Response to Consultation on removal of NEST constraints
Prepared by Dr. Ros Altmann
I am delighted to respond to this important call for evidence, which follows the Work and Pensions Select Committee’s report raising concerns about the impact of the two statutory constraints placed upon NEST and the need to consider removing them.
In my view, the restrictions on transfers into and out of NEST and the maximum £4,400 annual contribution limit have hampered the ability of NEST to compete on any kind of level playing field with other providers. These restrictions automatically rule NEST out as a provider to any employer who wants to have only one scheme. If the employer already has a scheme, it cannot switch members’ past contributions into NEST. If the employer does not have a pension scheme from the past, but has any employees who earn over around £60,000, then there would need to be a separate scheme established for them because their contributions would exceed the NEST cap.
NEST was supposed to be a low-cost simple pension scheme, to be used by any employers who had low and moderate earners and may not be attractive to other private providers. However, the restrictions placed on NEST and the lack of administrative or software support offered, mean it is not a simple provider. The restrictions make it complex for employers to engage with.
Most employers will want only one pension scheme, but this can’t be NEST: Employers with existing pension schemes cannot use NEST for all their staff pensions and many will not want to have to bother with more than one scheme. NEST means current pension accruals can’t be put into NEST and any high paid staff cannot be auto-enrolled into NEST if their minimum contributions exceed the maximum limit.
NEST is being forced to compete with two hands tied behind its back: I have long argued that these restrictions mean NEST will struggle to succeed. Removing the restrictions on NEST would have significant benefits
- Firms will prefer to use just one scheme: Employers would be able to use only NEST for all their pension arrangements. Many employers will want the simplicity of having just one scheme for all its employees, which would rule NEST out for large numbers of firms.
- Taxpayer loans will be recouped more quickly: The taxpayer has committed to supporting the set-up of NEST for the initial period, but this money must be repaid as soon as practicable. It has already spent over £170m in setting up NEST. The more assets NEST manages to attract, the sooner it can repay the taxpayer loans. It is therefore in all our interests that NEST becomes more competitive as soon as possible.
- Market failure for small pots can be addressed by NEST taking small transfers: There is likely to be a market failure relating to small pension pots which result from workers who only stay a short time with their employers and then move on to another firm. Existing providers will find it uneconomic to manage these small sums, so the member will have to move their assets, but a new provider may be equally reluctant to take on the small amounts of money. If NEST could sweep up all the small pots, as a default provider, this problem can be managed.
- NEST cannot just manage the pensions nobody else wants: It is important that NEST restrictions are reconsidered, in order the give NEST a better chance of eventual financial survival. NEST needs large pools of assets to help cover its costs. It is not financially sustainable for NEST to only be there to take the pension contributions that nobody else wants. It has a public service obligation to serve all employers who want to find an auto-enrolment scheme, but if it ends up only having the worst employers, with mostly low-paid short-stayers, it will have insufficient assets to function with the necessary economies of scale and the administration costs will make it uneconomic as a pension scheme.
- NEST upfront 1.8% contribution charge might be abandoned to give members better value more quickly if more assets come in: In order to repay the taxpayer loans, NEST has felt forced to levy an initial 1.8% upfront charge, which renders this supposed-to-be low cost scheme relatively expensive. This charge is a self-inflicted problem for NEST, but results from the way it has been set up. Indeed, this 1.8% charge means the first year of contributions could face charges of more than 2%. This is hardly a ‘low cost’ scheme. If NEST was able to count on more assets flowing in at the beginning, it may be able to alter its charging structure to become more competitive. Anyone who does not stay in NEST for long will end up paying much higher charges than the 0.5% target amount. NEST made it clear that the 1.8% initial charge was a result of having to repay the loan and once it is repaid, the charging structure will change.
If we really want NEST to thrive, these restrictions need to be removed.
SPECIFIC ANSWERS TO QUESTIONS ASKED:
1. What evidence is there that the current downward pressure on charges is sustainable as smaller, less profitable employers start to meet their automatic enrolment duties? Is this relevant in considering the impact of the annual contribution limit and the transfer restrictions on NEST?
