We have arrived at the sunlit uplands of part 3 of the Bill, which deals with collective benefits. We have dealt with scheme definitions: DB, DA or risk sharing, and DC. We are now talking about benefit-level definitions and the distinction between individual benefits and collective benefits, which is a relatively new concept in British pensions law. Clause 19 is introductory and sets out some definitions of collective benefits.
Why are we interested in that? If we look around the world at the most highly respected pension schemes—many are in Denmark, the Netherlands and Canada—very often, the schemes that are well regarded have collective elements to them. For example, in the Netherlands, around 350 collective schemes are operating. The Danish pensions scheme, which has collective elements in parts of it, was ranked No. 1 in the world in a survey for the integrity, adequacy and sustainability of its provision. In a sense, the question we asked ourselves in the UK is if these kinds of models can work well in other parts of the world, are they things that we could learn from, and is there something that we can do in this country? This part of the Bill—clause 19 begins that process—establishes the concept of collective pensions. It says what it is and what it is not, and enables us to have a discussion about this exciting new form of pension provision.
To be clear, as part of reinvigorating the private pensions landscape, we want to enable people to access a wide range of pensions. We are not saying that this is the right model for everybody, but we think it should be part of the mix, and as I have said, some of the best pension schemes in the world offer collective pensions. Although we tend to get fixated on the Netherlands, in Canada there are a number of very interesting—well, relatively interesting—new forms of pension provision that are of a collective nature. We take the view that we have a lot to learn from high-quality pension systems of the sort that are viewed as the best around the world.
One reason why we are keen to allow for this sort of provision is that collective benefits can potentially provide more stability in outcomes, compared with individual DC schemes. As a Government, we are not making grand claims that collective schemes will always be a vastly bigger. They may be, depending on the circumstances, but that is not the claim we are making. However, our modelling suggests pretty clearly that in general, they will provide more stability of outcome and our consumer research shows us that that is what consumers want.
The Bill will mean that collective benefits in the UK cannot attract a funding deficit for an employer, which will limit the employer’s liability and reduce risk. From an employer’s point of view, a nice thing about CDC is that it might offer greater stability than an individual DC scheme, but without all the risks associated with having a DB pension scheme on their balance sheet. There is also the potential in future to develop sector-wide schemes that provide collective benefits that could allow people to build a pension in one scheme over their whole career, even if they move employers. On one of my visits to the Netherlands, I recall being introduced to the Dutch tulip growers’ scheme; if someone spends their entire life growing tulips, even with a range of employers, they will remain a member of the tulip growers’ scheme. I do not know how many tulip growers there are in the Netherlands, but the principle is that for larger industries, that could deliver on a large scale that could further boost members’ pensions by enabling more efficient operation.
We have evidence of demand and interest from employers. As we heard in oral evidence, although it is difficult for employers who are interested to say so publicly, we know that there is interest—indeed, a witness said that one of his clients was looking at this model, and I think that as we get nearer to 2016, as we discussed this morning, the level of interest will grow. For example, the Ford Motor Company said in its response to our consultation that it thought that collective DC plans could provide a successful addition to current pension scheme models. As the hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East said this morning, the Institute for Public Policy Research conducted research with employers and consumers, finding that
“there would be strong public support for a collective pension…it appealed across different income levels, life-stages and ages.”,
“participants in our research preferred a Dutch-style collective scheme that shares the risk among all members and removes the need for an annuity, and that incorporates some form of smoothing into the accumulation phase.”
Given the attractiveness of the model, we think it is crucial that we have a fresh definition and separate provision for collective benefits, because they are different from the current pervading models. To reiterate, collective benefits and shared risk schemes have different identities. Part 1 of the Bill defines three categories of scheme. Part 3 introduces a new legal definition of “collective benefits” and contains powers to enable us to create a governance framework for schemes to the extent that they offer collective benefits.
Clause 19 defines a collective benefit as a benefit where, in all circumstances, the rate or amount payable depends entirely on the amount available to pay that member’s and other members’ benefits and the factors used to determine what proportion of that amount is available for the provision of a particular benefit. To state the blindingly obvious, it is not a collective benefit if it is a straight money purchase benefit, or of a description specified in regulations. We will be able, as new models emerge, to clarify what is and is not a collective benefit.
This is a building block. It provides for key legal requirements to be applied or disapplied, and that definition is used throughout part 3 for schemes to the extent that they provide collective benefits. They are distinct to the nature of collective benefits. That is why we have a distinct definition and why they are not merely defined at scheme level or synonymous with the shared risk scheme definition. The new benefit definition is also used in the context of existing legislative requirements so that certain elements of current requirements are applied or disapplied as appropriate.
