Good morning, Mrs Riordan. We were in the middle of a thoughtful discussion about clause 19, to which the hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East and my hon. Friends the Members for Amber Valley and for Gloucester had all contributed. It will be helpful if I try to respond to some of their points. I am sure that they remember every point, but in case they do not, we were making notes, so I hope that I will be able to reply to their points, and I am more than happy to take interventions.
We have reached part 3, where we deal with collective pension schemes, which is a relatively new concept for us in the UK, but it is one that many pension schemes around the world are familiar with. Various themes have been covered in the contributions to date: communications and governance; reducing pensions in payment; the difference between shared risk and collective schemes; the potential overlap with the Taxation of Pensions Bill; and the conversion of defined-benefit and collective defined-contribution entitlements and schemes. I will try to cover those topics in order.
Various points were made about the importance of explaining to scheme members how things work. As I observed on Tuesday, I hope we can learn from other countries where some of the problems and conflicts arose from the fact that different parties had different expectations. Scheme members in the Netherlands, for example, thought that they had a guarantee—a rock-solid pensions certainty—but that was not the basis on which the scheme was set up and that was not adequately communicated to them, so when things changed, they said, “Nobody told us,” and understandably felt aggrieved. We aim to go into this with a blank sheet of paper. Although, as we have discussed, having a blank sheet of paper raises issues about getting started, it also gives us opportunities to try to learn from what other countries have been through and to try to get to a better place to begin with.
We clearly have to explain to people how schemes that provide collective benefits will work and we must ensure that we use language that people will understand. I entirely agree with the points that hon. Members made. Clear communications and good governance of schemes are both essential to the effective working of the new types of collective models that we are trying to create space for. For employees, it is absolutely critical that they have information about how their pension arrangement works and that schemes operate transparently. We have designed the new framework for collective benefits with that in mind.
For collective benefits, the Bill—in clause 19 and the following clauses—sets out an overarching regulatory framework that will be underpinned by a comprehensive set of regulations governing their day-to-day running and decision making by trustees and managers in areas such as benefit targeting and investment performance. We have taken powers in the Bill in relation to scheme policies and their publication, and we already have further powers on disclosure and governance requirements under existing legislation.
There is always a tension in primary legislation in relation to how far we put things in the Bill or in regulations, and we feel strongly that the Bill should set an overarching framework and a requirement for good communications and good governance. The nitty-gritty of what that actually means is better dealt with in regulations, because, if they need to be improved and refined, the process is a lot quicker than with primary legislation.
An important part of all this is the continuing engagement with employers, providers, regulators and consumers to ensure that the language used in communications is clear and effective. In our other pension reforms—for example, automatic enrolment—we have done a lot of talking to consumers and employers, and in our communications campaigns, we have done a lot of testing of what messages work. Those insights and that work will continue when drawing up the framework for collective pensions.
I want to focus on a specific issue that is not familiar to us in the UK, other than in circumstances of insolvency: the reduction of pensions in payment. That is obviously a tough concept. We need to be absolutely clear up front that, in extremis, people could find that the pension they are receiving will go down. It is important not to overstate that. The narrative has become, “Oh, everyone in the Netherlands has had their pension cut.” In fact, the majority of Dutch pension schemes of that type did not cut pensions in payment, and of those that did—the big tranche of cuts that happened in April 2013—the average reduction was 1.2%. Although that is not what people are used to, not what they expect and not what we have done in this country, it is worth keeping that sense of perspective. Many things can happen before pensions in payment are cut. When it looks as though a collective scheme will not reach its targets, a whole hierarchy of things can happen before pensions in payment are cut.
I want to give the Committee an example of the Canadian experience from some research that the Pensions Policy Institute undertook for us. It looked at some specific schemes, in this case the New Brunswick hospitals plan in association with the Canadian Union of Public Employees, and what happens when there is a surplus or a deficit. By surplus, we mean when there is more money in the scheme and more prospective returns than are needed to meet the probability target that is being set, and the converse for a deficit.
In the New Brunswick scheme, if the funded ratio falls below 100% for two consecutive years, or the plans fails to meet the risk management goals of a shared-risk plan, various things can happen to try to deal with the imbalance. First, contributions could be increased. If they are not on course to reach their target, scheme members could be told, “You need to put more money in.” That could happen rather than pensions in payment being cut.