It is highly unlikely that the majority of private providers will be able to service much smaller employers profitably at low cost. These providers are likely to have a limited capacity and may ultimately reject some employers. In fact, if the restrictions on NEST are not removed urgently, there could come a point in the next couple of years when employers are actually unable to fulfil their auto enrolment duties, because they cannot find a provider who they can engage with in the private sector and the NEST restrictions prevent them from auto-enrolling all their workers. If a private provider has taken on an employer and then finds it is unable to fulfil the duties and wants to transfer members out, or if the provider fails, it will be important to know that NEST is there and able to accept transfers.
2. What evidence is there that the current pension industry has the capacity to serve the peaks in employer demand and put solutions in place to meet the demand for good quality, low-cost schemes? Is this relevant in considering the impact of the annual contribution limit and the transfer restrictions on NEST?
The evidence from the past is that the current pension industry is normally not geared up well to service low earners, with high turnover rates. The current industry can only service these types of members at high cost, although B&CE does have a record of success in this area.
3. Do you agree that NEST should be able to fully participate in any automatic transfer solution?
It is essential that NEST should be able to fully participate in automatic transfers. This would be a good way to help NEST add to assets under management and help repay the taxpayer loan, but also can help ensure that there will be a quasi official body to use for this purpose. We know that most providers simply do not want to take on this kind of business and it makes much more sense for NEST to be used as an aggregator so that individuals can keep track of their pensions in one place, without the need to keep switching every time they move jobs, unless they wish to.
4. What evidence is there that the annual contribution limit and the transfer restrictions placed on NEST are or will influence employers’ decision making?
It is self-evident that employers who want only one scheme in place will not be able to use NEST.
5. Is there evidence of employers feeling unable to choose NEST for their workers due to the annual contribution limit and/or the transfer restrictions?
I have spoken to a number of employers who, when the realise there are complex restrictions on NEST, say they will not want to use it. Most smaller employers want one scheme only and would also prefer to use a scheme which offers help with administration. From the employers’ perspective, they want a scheme that is as easy as possible to engage with and the cost to members is less relevant than the cost to the employer.
6. Is there evidence that employers (of any size) are prioritising or will prioritise a single scheme solution for automatic enrolment?
There is significant anecdotal evidence from employers who have not yet engaged in pensions, or from those who have already been using a provider and do not wish to add complexity by introducing a new provider, that these employers will steer clear of NEST. Either they will use their existing provider to auto-enrol all workers, or they will choose another provider for future auto-enrolment who can cope with all workers, not just a subset. Those who are looking at NEST tend to be employers who are happy to have some diversification of pension offering and believe NEST may be more suitable for a particular section of their workforce.
7. Is the existence of the annual contribution limit and/or the transfer restrictions on NEST adding to the cost to employers of responding to automatic enrolment?
It is not clear that these constraints actually add to the cost of responding to auto enrolment. Employers will look around for a provider, but they are likely to consider a few schemes, of which NEST may be one, however the process of considering a number of schemes is one which will not really incur extra costs by considering one more provider such as NEST.
8. Is there evidence that the impact of the annual contribution limit and/or the transfer restrictions on employer decisions is leading or will lead to sub-optimal pension outcomes for workers?
We cannot tell about pension outcomes because we do not know what will happen in future. Auto enrolment has not been in place long enough to make this kind of judgment. It is not clear what the impact, for example, of the 1.8% upfront NEST charge might be on long term pension outcomes, nor what policy NEST will follow on annuity conversion, relative to the policies followed by alternative providers.
9. What factors should the Government take into account when considering the likely impact of the annual contribution limit and the transfer restrictions on employer choice as smaller employers are brought into the reforms?
The Government needs to consider the possibility that the private marketplace may be so overwhelmed by demand that it has to turn away employers or that some private providers may fail and leave employers without a pension scheme. If such eventualities take place, there needs to be a provider of last resort who can take in other pension contributions and service companies which the rest of the market cannot cover. If there are only two other bulk providers (NOWpensions and People’s PEnsion) and they become overloaded, NEST would need to pick up the slack. If a private pension firm failed, again NEST would need to step in, but if it could not accept transfers then auto enrolment would be interrupted. The legislation for freeing up NEST to step in if needs be, by taking transfers and removing the cap, needs to be put in place now, before such a crisis occurs, rather than waiting for it to happen. As auto enrolment proceeds through 2014/15 and beyond, with so many smaller employers coming in, there are significant dangers for the marketplace.