We talked this morning about the concept of a pensions promise, but to be clear, collective benefits cannot contain a promise. Promised benefits are excluded by the definition of “collective benefits”, as such benefits will not depend entirely on the amount available to pay that member’s and other members’ benefits and the factors used to determine what proportion of that amount is available for the provision of a particular benefit. Collective benefits are provided on the basis of investing members’ assets on a pooled basis in a way that shares risk across the scheme’s membership.
There are a number of concepts that we will come to in this clause and the succeeding clauses. Clause 20 refers to targets, so I will say a word about those. There will always be a target attached to collective benefits. That target must be achievable within a specified probability range, in order to provide all scheme members with some confidence about the indication of what they might receive from the scheme, but it is not the same as promising members that they will receive a benefit at a specified level or amount. Collective benefits are not the same as the definition of a shared risk scheme. There could be collective benefits in a shared risk scheme if there is also another form of non-collective benefits that offer a promise, for example. Alternatively, there could be collective benefits in a DC scheme, either as the sole type of benefit or in conjunction with money purchase benefits.
Another attraction from an employer’s point of view is that there is no employer liability to stand behind or guarantee a target offered in relation to a collective benefit, because there can be no promise attached to a collective benefit. We have chosen the definition so that there can be no liability on an employer’s balance sheet, as well as to allow the scheme to pool the available assets and distribute them among members so as to provide the benefits on a collective basis.
To be clear, collective benefits and money purchase benefits are mutually exclusive, as is specifically mentioned in clause 19. That is due to the unique nature of collective benefits. They need a different set of governance requirements and involve a different approach to the distribution of assets among members compared with a money purchase scheme. The rights to a collective benefit are different from the rights in a money purchase scheme. For example, there can be redistribution of assets among members in respect of a collective benefit in a way that is not possible for a money purchase benefit. That feature is also reflected in the definition of a collective benefit in clause 19, such that in all circumstances, the rate or amount of benefit must depend on the amount available for the provision of benefits to or in respect of a member and one or more other members collectively.
Finally, regulations allow us to make exceptions from the definition to ensure that we can attach the right requirements to the right types of benefit. The power will be used in situations where it would be more appropriate for the provision of those benefits to be subject to a different regulatory regime. For example—I know that the hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East likes to ask me for examples—the Government might wish to exclude certain with-profits pensions arrangements, which currently exist and are regulated by the Financial Conduct Authority, from the definition of collective benefits to ensure that they are not regulated twice: once by the Pensions Regulator and once by the FCA. The power to exclude benefits of a certain description from the definition of collective benefits is delegated to secondary legislation to allow the Department to react flexibly—there is that word again—and responsibly.
We heard in oral evidence that probably the most difficult part of the schemes is getting from zero members to a critical mass. Does the Minister have any thoughts on what approach the regulator ought to take to ensure that early movers do not join a scheme that is insufficiently resourced and not capable of providing collective benefits? That would leave them in a bit of a mess.
Yes, we have given a lot of thought to that. There are various ways to do that. At the start, a solvency buffer might be needed. Because there is a target, in order to be reasonably confident of reaching it, the scheme must put some money aside that is not invested aggressively. Although that helps to achieve the target, it does not give people as big a pension as they might otherwise get. One potential way around that is for the target-setting to take account of the stream of future contributions that we know are going to come. Because we know that money is coming in future years, we can take account of that on day one when modelling a scheme’s ability to reach its targets. We do not say, “Well it might not be there in a few years’ time, so we have to hoard the money now and not invest it aggressively.” That is one example.
A lot depends on where such collective schemes come from. For example, if a former DB scheme, which could potentially have tens of thousands of members, decides to become a collective DC scheme, it could quickly build up scale and volume of assets, so that might be another route in. I am not speaking for the National Employment Savings Trust at this point, but one could imagine scenarios in which NEST has a role to play. I have not discussed that at length with NEST, but I can see immediately that that is a scheme with scale. Some of the master trusts that exist at scale could come into this space. Although there is a blank sheet of paper problems, I regard those problems as opportunities because they mean that we can learn from the mistakes of others. Of course, auto-enrolment has a great advantage. Due to very low opt-out rates, if an employer uses a CDC scheme for auto-enrolment, people would, on the whole, stay in and volume would potentially build up relatively quickly. My hon. Friend raises an important issue, but there are ways in which we can seek to mitigate it.
