Changing Occupational Pension Funds
British employees have traditionally relied on occupational pension funds in addition to Pay-As-You-Go State pensions to provide retirement income. These workplace funds are becoming less able to provide income security for all, let alone promote economic growth and financial stability. A change in state benefits must form the core of any retirement income provision system. If occupational pensions are to form a meaningful part of the change, a number of problems need to be addressed.
How could the occupational pension system be reformed so that individual income retirement security can be achieved, alongside promoting economic growth?
Occupational pension funds have played an important part in the overall provision of retirement income in the UK, for higher earners in particular. Whereas in many other European countries recent reforms have been guided by the aspiration of reducing Pay As You Go state pension benefits, in the UK (where these are already comparatively low) the focus has been on expanding the coverage of occupational funds. This has been achieved through the introduction of auto-enrolment to an occupational scheme for most workers and the obligation for employers to make a minimum contribution to this scheme. The last Labour government set up NEST, a workplace pension scheme for smaller companies without access to their own to facilitate this change.
There are several so-called technical problems with the new system. All workers may not accrue benefits. They might work multiple jobs, all below the threshold for employer contributions, or work in precarious employment which does not allow for the stability required for pension saving. Current pension schemes are de facto individual savings accounts, with tax benefits and employers’ contributions, but it is nonetheless difficult to pull separate pots together when moving positions.
This approach may not be in the interest of many workers, particularly the low paid, because they lock money into a pension rather than holding savings in a deposit account, or ISA. In these more flexible forms the money could be accessed in the case of unanticipated financial need. Where wages are low, saving for pensions is an unaffordable luxury. For this reason retaining and increasing the public sector pension system is essential.
More broadly, while expanding the coverage of workplace pensions is unobjectionable, contemporaneous changes to the nature of these schemes create confusion. Financial risk has progressively shifted from employers to workers. Defined Benefit schemes are rapidly closing to new entrants. The majority of workers contribute to individual Defined Contribution funds, where individual benefits on retirement depend on the vagaries of financial markets.
Individual workers are fully and personally exposed to the uncertainty of financial markets. Retirement during financial turbulence or unfavourable financial conditions (e.g. extremely low interest rates) can have a significantly negative impact on retirement income. At present there is no protection against this possibility. Pension funds themselves are being pushed towards holding dubious assets in search of yields at a time of low corporate and government investment and low interest rates.
Occupational pensions need to change if they are to provide income security for all working people as they retire, and be positive and stabilising factors in financial markets and the economy.
The following principles should guide the reform of occupational pension schemes:
1. Income security and equity. Schemes should provide a basic guaranteed periodic income at retirement. This could be calculated on the basis of contributions as in cash-balance plans, in order to respect actuarial equivalence. This should be complemented with measures that reduce income inequalities by setting floors and ceilings in pension payments and/or tax credits and contribution support from the state for poorer workers. Actual benefit payments would exceed the minimum should returns be sufficiently high to pay for this.
2. Sharing the burden. Providing for retirement should not fall entirely on individuals, as in current individual retirement accounts, or individual employers, as in traditional final salary schemes. Schemes must be large enough so that the risk and cost of retirement are equally shared by all workers of all ages and employers.
3. Transparency. Schemes should be simple and transparent about their workings and cost. They should have a simple contributory structure, and a straightforward calculation of benefits as an annuity with guaranteed rates. This should also favour the ability transfer pensions across employers, which is required given the current structure of the labour market.
4. Cost efficiency. The simple structure of these funds should also work to reduce the costs of their maintenance. These funds should be large enough to realise economies of scale; for example by having an internal management team, rather than having to rely on costly external managers.
5, Long-term investment strategies. The pension funds should be oriented towards long-term returns. Given their large size and stable maturity, liquidity to pay current pensioners can be easily obtained, reducing the need for short-term investment strategies. Pension funds would therefore be ‘patient’ investors, contributing to finance the projects the economy needs as well as being stabilising actors in financial markets.
6. Regulation and management. Regulation should be implemented to ensure proper management of pension funds, which may include quantitative guidelines on asset allocation. Regulations should avoid excessive reliance on accounting procedures that encourage a short term perspective on returns.
7. Professional management with wide stakeholder representation. In line with the trust-based structure of pension funds in the UK pension funds should ensure effective representation of all stakeholders, especially workers, employers and the state. This is particularly crucial for decisions regarding the size of the benefits over and above the limits. Within the mandates given by trustees, the long-term investment horizon and regulatory constraints, actual asset management should be entrusted to (internal) professional managers.
There are several concrete proposals that could be used to model an occupational pension system in line with these principles. One option is to base it on the so-called “collective defined contribution” pension plans, which were proposed towards a few years ago, and were endorsed by the Trade Union Congress. Another is the establishment of local or national government-based retirement accounts, similar to the proposal made by Teresa Ghilarducci in the United States for Guaranteed Retirement Accounts, perhaps by reforming existing state-sponsored pension scheme NEST.
Bruno Bonizzi is a Lecturer in Political Economy at University of Winchester. Jennifer Churchill is Lecturer in Economics at Kingston University.
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