Chris Curry and William Wright gave evidence.

We will now hear oral evidence from Chris Curry, director of the Pensions Policy Institute, and William Wright, managing director of New Financial. We have until 4.45 pm for this panel. Would the witnesses kindly introduce themselves?

Chris Curry:

Good afternoon. My name is Chris Curry, and I am director of the Pensions Policy Institute. The PPI is the leading UK research organisation working in pensions and retirement income, with a remit to provide an evidence base, analysis and data across all pensions issues.

William Wright:

Good afternoon. Thank you for the opportunity to be with you today. My name is William Wright. I am the founder and managing director of New Financial, a think-tank that makes the case for bigger and—crucially—better capital markets across the UK and Europe.

I call the Shadow Minister.

Q Obviously, the most controversial part of the Bill is mandation—or rather, reserved powers for mandation; I am corrected by the Minister, who is flashing me interesting looks. Why do you think it is that Canadian pension funds are investing more into UK assets than British pension funds are—without being mandated?

Chris Curry:

We heard a little about that from the previous witness, who I think also has first-hand experience of the Canadian investment models, but there are a number of different reasons. First, there is the aggregation in the system that was talked about; the UK has a very fragmented pensions system. There are a number of different large sectors, but each large sector is not large internationally speaking. Scheme maturity, scheme size and scale generally are a factor. Very few individual schemes have the scale and the amount of assets to invest large-scale in some of the UK opportunities in the way that Canadian schemes have invested on a large scale—as has been said. Half a billion pounds to £1 billion in a single investment is very large by UK standards, compared with the size of schemes.

There is also, because of that lack of scale, a lack of development of the expertise required by some of those specialists—sophistication has also been mentioned—across some of the different individual schemes that we have in the UK. If you are larger, you can afford to have those specialist management teams or specialists on the board. It is not such a proportionate cost as it would be to a relatively small scheme.

Cost is another factor. As we heard from previous witnesses, in the UK a lot of focus on schemes has been on the cost of providing a scheme; in the workplace especially, by default a lot of competition is based on cost. With some of the opportunities we are talking about, especially in productive finance, in the UK space, investing in the UK would come at a high cost, so there is less scope for that cost to be absorbed in an overall larger fund. A lot of the things that the Bill is trying to address are probably some of the reasons why we have not seen that UK investment up until this point.

Q A previous witness, Michelle Ostermann, made two really interesting related points. One is that, having derisked the UK pensions industry, there is not the appetite to make some of these investments. The second is that other countries are much better at leveraging their pensions industries in order to promote economic growth. Is that something you have looked at, William?

William Wright:

Certainly on the derisking side, while we are blessed to have the second or third largest pool of pensions assets in the world, the structure of our pensions system—the fact that so many DB schemes have closed or are running off—means that the overall risk appetite simply is not there. There is a danger in this debate of comparing the outcomes that we see in different types of pension fund systems around the world and thinking, “We like the look of that. Can we have a bit of that, please?” I am simplifying here, but we tend not to be too keen on looking at the inputs and the decisions, often taken 20, 30 or 40 years ago in different markets around the world, that have helped to lead to the development of those systems as they are today. The Canadian public sector defined-benefit model did not happen overnight. Michelle knows the history of it better than I do, but it goes well back into the 1980s. That is why so many of the aspects of the Bill should be welcomed. They look at the fundamental drivers of what will help to define pension fund outcomes for members and the structure of our system in 10, 20 or 30 years’ time.

On how other systems think about pension systems in relation to growth and economic wellbeing in their domestic markets, one of the things that we found particularly striking is that when you compare DC pensions in the UK with DC systems in other countries, or public sector DB in the UK with public sector DB in other countries, there tends to be, for DC pensions in other countries, a higher domestic bias. There tends to be more investment, whichever way you look at it, in their domestic equity market than we see from UK DC pensions in the UK equity market. You also see, almost universally, higher levels of investment in private markets. So much of that comes back to scale. Scale is a threshold—it is not enough on its own—and then there is the sophistication, governance and skillset that needs to be built over many years on top of that.

