This article by Rosalind Connor, Partner at ARC Pensions Law looks at auto-enrolment, the gig economy and the future of pension provision.
In the early days of the Labour Government of the late 90s, when we all had high hopes of the future and no one had heard of Brexit, and only a few had heard of Donald Trump, Tony Blair asked a veteran radical MP, one Frank Field, to 'think the unthinkable' on pension and welfare provision. The result was a Green Paper in 1998 called 'Pensions - a new contract for welfare' which, although largely forgotten today, has been incredibly influential on pension policy in the last two decades.
The "squeezed middle"
A significant problem of pension provision, Field found, was the people in the middle. Put simply, middle class people save for their pensions because (a) most of them see a financial adviser at some point and (b) however badly off they feel, they do have spare money. At the other end of the scale, people on benefits remain on benefits in their old age and, although their situation is hardly enviable, their income remains much the same and, with the adjustments made over time, can improve a little.
The people for whom retirement can be a catastrophe are those between these two large groups - those who have worked most of their lives, but haven't been able to save sufficiently to have any valuable assets, such as their own home, or a pension. Suddenly, they move from a decent living wage, to having to survive on state benefits. Of course, the really lucky ones have a decent employer-provided pension, possibly a defined benefit one. However, in the 1990s these were already becoming rare and there was no alternative saving provision for this group - no one was targeting them for financial products.
The auto enrolment solution
Nearly two decades later, we are still trying to solve the problem for that middle group - how do you provide a pension for people that pension providers aren't interested in? How do you get people to save for the future when they may be struggling to clothe and feed their families? How can you do all this in a market economy, where compulsion is a dirty word?
Automatic enrolment is an attempt to solve this problem. All employers have to enrol their employees in a pension scheme and make contributions, and although employees can opt out, they are regularly re-enrolled so that the inertia that historically prevented people joining a pension now operates to keep them within it. Financial providers who don't want to sell a pension to the office security guards now rush to do so because they get the managing director as well, and for businesses who cannot get private sector engagement there is NEST, the pension scheme of last resort.
The process has been a long time coming - from the green paper to, eventually, an act in 2008, which only started rolling out in 2012 and is just finishing five years later, the length of time has allowed three different political parties to take credit for what was, in essence, a Labour government proposal originally inspired by Frank Field. Now it is in place, does auto enrolment solve the problem for that middle group identified in the Green Paper 19 years ago?
The unsurprising answer is no, and there are really two reasons for this - the inadequacy of reach and of contributions.
The inadequacy of reach
Auto enrolment was designed to target everyone - there is no small employer exemption, and it is aimed at 'workers' not just 'employees'. However, there is an exemption for those earning small amounts, which means that people with multiple part time jobs end up with nothing. In addition, in practice compliance is monitored using PAYE references, so easily misses the self-employed.
If, as experts suggest, we are moving to a 'gig economy' with fewer and fewer people falling into the categories who are easily auto enrolled, particularly amongst those lower income groups Frank Field identified all those years ago, then auto enrolment is failing the people at whom it was really aimed. This isn't an easy problem - the Conservative manifesto notes it, then rather smartly suggests it needs to wait for the outcome of Matthew Taylor's review of modern employment practices before it does anything.
Solutions would either follow on the coat tails of a tightening of the employment regime to effectively regulate away the gig economy phenomenon, or otherwise something rather grandiose on pensions, such as a specific fund for those not in employment, taken from their income as an optional tax.
Neither seems particularly likely or politically palatable, but it is clear that there is a strong political wish to act. Without coverage for this large group, auto enrolment roll out with its low opt out rates and millions with a pension for the first time is a hollow victory. Some way of reaching this growing segment of the population with an opportunity to save for their old age is certainly being sought.
Ironically, auto enrolment is often cited (along with the move from minimum to living wage) as a reason why employers are embracing the self-employed model. Employer pension contributions are small, but for those employing low wage workers in low cost model businesses, small amounts per employee can be the difference between success and financial collapse. It may be that this dilemma can't be overcome and we are moving to a two class employment structure, where the unlucky class not only have no protection under employment laws, but nothing to live on in retirement.
The inadequacy of funding
Pensions are expensive, particularly as our expectations are increasingly of a very long and comfortable retirement, often stretching nearly as long as working life. Auto enrolment contributions are minimal.
In general, auto enrolment is into a defined contribution fund, which gives no guarantee of a specific pension at retirement. This means that we can't specifically assess what individuals might get at retirement - we just know it isn't enough!
Presently, the minimum auto enrolment contribution is 2% (shared equally between the employer and the employee), which rises by April 2019 to 3% from the employer and 5% from the employee. The contribution is of the upper earnings band in any event, so the payment for the lower paid can be a tiny proportion of salary.
Prior to auto enrolment, standard, not particularly generous contributions were at around 5 or 6% of salary "matching", i.e., the employer would match employee contributions up to about 5 or 6%. Most employees would opt for the maximum, giving about 10 or 12% of gross basic salary. This was generally thought inadequate - defined benefit contributions are generally around 30% of salary or higher. 8% of part of salary is definitely inadequate, and is compounded by the tendency of people who cannot afford financial advice to assume (not unreasonably) that auto enrolment means their pension is "sorted".
The solution to the inadequacy of contributions is simple - demand more contributions. Of course, this is not politically popular, and has inevitable consequences - more employees will opt out, and more employers will cut staff numbers. However, there is simply no other solution, except to leave employees without adequate saving, resulting in the middle group remaining exposed to a poor retirement.
The future
Auto enrolment may well be the solution to the problem of inadequate retirement provision, but there are some serious problems to be dealt with first. Including the self- and casually employed is surely a fundamental requirement and not a simple problem to solve. Contributions will also need to rise if the problem identified 20 years ago is to be solved.
It remains to be seen if governments have the courage to solve the challenges. Pensions are a gift to the cynical politician who is happy to see good headlines and leave the issue of inadequacies to materialise in the decades to come when, if they don’t have Frank Field’s tenacity, they might be expected to have left the political stage. There remains a serious risk that pension coverage is put in the "too hard" box, the present arrangement continues, and the lack of auto enrolment coverage becomes a scandal in the middle of the century.
By Rosalind Connor, Partner at ARC Pensions Law