What should the next government prioritise in relation to pension policy, and are there industry benefits to political instability? We posed this question in the 11th edition of the PMI Students' essay competition, sponsored by ITM. We're thrilled to announce that James Turner, Acting Pensions Administration Team Leader at Quantum Advisory, took home third prize. Sarah Meehan and Rhys Keeling earned first and second prizes, respectively.
James Turner's Essay
There are many areas of pension policy in which the government of the day should invest time and energy. However, not all areas can attract the attention they deserve. This essay discusses two areas that should be prioritised by the next government:
- Reducing inequality of pension provision for ethnic minorities; and
- Directing pension scheme assets to target investments that actively seek to reduce the effects of climate change.
In addition, this essay considers whether there are advantages to the pension industry to political instability and seeks to answer this question by discussing the following advantage and disadvantage:
- Former prime minister Liz Truss’ September 2022 mini-budget ‘chaos’ and how it improved many DB pension schemes’ funding positions; and
- Delay in correcting the scheme specific tax-free cash sum legislation for DC pension schemes caused by the July 2024 general election.
For the avoidance of doubt, the ‘next government’ is defined in this essay as the Labour government which came to power in July 2024.
Priority one for the next government - Reducing inequality of pension provision for ethnic minorities
A lot has been written about the gender pay gap and the pension inequities this can lead to between men and women. However, a topic not discussed as often is the pension inequalities facing those belonging to ethnic minorities. Although the term ‘ethnic minorities’ is of course an over simplified term, given that this encompasses many different groups which face varied issues and to lesser or greater extents, those belonging to an ethnic minority are defined in this essay as those that are not ‘white British’.
According to Legal & General Investment Management’s (LGIM) ‘Just don’t mention the pension: the ethnicity pensions gap’ report, those belonging to ethnic minorities have on average a pension pot of c.£52,300 compared to c.£114,900 for their white British counterparts (i.e. c.46% the value).
There are a number of different contributing factors to this inequality. The Pensions Policy Institute’s ‘The under pensioned: Ethnic minorities’ report highlights some of these contributing factors. This includes analysis that people belonging to ethnic minorities are less likely to be employed in pensioned industries, be employed in a full-time capacity and earn on average lower salaries when employed.
Action has of course been taken to address the first of these factors. With the phasing in of automatic enrolment starting in October 2012, many more workers in the UK have been enrolled in a workplace pension, which will have inevitably also benefitted those belonging to ethnic minorities. However, the next government can take automatic enrolment a step further by removing some of the barriers to enrolment, such as reducing the current age that a worker must be automatically enrolled from 22 to 18 years and by abolishing the lower earnings limit of £6,240 per annum.
According to Pensions Age’s ‘Govt urged to 'hit the ground running' with AE reforms’ article, pension industry professionals are calling on the next government to make these changes. As those belonging to ethnic minorities are younger and earn less on average than their white British counterparts, these changes to automatic enrolment could have a significant positive effect for them by ensuring more individuals from those communities are automatically enrolled in a workplace pension.
The LGIM report (referenced above) also suggested actions which could be taken to reduce inequality, one of which was to ensure pension communications are written in clear language to help readers understand and take an active interest in their pension provision. This may be of help to those belonging to ethnic minorities, as it is possible that some will not have as strong a command of written English, especially if English is their second language. Also, the use of particular investment funds may encourage a greater level of pension saving amoung those belonging to ethnic minorities. An example of this would be offering an Islamic (or Shariah-compliant) investment fund to give greater investment opportunities, and thus greater incentivise to save into a pension, to those of the Islamic faith.
Although these suggested actions are unlikely to completely remove the pension inequality experienced by ethnic minorities, the next government can surely help reduce the problem by adopting some or all of them as policy.
Priority two for the next government - Directing pension scheme assets to target investments that actively seek to reduce the effects of climate change
The climate emergency is perhaps one of the greatest challenges now facing mankind. Increasing atmospheric temperatures, rising sea levels and an unprecedented rate of extinctions effecting many living species are just some of the threats. However, the emergency can be addressed, at least in part, by channelling funds into sectors that seek to help stem and even reverse the effects of climate change.
According to the NEST Pension website’s ‘How climate change could impact your pension’ section, c.£6.5 trillion of UK pension assets are invested in the global economy as at March 2020. This is an enormous amount of capital.
Previous governments have introduced legislation to encourage investment of pension assets into the green economy. The House of Commons library’s ‘Pension scheme investments and climate change’ report gives examples such as the requirement from October 2019 for pension scheme trustees (of schemes with more than 100 members) to include details in their Statement of Investment Principles of their policies in relation to financial material considerations, including those relating to climate change. There is also the Climate Change Governance and Reporting Regulations 2021 which requires larger pension schemes (including Master Trusts) to set climate related targets and to report on their climate related activities and their impact.
However, the next government could go further. One option would be to widen the scope of pension schemes required to set climate related targets and to report on them to encompass the smaller schemes. This will bring even more pension investment capital, and whether it is being used to tackle climate change, under scrutiny.
In addition, the next government could introduce legislation to encourage individual pension savers to invest in the green economy. This could be achieved by requiring pension schemes to offer a wider range of green funds and requiring the default investment strategies of automatic enrolment schemes to include green funds.
Taking this a step further, the next government could incentivise pension savers to invest in green funds by using a method already used to encourage contributing into a pension; namely tax relief. Considering the ‘relief at source’ model, where the government will contribute an additional 25% of the contribution into a pension (for a basic rate tax payer), the next government could increase the amount of tax relief available for contributions which go directly into green investments. There would be practical issues to overcome with such a policy, including the need to ensure these contributions were not immediately switched into non-green investments after receiving the tax relief, but these could be overcome with carefully worded legislation and direction to scheme pension trustees (or Independent Governance Committees).