Q On this derisking thing, a number of investment managers over the years have pointed out to me that the rules were brought in as a result of Maxwell absconding and taking a lot of money out of his pension fund. Deficits are now placed on to the balance sheet of the host company, which means that the inclination of those companies is to prefer those pension funds to be invested in less volatile assets, not equity markets, where you can have a stock market crash one day as a minor correction in a long-term growth market. Do you think that is the kind of thing that Michelle was referring to in talking about derisking, where legislation that was well-intentioned at the time has had perverse outcomes?

William Wright:

Yes. As a number of witnesses have mentioned today, because of the structure of the UK pension fund industry, there are many different perspectives, often not entirely aligned, shall we say, with each other. Every participant in the industry has responded perfectly rationally to the incentives in front of them and the regulation behind them in their investment behaviour and risk profile. International accounting standards, rather than just UK standards, have helped to drive that in the private sector. We have seen similar derisking in other corporate DB pension systems around the world. It has been an entirely rational response. It is really interesting to see which elements of which markets around the world seem to have found a more positive response. Canadian public sector DB, the closest comparison to LGPS in this country, is one example. Others are Australian DC or some of the Nordic models—the Swedish and Danish DC models.

Q Chris, following on from the points about derisking and all the rest of it, we heard from Phoenix a little earlier about the value for money framework. Everybody seems to agree that the framework is a good thing because it is going to drive better performance and all the rest of it, with one exception, expressed by Phoenix: the consequences of an intermediate rating. It is one of those difficult things where you seek mediocrity rather than going for good performance. Do you think that is a valid criticism of that particular part of an otherwise welcome part of the Bill?

Chris Curry:

First, I agree that we have seen lots of positive response to the value for money framework. Looking across international examples—Australia, in particular—it seems as if it will be very welcome in trying to ensure that, as part of the consolidation and what is potentially coming with the next Pensions Commission, with more investment going into UK pensions, that investment is going into a place that is actually going to work on behalf of the members who are investing their money. That is really important in what we are doing. I would also echo some of the views we heard earlier that it is really important in moving away from just a cost-based analysis of pensions and into value, and in looking at the whole range of different factors that are going to determine whether you get a good outcome rather than just at how much the investment costs.

There are challenges. What we have seen in particular, which Tim mentioned earlier and echoes what we have seen in Australia, is that where you have a very hard measure over a relatively short period of time, that will affect investment behaviour. Because there is such a penalty for falling behind over a short space of time, you do everything you can to avoid falling behind, and there is fairly conclusive evidence that that has led to herding of investments in Australia. That is not to say that a framework, or even an intermediate marker, necessarily has to lead to that; I think that depends on the parameters you set and whether you are looking at the returns over one year, three years or five years, and how that works.

Ideally, recognising that pensions are a long-term investment, you would not want to be looking too much at what happens over a short period of time in investment markets; you would want to be looking over a much longer period and at how the underlying strategy is performing. That is always very difficult, and one of the challenges is trying to get the balance right between what you can measure objectively and what you can measure subjectively. Where you are looking at things like an intermediate report, you tend to be looking at something that is objective, and it is quite difficult to do that over a long period of time. There is always a balance to be struck as part of this, and it would be good to investigate that more as we get further through this process, to work out the best way of doing it in order to achieve the best outcome for members.

If I remember rightly, the Bill allows for the detail to come in afterwards, so we will have a bit of work to do when this is all over. Thank you very much.

Q We all have work to do; it is never all over. Chris, this question is mainly for you, as I am conscious that you have done lots of work over an extended period on the dashboard. Obviously, there are elements of the Bill that relate to that—mainly relating to the PPF—but not many. However, is there anything you want to tell the Committee about the lessons from it for when we come to the small pots work, which obviously is a central part of the Bill?