There are obviously a lot of detailed issues to discuss on collective benefits in this part, and clause 19 gives us some introductory concepts and definitions.
The Minister is right that this is an important part of the Bill. We are discussing what we mean by “collective defined contribution.” The Minister made an admirable stab at it, but at this stage it might be useful to try to get a sense of what we are talking about in language that is intelligible to people who are not pension experts like us.
This came up in the witness sessions, so it might be useful for the Minister to say what he thinks is the big advantage of collective defined contribution vis-à-vis individual defined contribution. I know that it is implicit, and to some ears it may be explicit, in what he says about smoothing, targets, stability and outcome, but it might be useful to bear down on that language. We are constantly searching for more straightforward language on pensions.
It would be equally useful to be honest about the potential downsides of collective defined contribution. Most things have upsides and downsides. The Minister used the term “balance” a moment ago, and it would be useful to have a sense of where he sees the potential downsides. There is an issue with one scheme potentially cutting pensions in payment, which he is concerned about. He has tried to do this, but he should explain it simply at a general level. He said that collective benefits cannot contain a promise. There will be people who do not understand what that means, so it is important that, as we begin discussing these clauses, we have a common vocabulary on these issues.
The Minister talked about the fixation on the Netherlands, and he also mentioned Canada. I suspect that the Department for Work and Pensions has been looking at New Brunswick as an example. He quoted the IPPR, which has done some research on this subject. This morning I asked whether there is a danger in defining something as shared risk if all the risk is being borne by the employee, the scheme member, rather than by the scheme. Are there forms of collective defined contribution that would fail that test?
Another issue, which we have not yet discussed, is the best form of collective defined contribution and whether it should be at an industry level. The Minister mentioned master trusts—does he have a sense of whether we are talking about master trust level or company level? It might even be on a national basis, which is certainly how some schemes operate, admittedly in smaller places.
There are a number of issues with the language. The Minister did not create that language, and it is a constant issue for all of us. This is a cliché, but it has struck me that the communication challenge with this will be significant. The governance challenge will also be significant, and I will say more about that. If we can find a common vocabulary and agree on the terms we use and what they mean, we can hopefully make some useful progress. Those are not the easiest questions—if they are questions—but they are my observations on a common vocabulary as we proceed into the collective benefits part of the debate.
It is a pleasure to serve under your chairmanship, Mr Bone. I entirely welcome the move to create collective pension schemes. That has to be the right way forward. The headline figure of the potential increase in pensions—the idea that someone could get a 30% higher pension than they would with an ordinary defined-contribution scheme—must make these schemes worth pursuing. I suspect that a lot of that is down to the fact that someone would not have to have their investments de-risked towards their retirement date and would not be locked into a particular day when they have to cash in their pension scheme. The scheme could take a longer-term view of the investment risk, and that has to be an attractive way forward.
I agree with the Minister that we want to let a thousand flowers bloom and see what grows up in this market. At some point, however, we have to plant some seeds in the right place if we want to see certain sorts of flower bloom. I wonder if, at some point, these schemes will come to fruition and provide the very real advantages that are often cited. There perhaps needs to be a duty for the regulator or the Department to help employers, trade unions or others to start creating these schemes so that we can get from where we are—zero people in these schemes—to having some top-quality, well managed schemes around and get those higher pension returns. Even as someone who prefers the free market, I think we perhaps ought to look at how we get over that first hurdle, get these schemes into existence and realise their great advantages. I suspect that it will be very hard for the first person to make that move.
I can see a defined-benefits scheme trying to move into a collective scheme, but at that point the employer promise is lost. I suppose that any of the pre-existing fund could be moved, because that is when the promise was pledged, so a whole collection of employees and their contributions would be moved over. I sense that we need to be very careful with employees who are going from having a pension that is promised by their employer as a certain amount to being told, “I’m moving you into a collective scheme where not only am I not guaranteeing it but your contributions could be used to fund other people’s pensions or top them up, and you may end up getting less than you paid in for.” I suspect that move would not be easy to convince people of.