10. How should the Government best protect consumer interests? Would a different policy response be appropriate for smaller employers?
Consumer interests can be protected by thinking ahead and putting contingency arrangements in place in case some major dislocation occurs, rather than waiting for that to happen. That means legislating soon for NEST to be able to take transfers, aggregate small pots and have no maximum contribution cap, so it is ready to step in if needs be. I would not differentiate between smaller and larger employers, since there is no specific rule that would apply to a particular sized employer. There should be the same rules for all employers, otherwise size cut-offs could become a problem and workers for employers falling one side of a line could lose out.
11. Are there other aspects of consumer detriment relating to the annual contribution limit and/or the transfer restrictions on NEST that the Government should consider?
The Government should consider whether restricting the competition in the marketplace, by fettering NEST’s ability to serve all employers properly, could lead to higher costs and worse outcomes than would be the case if there was more competition.
12. Is the end of implementation the appropriate time to remove the annual contribution limit and the transfer restrictions?
The restrictions need to be removed now, not waiting until all employers have already chosen schemes for their auto-enrolment. NEST needs to gather assets and just leaving it to predominantly pick up the employers no private provider wants, or which are uneconomic for others to serve, will hamper NEST’s ability to offer a really low cost pension scheme to employers. The 1.8% upfront charge will not be lifted unless the Government loan is repaid, and the loan cannot be repaid until NEST has enough profitable business.
13. What would be the impact on individuals, employers, NEST and other pension providers of this approach?
There will be less competition in the market if the restrictions are only lifted after implementation ends. Also, once an employer has a scheme, the inertia is likely to mean less movement, so if NEST is not in at the beginning, it will find it hard to pick up new business for a long time.
14. Do you agree that NEST should be able to participate in an automatic transfer system?
15. What would be the impact on individuals, employers, NEST and other pension providers of this approach?
Yes. I think it is important for NEST to participate in any system of automatic transfers, so that it can achieve more assets under management and also broaden competition in the market.
16. Should NEST members be allowed the same transfer rights as members of other occupational pension schemes, and if so from when?
17. What would be the impact on individuals, employers, NEST and other pension providers of this approach?
Yes. Immediately. Transfers into and out of NEST should be the same as other schemes, which will help market competition and also force NEST to compete properly.
18. Should bulk transfers into NEST be facilitated?
19. What would be the impact on individuals, employers, NEST and other pension providers of each of these approaches?
Yes. If we believe that NEST is a good provider and are setting it up to help small employers and low paid or transient workers, why would we not want to allow people to transfer in in bulk? If an employer has a scheme they are not happy with and want to move all workers into another scheme, it makes sense for NEST to be able to be that provider.
20. Are changes to the annual contribution limit required?
21. What would be the impact on individuals, employers, NEST and other pension providers of each of these approaches?
Yes. Having a contribution cap rules out using NEST for all workers in a company. It is hard to understand why NEST must have a cap of this kind. Obviously, other providers would like to cherry pick the best customers, but that is surely unfair on NEST.
22. Which of the approaches – or combinations of approaches – achieve the optimum balance between focussing NEST on its target market and enabling employers to meet their automatic enrolment duties whilst supporting good pension savings outcomes for individuals?
The best approach for helping NEST thrive and enabling employers to meet auto enrolment duties is to free NEST of its restrictions and allow it to compete properly with other providers. The restrictions on NEST do not help it to ‘focus’ on a target market, they just help it to be unable to serve the more profitable and attractive segments of the pensions market and force it to focus on the least attractive areas of the market. This is not in the interest of NEST or taxpayers, nor of employees.
23. Are there alternative proposals which address the concerns that have been raised?
It is likely that NEST would benefit from being allowed to offer other products alongside pensions, such as ISAs, and also to perhaps offer help and guidance with the administrative burdens of pensions.