Chris Curry:

I listened with interest to some of the earlier witnesses talk about dashboards, and there certainly are some lessons that we can learn from the pensions dashboards programme, as it has been evolving over the past few years, for small pots in particular.

There are two issues that I would pull out. The first is on the technology front. I think someone suggested that the next five years or so could be quite a tight timetable to build a technological solution and get it in place. You have to be very careful—you cannot underestimate just how much complexity there is and how long it takes to do these things—but I would say that the work that we have done on pensions dashboards is giving us a bit of a head start. That is not to say that we necessarily need to build on or use parts of the system that we have already built, but it has helped us understand a lot about, for example, how you can find pensions—the way you can use integrated service providers rather than having to go direct to all the schemes, and use a syndicated model to find where people might have their pensions.

It has helped the industry get a long way down the path to where it needs to be, as well. One of the big challenges for pensions dashboards is the quality of data. Enabling individuals to find their pensions means data quality: it needs not only to exist and be there; it needs to be accurate and it needs to be up to date. When you are thinking about an automatic consolidator or default consolidator for small pots, that is even more important. You are not just transferring information, but transferring money, so it is really important that the data is high quality. The work that is being done on pensions dashboards will get people in the industry a long way to having part of that in place as well.

There are definitely lessons that can be learned from how we progressed on the pensions dashboards programme. It has got us much closer to where we would be if we had had a completely blank page to start from, but there is still a reasonable amount of work to do, because it is working in a slightly different way.

Q The Bill makes the notion of using pension money for macroeconomic benefit—investment in the UK—an explicit objective. Other countries seem to have done this already. Did they do so explicitly and deliberately, or was it just an accidental outcome of good investment decisions? Did it take a conscious effort to make it happen?

William Wright:

I think it is a mix of both. It very much depends on what sort of assets we are talking about. For example, if we are thinking about the UK stock market or domestic equity markets, we tend to see that markets such as Canada and the Netherlands have an even lower allocation to domestic equities, whichever way you look at it, than comparable UK pensions have to the UK market.

Ultimately, this comes down to what you might call the accidental design of the UK system. It has evolved over 20, 30 or 40 years, whereas the systems with which we like to compare the UK system, or large parts of them, were actively designed anything from 30 or 40 to 50 or 60 years ago. We are now seeing the benefits of that active design in those systems. Their focus on scale enables them to invest in a far broader range of assets at a lower unit cost.

Going back to the value for money point, UK pensions have ended up in the worst of both worlds. Fee pressure, particularly in terms of winning and transferring new business between providers, is driving down fees, but the average fees on DC pensions today are very middle of the pack: 45 to 50 basis points a year. That is much higher than much larger schemes in Canada, such as the Canada Pension Plan Investment Board, the big Canadian reserve fund, and much higher than large UK schemes, such as the universities superannuation scheme, but they are stuck in the middle: they are actually paying higher fees, but because of the fee pressure they have a very vanilla, almost simple asset allocation. As Tim Fassam from Phoenix pointed out, that tends to steer people towards the lowest cost investment option. Active design, focusing on scale and sophistication, enables pension schemes to take a much longer term and much broader view of what they should invest in and where they should invest in it, whereas in the UK we have tended to accidentally move from one system to another.

Q So to summarise, you approve of the attempt to take control, as it were.

William Wright:

Absolutely. One of the huge challenges in the UK pensions debate over the past 25 or 30 years has been that we sort of knew what was not working and where corporate DB pensions were going to go, and then there was a hiatus and no real active design of what was going to replace them. Auto-enrolment did not start to kick in for a couple of decades, and now we are beginning to see the benefits of that, but the opportunity to actively redesign the structure of the defined-contribution pensions system in this country, and the structure of public sector DB, is long overdue.

If there are no further questions, I thank the witnesses very much for their evidence this afternoon. Given that the Committee has been sitting for a couple of hours non-stop, I will suspend the sitting for a brief period.

Sitting suspended.