There are a range of risks in how these schemes are managed and how people understand what they have. The key risk is what happens if we have to reduce pension payments. A retired person might think they have £12,000 coming in a year, but something could go wrong in the investment market or the fund, meaning that that pension then has to be cut. That has to be the right thing for these schemes because we cannot have future savers taking all the risks. Otherwise we will have no future savers left or a sort of Ponzi scheme with no one paying in and everyone trying to draw out but having no money left. That has to be the right answer, but it is a real change in risk for the UK pension market. It involves moving to a situation where what we thought was safe could be reduced overnight by quite a large amount. People need to understand that fully, because that is the risk: someone could sign up for a scheme and start to contribute when they are 25, but almost up until the point when they die their pension will be at risk. There will be no point at which they have an absolutely safe pension income, whereas now if someone buys an annuity they at least have some certainty at that point about what they will get in retirement. These schemes will not provide that.
It may be that losing that certainty is a trade-off for a better pension. I can see the advantages of mixed schemes, in which a certain level is completely safe in retirement but some of the money is not. However, we must be very careful that, before schemes are registered, we know what communications about them should look like, so that when people first start saving into the schemes they are certain that they understand the risks they are taking and the advantages. Perhaps the regulator should undertake a long consultation on those details before it gives approval to any of those schemes to start taking cash.
I am sorry to stop the hon. Gentleman in the middle of his interesting contribution. Listening to him talk about the challenge of communicating with savers, it strikes me—it is probably clear to all of us—that this approach to pensions could well have significant advantages in terms of actual retirement income, but it is clearly a form of building up such income that depends on a lot of expertise. Individuals will have to accept that a lot of complicated decisions about smoothing, targets and management of assets will have to be placed in the hands of actuaries, investment experts, and either trustees or managers, as the Bill describes them.
It also struck me, listening to the hon. Gentleman’s contribution and our debate so far today, that that is somewhat in tension with the approach the pensions tax Bill—and this Bill, to some extent—brings in, in which the idea is that individuals themselves will take control of their retirement income. Does he think that that is a potential issue, as pension flexibilities come into play that encourage an approach and a cultural change that focuses on—
Thank you, Mr Bone. The shadow Minister has raised an interesting point. It is right that people have choice and that we do not have a regime that punishes them for making certain choices, but equally we want a pension market in which people can choose the best quality schemes that provide the best quality return. The issue is how we end up with informed customers and scheme members at that early point, and how we make sure that people understand that this sort of scheme is not a simple one. It is not like a defined-benefits scheme, in which people have a chance of understanding what the final benefit might be. Even in a defined-contribution scheme people effectively get what they pay in and pray that it works at the end. This scheme has a completely different set of risks.
There is a danger of confusion about who will make what decisions and who will be responsible for them. One concern that my hon. Friend flagged up was that those currently in DB schemes would suddenly be plunged into a CDC scheme and so on. The point of the offer of defined ambitions in the Bill is that a risk-sharing offer can be available to people who are currently running DB schemes but may be thinking of closing them when contracting out comes to an end. For the individuals in DC schemes, those schemes will continue and they will have control over their own pensions.
The third category—the 100,000 new schemes that are likely to be created at the beginning of 2016—will come into auto-enrolment and the employer will make the decision. That is the opportunity for CDC, with organisations such as NEST, the People’s Pension and the Danish scheme offering a collective vehicle that might suit very small employers really well. I hope my hon. Friend agrees that that is a way of summarising the three different situations.
I do agree. When I mentioned moving defined-benefits schemes into CDC, I was responding to the Minister’s response to me about large CDC schemes starting. I was expressing concern that if I were in a DB scheme, I would not fancy that change in my situation. It is an interesting question. When relatively small employers start creating new pension schemes in 2016, I imagine that trying to create a collective one may be a little ambitious for them. I wonder whether the ideal situation would be to have industry-wide schemes, or ways of aggregating schemes, so that people would have the chance, through their employer, to sign up to a collective scheme that was not the employer’s own. The idea of the proposal is to ensure that employers are not on the hook for anything other than their annual contributions, so it would strike me as a great opportunity for them.
Before any of the schemes can register and start inviting members and signing up employees, I suspect that we need the regulator to implement a framework to make clear the requirements for communication, scheme rules, quality standards and management. Otherwise, we may end up with some pretty bad collective schemes, run by people who do not know what they are doing. If that happened, some members might end up in collective schemes that had huge downsides, when they did not really want to do that and did not understand what they were doing. They could find themselves with a large amount of their savings trapped in such schemes.
I do not want us to have a mis-selling nightmare in 10 years’ time where people who are in these schemes are all underwater and will never receive what they were aiming for, and companies have to start worrying about paying out to people who have already retired with certain promises. If we get the system right at the start, it could be really powerful, but if we get it wrong, we could end up with the next mis-selling nightmare.
