The government needs to be far bolder on pension reform

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In his Mansion House speech early this month, Jeremy Hunt, chancellor of the exchequer, recognised some of the defects of the UK’s pensions mess. He acknowledged, for example, the low prospective returns on pension assets and the failure of institutional investors to back high-growth home companies. But he failed to deliver hope for radical reforms.

The shortcoming starts with Hunt’s three objectives, which were “to secure the best possible outcomes for pension savers”, prioritising “a strong and diversified gilt market” and strengthening “the UK’s competitive position as a leading financial centre”. The first is fine. But the second is a plea for retaining captive investors in UK debt. This is “financial repression” aimed at benefiting an over-indebted government at the expense of savers. The third reflects the enduring confusion between the role of the financial sector as a direct source of incomes and its more important role in creating economic prosperity. Hunt should have had just two goals: sound pensions and wide prosperity.

As was argued in Investing in the Future: Boosting Savings and Prosperity for the UK, from the Tony Blair Institute for Global Change, the best way to achieve these aims is via higher contributions to a limited number of large professionally managed funds invested in a diversified set of assets.

In the UK, however, there are more than 5,000 defined benefit pension funds. Worse, these have been forced by foolish regulations into being captive investors in government debt at near-zero real rates of return. But this has not even made them safe, given their exposure to interest-rate risk. The fragmentation of defined contribution plans is even worse, with nearly 27,000 funds. With private sector DB plans mostly closed, workers will depend on inadequate DC plans. Future generations of retirees will be impoverished, as will the country as a whole.

Unfortunately, given all these defects, Hunt’s ideas just do not go far enough.

First, he offers no serious plans for consolidation of the multitude of private sector DB funds into bigger and more aggressively managed ones. In the case of DB schemes, Hunt seems, instead, to accept the insurance sector in its lucrative role as undertaker of dying pension schemes. What will happen to the assets transferred into the hands of insurance companies? As the pension regulator itself states, “the insurance company will choose to invest in the least risky assets, which makes it the most expensive option”. The alternative would be consolidation into the Pension Protection Fund, an already highly successful public alternative. While Hunt mentions this possibility, it is not his preferred alternative. There is talk of consolidation of local authority pension plans, too, but this plan is also not very radical.

Second, Hunt offers no radical plan for consolidating the universe of DC schemes, or promoting the development of multigenerational collective DC schemes, or raising today’s normal contribution rates of 8 per cent to something closer to the 15 per cent necessary for most pensioners, particularly those for whom the state pension will be far too low.

Third, Hunt claims that the “Mansion House compact” commits funds that account for “around two-thirds of the UK’s entire DC workplace market, to the objective of allocating at least 5 per cent of their default funds to unlisted equities by 2030”. If the rest of the DC market follows this, he claims this could “unlock up to £50bn of investment into high-growth companies by that time”. But, if the current DB system continues to migrate into the insurance buyout market, rather than be consolidated and invested in equities, a liquidation of productive assets dwarfing the sums in the compact is likely instead.

True, Hunt recognises the failings of our current non-system. He notes, for example, that “UK institutional investors are not investing as much in UK high-growth companies as their international counterparts” and at the same time “some defined contribution schemes may not provide the returns their pension fund holders expect or need”. But this makes the lack of radicalism even sadder. He is too concerned about protecting existing interests.

We need, instead, to decide now where we want to end up and how to get there. A good pensions system should be built on a multigenerational, national contract designed to deliver decent pensions and support prosperity into the future. It needs to generate adequate savings, invest them in productive assets and insure pensioners against volatile returns and uncertain longevity. What we have now fails on all counts. We have to do better. If this government does not dare, the next must.

martin.wolf@ft.com

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