the sake of future consumption is missing.

  

 Given all this, the temptation to opt-out, or cancel within the first year is going to be very high for lower paid workers. The Institute of Directors recently conducted a survey in which a quarter of employers who responded estimated that the opt-out rate could be as high as fifty per cent.

  

 This level of opt-out would cause significant damage to the government’s plans to compel everyone start saving for their future. Despite all the hype from the pension experts about the desperate need to increase savings and the positive results coming from focus groups, it seemsquite likely that the opt-out rate will be very high.

  

 Can we afford to fail?

  

 The truth of the matter is the government can’t really afford to let auto enrolment fail. What would happen in the future if half the population had some pension savings and the other half had none?

  

 The government in power at that time would not be able to reduce the state pension without impoverishing the segment of society that didn’t save. Yet by keeping the state pension level high it would end up over-funding those who had saved; thus the whole premise of the auto-enrolment project would be undermined.

  

 In this scenario the state would end up with the same level of pension funding that the whole project was designed to avoid, as the only other alternative would be a means tested approach that would subsidise those who didn’t save, while effectively penalising those who did. This would be a politically unfeasible and morally indefensible stance for them to take.

  

 Is compulsion the answer?

  

 This will leave the government with a number of choices: accept the level of opting out that occurs, even if it is dramatically higher than its original estimates and hope that over time the take-up rate will increase. The alternative is to move to enforcing the savings behaviour that is currently only encouraged, by abandoning the opt-out facility and making membership of a pension scheme by all qualifying workers compulsory.

  

 Of the two approaches, the compulsion path is the better way to go, as it guarantees results. The Australian government has shown what can be achieved when one is prepared to take forceful action and mandate pension savings across the population. At least the Treasury would then be in a position to make realistic calculations of the amount of future pension savings within the UK and therefore they would be in a better position to forecast the likely demands on the state from an ageing population.

  

 The question remains how long should the government wait before moving to compulsory auto-enrolment?

  

  

 Is NEST a mis-selling scandal in the making?

  

 A second question that the government needs to consider has arisen since NEST published its investment strategy. This is due to the rather unusual approach that has been decided upon by NEST, i.e. to take a cautious approach for individuals in their early twenties; a higher risk with those in their thirties and forties, returning to a cautious approach again as the employee approaches retirement. This strategy is designed to maximise the number of participants in the scheme as NEST believes that poor returns in the early years would make people opt-out.

  

 The danger is that NEST may be deemed to have failed in their fiduciary duty, as they are positioning the investment strategy to maximise the number or people saving – a societal view – rather than by providing the maximum return for the individual, which is the scheme member’s primary concern.

  

 Employers that choose NEST as their scheme, and the IFAs that advised them, may have difficulties defending the over-cautious investment approach taken by that body, and could be held responsible when the final pension pots are calculated, if the amounts are not as high as initial projections had led employees to expect.

  

 So the choice of where employers should put their employees’ savings is not as straightforward as it may initially seem, and the government option does not necessarily provide the easy answer.

  

 Compulsion

  

 It appears at this stage that there are sufficient grounds for an independent review to examine these issues. It is still early enough to look to make the changes needed, without waiting for something to go wrong first.

  

 Compulsion undoubtedly needs to happen, so the sooner the government grasps the nettle, the sooner they will be able to ascertain the pension landscape of the mid twenty-first century; an essential first step for proper planning. As a bonus, it would relieve NEST of the pressure to maintain membership levels, allowing them to take a more traditional commercial approach to investment, focusing on the returns to the individuals rather than trying to prevent leakage from the system.

  

 When considering pensions, perhaps politicians need a new syllogism: Only compulsion will make people save; we need people to save; therefore we need compulsion.