These suggested actions could go a long way in directing the immense financial power of UK pension capital to play its part in fighting climate change, while still producing good retirement outcomes for the pension scheme members to whom it belongs.
Advantage for the pensions industry of political instability - Former prime minister Liz Truss’ September 2022 mini-budget ‘chaos’ and how it improved many DB pension schemes’ funding positions
A key reason the former Conservative government introduced the, what turned out to be, calamitous September 2022 mini-budget was political weakness and fear that the opposition was gaining popularity and would win a general election if one was called. Although it could be argued that the effects of the budget were economic instability, I would instead consider it political instability.
Few that were working in the pensions industry when the September 2022 mini-budget was announced will forget the impact it had. For a few weeks, it really did seem as though the market’s reaction to then prime minster Liz Truss’ £45 billion in unfunded tax cuts could bring the UK economy crashing down, bringing many pension schemes with it.
Indeed, there were some serious negative effects for pension savers. An example is members of Defined Contribution (DC) pension schemes which were invested in ‘lifestyling’ strategies which utilised gilts and bonds for those nearing retirement. These traditionally ‘safe’ investments experienced a large fall in value, which badly impacted the value of DC pots of members which held them.
Defined Benefit (DB) pension schemes, some of which held large amounts of gilts and bonds, did experience a similar fall in the value of their investments. However, according to Pensions Expert’s ‘LDI and the Liz Truss mini budget: One year on, what - if anything - has changed?’ article, it wasn’t all bad news for DB schemes. Although they experienced a fall in assets, they experienced an even greater fall in the value of their liabilities in comparison, which means they experienced an overall positive impact on their funding levels.
In turn, this moved many DB pension schemes closer to the ultimate goal of achieving a buy-out of their liabilities with an insurance provider. Although it can mean that those involved in the pensions industry, such as third-party administrators, lose business as the schemes they administer transfer liabilities and services to the chosen insurer, it does open up new business opportunities for those advising trustees on the buy-out process and for the insurers themselves. And of course, it secures the safety of members’ benefits, which is the ultimate goal of the pensions industry and as such, must be considered an advantage of political instability.
Disadvantage for the pensions industry of political instability - Delay in correcting the scheme specific tax-free cash sum legislation for DC pension schemes caused by the July 2024 general election
With the previous government having abolished the Lifetime Allowance from April 2024, the method used to calculate a DC pension scheme member’s scheme specific tax-free cash sum of more than the standard 25% (if applicable) is no longer operational, as it used the value of the Lifetime Allowance. HM Revenue & Customs’ (HMRC) legislation which introduced a new calculation method, as they admit in their ‘Newsletter 159’, does not operate as intended. This has resulted in the advice from HMRC to not allow members with this entitlement to take their benefits (if opting to take a tax-free cash sum in excess of 25%) until after the legislation has been amended.
At the time of writing, the Lifetime Allowance has been abolished for four months and amended legislation has not been released. This will be in part to the calling of the July 2024 general election and the suspending of parliamentary business for a number of weeks, followed by a change of government. Although a democratic decision to change governments, it cannot be denied that this caused a measure of political instability. This is bad for affected pension scheme members and the industry. Members which feel that they are being denied access to their full benefit entitlement, even though this is on the advice of HMRC, are more likely to complain, which can cause additional work and expense for the pension schemes and those running them. As such, this must be considered a disadvantage of political instability.
Conclusion
There are a number of pension related areas on which the next government should focus but two of the most important are trying to reduce pension provision inequality faced by those belonging to ethnic minorities compared to their white British counterparts and encouraging the use of pension assets to make an even greater contribution to fighting climate change.
In addition, there are both advantages and disadvantages to the pensions industry of political instability but different individuals from different pension schemes can be impacted, both for better and worse. So, the answer to whether there are benefits to the pension industry; yes and no.
Sources
Source 1:
Legal & General Investment Management’s ‘Just don’t mention the pension: the ethnicity pensions gap’ report
https://www.lgim.com/landg-assets/lgim/capabilities/defined-contribution/dc-retirement-solutions/the-ethnicity-pensions-gap-report.pdf
Source 2:
The Pensions Policy Institute’s ‘The under pensioned: Ethnic minorities’ report
https://www.pensionspolicyinstitute.org.uk/media/vwmgtatl/20031127-the-under-pensioned-ethnic-minorities.pdf
Source 3:
Pensions Age’s ‘Govt urged to 'hit the ground running' with AE reforms’ article
https://www.pensionsage.com/pa/Govt-urged-to-hit-the-ground-running-with-AE-reforms.php
Source 4:
NEST Pension website’s ‘How climate change could impact your pension’ section
https://www.nestpensions.org.uk/schemeweb/nest/investing-your-pension/how-nest-invests/climate-change-impact-pension.html
Source 5:
House of Commons library’s ‘Pension scheme investments and climate change’ report
https://researchbriefings.files.parliament.uk/documents/CBP-8950/CBP-8950.pdf
Source 6:
Pensions Expert’s ‘LDI and the Liz Truss mini budget: One year on, what - if anything - has changed?’ article
https://www.pensions-expert.com/Investment/LDI-and-the-Liz-Truss-mini-budget-One-year-on-what-if-anything-has-changed
Source 7:
HM Revenue & Customs’ Newsletter 159
https://www.gov.uk/government/publications/pensions-schemes-newsletter-159-april-2024/newsletter-159-april-2024
Last update: 4 December 2024