Secondly, changes could be made to the rules for retirement benefits such as, for example, those that were not core benefits. Future accrual rates could be changed. People who are of working age could be told that future service would accrue pensions at a slower rate. Additional benefits or the base benefits could be reduced. Where elements of indexation were discretionary, it could be decided that the next round of indexation would not happen because of the pressure on the scheme’s funds. The pension would not be cut; it just would not be increased or not by as much. It might be clawed back. A lot of things can happen instead of or as well as in the interim between the pension scheme needing more money and cutting pensions in payment.
The hon. Gentleman is right to say that these are public sector schemes. The scheme that I gave as an example is a hospital scheme, and the Canadian Union of Public Employees was very much involved. I am not sure about the exact arrangements for the scheme’s insolvency, but he is right to say that the Canadian experience to date has been in the public sector. I assume that there is a public sector underpin, but I am not certain.
My understanding, which is not beyond question, comes from the fact that I recently met one of the architects of the New Brunswick scheme and was told that it is underwritten by the state. We need to be aware of that when we discuss its approach.
That is consistent with my understanding. I do not mean to be rude here, but I am not sure how relevant that is in the sense that the scheme has a target. There will be a slight difference between the way that we do this in the UK and the way that it is done in Canada, because we will target a probability of reaching target benefits, whereas a funding ratio is the criterion in Canada. In that case, where the funding ratio will not be met with a certain probability likelihood, the scheme has processes for getting things back into equilibrium. It is fair to say that the sponsoring employer presumably cannot become insolvent, but insolvency is to some extent a separate issue from scheme funding. The processes of what happens when someone will miss the target are much more to do with the rate at which future service is accrued, the rate at which discretionary benefits are paid and the contributions required from the employees. Those are the adjustment factors. The hon. Gentleman is absolutely right to point out that these are generally public sector schemes. I do not think that that alters the basic point that I am making.
I want to correct the record on the cuts in the Dutch pension scheme that I referred to. I think that I said 1.2%—for some reason, I have the headline rate of inflation in my head—but in fact 1.9% was the average cut of those schemes that made a cut. As I said, the majority of schemes did not make a cut. We need people to know what the target and the probability mean. We require honesty about the fact that pensions in payment can be reduced.
My hon. Friend the Member for Amber Valley asked what would happen if there were not a flow of future savers and we ended up just with older people and pensioners. Clearly, collectives work well. The point of collectives is the pooling of risk, so the more varied membership, the better. However, schemes can adjust. For example, a scheme that is not getting an in flow of new members could reduce its exposure to risk. It might have a relatively high exposure to risk if it has lots of young members, because on the whole that is what they will want. If the number of young members and their contributions start drying up, it might choose to rebalance its investment strategy and have a lower-risk approach. That would obviously lower the average expected return but increase the probability of reaching the target benefit. Adjustments can be made. It could merge with another scheme that has a more diversified membership. My hon. Friend is right to raise the issue, but there are mechanisms for responding to it.
The hon. Member for Cumbernauld, Kilsyth and Kirkintilloch East asked whether it was shared risk if all the risks fall on the employee. To be clear, when we talk about a shared-risk scheme, there must be a promise during the accumulation phase in relation to some of the benefits provided by the scheme. Clause 19 talks about schemes providing collective benefits and those do not carry a promise.
To be clear, there is no promise during the accumulation phase of a DC scheme, so the members bear the risk. In a collective DC, the members together collectively bear the risk. The point is that the pooling of risk in a scheme of collective benefits can lead to more stable outcomes for members than an individual DC scheme where the member alone bears all the investment risk.
I have a couple more points in response to Tuesday’s debate. The Budget freedoms and the fact that post-55 people will be able to use their pension pots as they wish were raised. The hon. Gentleman asked how that interacts with collectives. If someone wants to take their money out, there needs to be a value for that transfer. With an individual DC pot, it is pretty obvious what the value lies; in DB, it is a bit more complicated. With CDC, clause 30 will require schemes to have a policy that they will follow to calculate a transfer value when someone wants to leave a scheme. As part of that we will be able to set out certain provisions of that policy, and our regulations of policy will reflect the need to ensure that those transfers out do not have an impact on the probability of being able to pay the target benefits of other members. That is the crucial point.
Someone in a CDC scheme could reach 55 and want to cash out but would not do so in a way that is detrimental to the people left behind. That will in turn be reflected by the transfer value. The people running the schemes will know the law. They will know that people aged 55 and beyond can cash out. They will plan for that and make assumptions about the likelihood of that happening, but they will have discretion to reflect the impact of someone leaving earlier than expected in the transfer value.