Is the hon. Gentleman as concerned as I am about risk? I think that is what he is talking about. If someone takes their pension assets out and sticks them in the bank, they will have some guarantee of return on those assets, and they will have a guarantee on their cash lump sum. Alternatively, if they take their assets out and buy a house, they will probably have some security there. It seems to me that what is being proposed is a pension scheme that does not give its members a great deal of safety that the assets that they have worked for years to build up will be protected, or that their income will be protected.
I think there is a point, once someone has retired, at which they have little chance to replace income that they lose. If they are absolutely reliant on the £12,000 that they think they will receive for life from their collective DC scheme and that is cut to £10,000, they have no way of replacing that lost £2,000. They really are exposed. Until they retire, however, they have the scope to extend their working life or whatever else. I think that that is the right situation.
I suspect that none of us fancies being Pensions Minister the first time one of the schemes has to reduce in-payment pensions. There will be a huge outcry, and everyone will be saying, “What on earth is this? How can you reduce payments in retirement? I never thought that would happen. Surely the taxpayer must ride in to the rescue and protect all those whose pensions have been slashed.” We need to get this right from the start so that if and when that happens—the experience in Holland was that that had to happen—people either know that it is a risk, or the material that they should have read made it clear that it would be a risk. I do not think that we can ever say that people will ever read or understand everything. We need to get the system right from the start and move slowly into it, so that we do not end up with a load of poor-quality schemes coming into existence for people who simply do not understand what is happening.
This time I will make a speech rather than the longest intervention on record, Mr Bone.
The hon. Gentleman has raised some interesting points. I was going to ask, but he caught me napping by sitting down, what he thought was the way to achieve the right outcome. There is a view, rightly or wrongly—I hope rightly—that the advertising campaign around auto-enrolment has been very successful, but we do not know whether that is the case. We know that auto-enrolment has been successful so far, but we do not know whether the campaign has been part of that. It is quite hard to assess. [Interruption.] The Minister says that we do, and that is good news.
Communicating to individuals that their pension in payment could be cut, which has never really happened in the UK system, is a big challenge. Most people will not know what a pension in payment is, to start with. That language will not make sense to them. However, they will soon work it out if we say that their pension when they retire could, in the worst circumstances, be cut.
I was trying to say at great length earlier something that can be said quite simply. The Government are going down the path of saying to individuals “This is your money,” and they are on the side of people turning their pension pots into an income. The language is very much, “You will have savings that, from the age of 55, you can do what you want with.” That potentially increases the difficulty of selling a form of pension that involves smoothing the process and gives a retirement income, rather than one that allows people to buy something for themselves. The challenge is perhaps significant to begin with, but the way in which the budget reforms interact with the Minister’s desire to promote CDC might well not work to the advantage of those who favour it. That question needs to be asked. There cannot be a definitive answer, but I am concerned about getting people to believe on the one hand that CDC is the way to go and, on the other hand, putting powerful emphasis on “This is your money, you can access it whenever you want.”
There is obviously a specific question: what impact will the possibility of exit at 55 have on CDC? We heard from one witness who thought that it could be overcome, but that depends on the design of the scheme. To be fair to the witness, they seemed to give a rounded explanation, but it was not one that we could communicate to a member of the public in any clear fashion, and that is a significant challenge.
The only point worth adding is that we do not need to take too seriously the contribution from one witness that the presence of a CDC pension necessarily means that the people in it are going to get pensions that are 30% to 40% better than those who are not in it. I do not think the witness presented any credible evidence to substantiate that suggestion. The reasons for having a CDC pension are much more to do with administration, simplicity, governance and making life easy for small employers who are going to do the right thing under auto-enrolment and put their employees into a pension scheme. They are not going to be able to offer all the trappings and substance of a large trust-based scheme that has been around for the past 50 years. I see that as the main role of the CDC, and it will save money on the cost side. We all hope that the investment returns will be better, but I do no think there is any evidence to substantiate that at the moment.
It strikes me that some of those advantages could be achieved by some big consolidated scheme whereby people are allowed to enrol members in a big, defined-contribution scheme rather than having any collective angle to it. Is that perhaps what my hon. Friend is envisaging?
Where my hon. Friend is right is that if someone has a big company with a significant number of employees, they can get economies of scale from their own scheme. The 100,000-plus businesses that are going to come into the scheme after January 2016 are small companies with fewer than 10 employees. For them, there are no such options available. If NEST and the other entities that I mentioned set up CDC options, they will be incredibly appealing to small employers.