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The writer is founder and managing director of New Financial, a capital markets think-tank
Most of the debate around UK pensions and the crisis in UK capital markets this year has been looking at the problem from the wrong end of the telescope.
That there is a glaring paradox in UK capital markets is clear. The UK is overflowing with deep pools of long-term capital in the form of pensions and insurance assets: we estimate there are more than £5tn of such assets in the UK, the second-largest market in the world after the US. But there is a drought in the appetite of UK investors for long-term investment in productive assets in Britain such as public equity markets, unlisted equities and infrastructure.
Critics argue that the woes of stagnating UK capital markets would be solved if only those recalcitrant pension funds could be encouraged or required to invest more in domestic assets. Meanwhile, the pensions industry has pushed back, arguing that the health of capital markets is not their problem and that politicians should keep their noses out of asset allocation and investment decisions.
The critics are asking the wrong question in “how can we get UK pensions to put more money into UK companies?” This should be reframed. The question should be “how can we enable the pensions industry to do a better day job of providing a secure and comfortable retirement for millions of people in every corner of the UK?”
While the UK pension system looks robust at first glance, the real crisis is that millions of people in the UK will retire in the coming decades with an inadequate pension. The median defined contribution pot for someone between 55 and 65-years-old is about £35,000 which, if you’re lucky, will generate an annual income of less than £2,000 a year assuming a 5 per cent annuity.
Despite the success of auto-enrolment of employees into retirement funds over the past decade, nearly a third of the UK workforce are not saving for a pension at all, and most people are not saving enough (minimum pension contributions of 8 per cent are roughly half where they need to be). Structural challenges embedded in the UK pension system such as fragmentation make it worse: strip out micro-schemes and there are still more than 8,200 mainly subscale and inefficient pension funds in the UK, which sounds like at least 8,000 too many.
At the same time, the focus on cost at all costs has restricted the investment horizons of most schemes and left them in paradoxical position of having higher costs on average than much larger schemes overseas, but with a much narrower asset allocation.
In short, the structure of the UK pensions industry is undermining its ability to perform properly its day job of providing decent retirements, which in turn is undermining it ability to ride to the rescue of moribund UK markets. It is only by addressing the first challenge that you can begin to address the second.
Solving this problem will take a lot more than consolidation of the UK’s inefficient pensions landscape, although that would be a public good in itself.
Over the past few decades, layers of well-intended regulatory reform have created a regulatory framework, culture and mindset in UK pensions that seems actively designed to eliminate risk and discourage long-term investment.
Bulldozing pensions into propping up UK investment without a fundamental rethink of the arena in which they operate is unlikely to work. Instead, with sector reform high on the political agenda, this and future governments should commit to addressing the problems in the pensions system from the perspective of individuals saving for their retirement.
At the very least, as a new report from New Financial argues, the UK should commit to a rapid increase in pension contributions; urgently review how to shift the risk-averse regulatory and cultural mindset in pensions; and push ahead with consolidation of both defined benefit and defined contributions pensions.
It should also launch a new independent pensions commission akin to the one chaired by Lord Adair Turner in 2002-2006 to design a system fit for the next 50 years. In the longer term, the UK should embrace bolder ideas such as the radical consolidation of DC pensions in markets like Australia, Denmark, or Sweden.
A happy side effect of this approach would be that hundreds of billions of pounds in investment in productive assets could be unlocked in the next few decades. But most importantly, millions of individuals across the UK could look forward to a more secure and comfortable retirement — which is ultimately what pensions are supposed to be about.