I thank the Minister for that information. No doubt, we will come to that point with clause 30. It strikes me as a sensible clause. There seems potential for tension if an individual has been told that their pension money is their own and they can take it out at 55 and do with it as they like. As I read the Minister’s argument on clause 30, that will be weighed up against the collective interest of the CDC scheme. Is that a fair assessment?
The key point to bear in mind is that, when someone cashes out, they move from a target and a probability to certainty. Everyone else still in the scheme has a probability and a target but does not have certainty. The person leaving the scheme wants certainty now. There is a price for certainty. When that person leaves the scheme, the transfer value will reflect the fact that, before the expected age to draw benefits, they have said they want their certainty now rather than when everyone else will have it. There is a price to pay for that.
That crystal-clear explanation seems sensible. I made a point earlier that promoting the flexibility options at the same time as promoting collective defined contributions seems to be an area where that tension, if we want to call it that, emerges.
I understand the point that the hon. Gentleman makes. We have always taken the view that we want a pensions landscape; we do not want uniformity. There will be a set of people for whom certainty is very important, and they might end up buying an annuity with whatever they have accumulated in their working lives. Some people will want to maximise returns; some will want to minimise volatility, so a collective might be the right thing for them; and some will want cash up front as soon as they are 55. We are trying to create a framework where we have provided a coherent legislative and regulatory framework for all those different models and preferences.
I hear the argument that collectives are all about risk pooling and the Budget freedoms are all about individuals taking their pots. If I have saved in a CDC scheme and have grown to trust and value it, I might want to take some cash out at retirement or some such age, but if I want the rest of my money to go on being invested, I might well be happy to leave the money in the CDC scheme, benefitting from any scale, pooling or good governance that I have seen in the scheme. It will not necessarily be an all-or-nothing thing. People might take some of their cash from a CDC scheme, but they might well leave quite a lot of it in the scheme, perhaps if they anticipate a long retirement. Those are not black-and-white absolutes.
The Minister’s explanation seems fair, but will what the Government are doing with one hand at the Budget end impact on the likelihood of people entering collective schemes? That is really the issue. Creating a landscape with a wider range of pension options is fine—he knows that we support that—but I wonder whether potential scheme members will rapidly be told that, as the Budget reforms come into practice, they might not want to go into a collective scheme because they could get their hands on the money freely and without any detriment. That is a problem.
If we had said, “There are these things called collective schemes and because we are all bound together, you can’t exercise your individual freedoms, so there is a set of pensions that end up in freedom over here and a set of collectivist-controlled pensions over there,” that might well have reduced the appetite. That is clearly not what we are creating. It can be argued that the collective benefits in accumulation are clear; the reduced volatility can be seen, as can the benefits of collectives in decumulation in potentially 20 or 30 years of requirement.
I do not think that we are fundamentally arguing. We want to enable people to have freedom and choice over their own money, but people will have a variety of preferences over risk. CDC will be right for some and they will stay in. I do not see any inconsistency between catering for people’s different attitudes to risk and having a framework that allows for risk pooling; the two sit alongside each other.
I am probably misquoting him, but my hon. Friend the Member for Amber Valley raised the issue about converting from DB to CDC. We do not envisage taking a DB pot and transferring it into a CDC scheme, which would almost certainly be illegal. The accrued rights of the DB pot are hard-wired, statutory-protected rights. A CDC scheme has no promises in it. I think that clause 20 states that a target is “unenforceable.” A CDC scheme’s target is therefore not enforceable. DB pots would not be moved en bloc into CDC because people would lose a lot of rights. They could individually transfer if they wanted to, but it is possible for a DB employer to say, “I’m not going on with DB anymore. I’m a big employer with lots of members putting in quite a bit of money each year. I’m going to start or join a CDC scheme.” We get to scale quite quickly, not because we brought a legacy pot across, but because it is a big firm with lots of money going in each year. That is the distinction I would make, and I hope that is helpful.
To go back to the point about transfer values and so on, assets are pooled in a collective scheme. People have a right to a share of that pool when they leave, so their share depends on the assets across all members and not simply on how much they have put in individually. The members of a collective have a right to a share of the pool, under the rules of the scheme, and the transfer value could reflect the impact on the people who are left behind in the scheme.
I hope that the discussion has been fruitful for the Committee. I am grateful for the constructive and helpful questions that have been asked.