Cicero Policy Briefer

Issue 23, April 2008

Walking the tightrope: Introducing personal accounts

By Ian Naismith, Head of Pensions Market Development, Scottish Widows

If the government manages to introduce personal accounts without destabilising the existing pensions market, it will have pulled off one of the greatest balancing acts of the 21st century so far. The pension market is well-developed, serves many consumers very well and plays a key role in the economy, with £1,368 billion held in long-term investments with insurance companies at the end of 20061. Compared with other EU member states, private pensions in the UK are a resounding success.

Despite the risk of disruption to this market, there is widespread industry support for personal accounts. Existing pension providers recognise that they cannot serve parts of the market—largely small companies with low-paid staff—in a way that makes commercial sense. If a national pension scheme acts as the catalyst for a step-change in UK retirement provision, few will argue against it.

The Government has also recognised the need to focus on its target market and minimise disruption to good existing provision. This is not just to avoid damaging a key business sector but also because widespread switching of existing pension arrangements to personal accounts would lead to ‘levelling down’ of contributions. The personal accounts minimum employer contribution of 3 per cent of pensionable earnings is significantly lower than for most existing pension arrangements, and pensionable earnings will generally be lower too because they exclude the first £5,000 or so of income

To help ensure that personal accounts are appropriately targeted, the Government has put two important measures in place. There is a monetary limit of £3,600 a year (in 2005 terms) on contributions, and transfers in and out of personal accounts will be unavailable for at least the first five years. The latter measure ensures that the scheme will focus on attracting new contributions rather than existing funds, while also giving it the assurance that funds invested will not be transferred out quickly.

There remain two key areas where further work is needed.

The first of these is to establish simple criteria to exempt employers with good alternative pension arrangements from offering personal accounts to staff. If exemption was unavailable, employers might well decide to offer only personal accounts.

A potential barrier to exemption has been that employer-sponsored personal and stakeholder pensions are contracts between individual employees and the pension provider, and EU law has not allowed the automatic enrolment that is a key feature of personal accounts. It is heartening that the Government has shown considerable commitment to resolving this is sue , and we remain hopeful that a satisfactory solution will be found.

Another is sue , affecting both occupational and personal pensions, is that employer pension contributions are often a percentage of basic salary. For personal accounts, pensionable earnings include additional amounts such as overtime and bonus payments, but with the first £5,000 excluded. As mentioned above, this will normally, though not always, lead to lower payments. Many employers do not want their existing contribution basis disturbed, and this is sue is likely to remain prominent in the coming months.

The second area for further work is on the charges for personal accounts. The Government has promised that there will be no state subsidy, although this is not reflected in the Pensions Bill. Personal account charges must cover start-up and running costs. Anything else would be anti-competitive, and would also lead to the possibility that charges would have to be increased later or even that a Northern Rock style bail-out would be needed. It is encouraging that the current Personal Accounts Delivery Authority (PADA) consultation on the shape of charges looks at a range of different options, not just the single annual management charge which was imposed for stakeholder pensions and which would mean that initial costs could not be recouped for a very long time.

Existing pension providers have worked closely with the Government, and now also with PADA, to maximise the prospects of personal accounts significantly improving retirement provision in the target market while ensuring that good existing pension arrangements continue to thrive. Comments already made by the PADA executive appear to recognise the importance of keeping a level-playing field and we are hopeful that this will be the reality in 2012, when personal accounts finally come in.

1. ABI—UK Insurance Key Facts, October 2007

Ian Naismith is the Head of Pensions Market Development at Scottish Widows and can be contacted here.

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