My Lords, Amendment 62GA is designed to address shortcomings in the governance of pension schemes, particularly contract-based schemes. It would give the Secretary of State the power to set regulations that
“provide for requirements for the identification, avoidance and management of conflicts of duty and interest”.
They would require, in the event of a conflict of interest, for priority to be given to the interests of the saver and to ensure that the duties to the saver are met despite the conflict.
In his review, John Kay criticised FCA rules as falling,
“materially below the standards necessary to establish”,
trust, confidence and respect. He recommended a shift towards fiduciary standards. In an auto-enrolled world, that comment has even more resonance because, increasingly, private sector workers’ pensions will be contract based, where, as the noble Lord, Lord Turner, mentioned in debate last Wednesday, there is a,
“fundamental inefficiency of the market ... It is a system absolutely shot through with market failure where the process of trying to provide in a competitive fashion simply does not work well”.—[Official Report, 15/1/14; col. GC 161.]
My amendment seeks to capture that governance challenge. To achieve an increase in pension savings, workers are auto-enrolled into workplace pensions. There can be no caveat emptor, as the saver does not buy. The system is designed to restrict the saver to one choice—either stay in or opt out and lose the employer contribution. Current regulation of contract-based pensions is at odds with the assumptions underlying auto-enrolment. Contract-based regulation is built on informed consent and consumer choice. Auto-enrolment is designed and built on the principle of inertia, on a population of savers who do not engage with investment choice. A plethora of reports has revealed the conflicts of interest in the industry. The OFT report confirms a dysfunctional pensions market with a weak demand side and concludes that the market could not be expected to self-remedy and that there is a need for intervention.
The introduction of auto-enrolment has been a success and the Government should be pleased. Opt-out rates have been low. The Government must now secure a level of quality and governance that delivers optimal results for savers in terms of building trust so that workers persist with their savings, thereby setting the ground for increasing contributions beyond the current statutory minimum and improving savers’ chances of achieving a reasonable income in retirement. Measures to encourage savers to engage with their pension savings are important but of themselves are not sufficient. The majority of savers will not actively engage. It is that very inertia that can be used by some providers to create or sustain profitable inefficiencies. The legal framework must protect those who do not engage.
The challenge of inertia means that there is a need for efficient defaults over the life cycle of the pension saver. For example, there is a need to get people saving; to determine a minimum they should save; to determine their investment choice at different intervals in the life cycle on, for example, joining a scheme or
following a quality review as they get nearer to retirement age; and, by default, to transfer and consolidate their pension pots. Over time, I suspect that we will be considering default arrangements on decumulation when a person retires. The need for defaults raises the bar on governance because someone is using their discretion on behalf of the saver.
Contract pension provision has systemic weaknesses of governance and a particular feature that constrains efficient default arrangements. For example, looking forward, an employer conducting a triennial review that decides that the current scheme is poor value will be unable to switch workers in a contract-based scheme unless they individually consent. However, the very nature of auto-enrolment means that this active consent is unlikely to be granted by many savers. On legacy schemes and pots, I am sure that any OFT-driven audit will reveal poorly performing funds and high charges, but the solutions will not be effective if they require individuals’ consent.
We have a misalignment between what contract-based provision can do and what it is necessary to deliver in the interests of the saver. How does one respond to that challenge? Recent press comments are peppered with references to making it easier to move contract-based scheme members from old to new schemes. Standard Life’s head of workplace pensions, speaking at the NAPF conference, said that contract law acted as a barrier to moving people from poor-quality schemes to good-quality schemes, and added:
“We need to learn the stuff that works in the trust-based world”.
A recent Pensions Institute report found potential for massive improvement in outcomes where poor-quality legacy schemes transferred en masse into better-quality modern schemes with lower charges. The Pensions Institute called on the Government to facilitate changes to contract law to allow such transfers to be made without the individual consent of scheme members where it is clearly in their best interests. However, there is the rub. Who decides where it is clearly in their best interests? How is the primacy of the saver’s interest protected? Governance requirements must be fit for purpose under auto-enrolment and remove a constraint in contract provision, but in a way that ensures that the interests of the saver trump the interests of others when there is a conflict. Putting the legal responsibility for the best interests of the saver on the employer will be problematic, particularly for the long tail of SMEs and micros.
The Government’s use of statutory overrides has a role to play, particularly in placing new quality and governance requirements into future, existing and legacy pension contracts. I ask the Minister to confirm whether this Bill would give the Secretary of State the power to change retrospectively the terms of existing pension contracts to embrace any new quality or governance requirements.
However, the solution must rest in major part in raising the governance in the pensions industry. Like trustees, it should carry a fiduciary responsibility in the management and provision of its pension products and investments. Conflicts of interest must be resolved in the interests of the saver. An efficient private pension
system that requires the default transfer of savers’ pots to new schemes and funds simply cannot happen without that.
There is an imbalance in the duties of contract-based pension providers, compared to those placed on trustees, which challenges the success of auto-enrolment. The OFT stressed the need for stronger measures to improve governance but I fear that the independent governance committees that it has agreed with the industry—here there are shades of what the noble Lord, Lord Lawson, referred to as the fox in the hen coop—will fail to achieve the requirement of aligning scheme governance with the interests of savers.
The proposed independent governance committees have many weaknesses. At the very least, such bodies need both a duty to act in members’ best interests and the power to make decisions. The current OFT proposal fails on both points. As the Law Commission commented,
“there are many difficult questions about how these committees will work”.
They,
“will not have the power to change investment strategies or investment managers ... Furthermore, it is not clear whether ... the committees will be under explicit legal duties to act in the interests of”,
the savers. Introducing independent governance committees accountable to the boards of pension providers, without addressing any of the conflicts faced by these providers, or clarifying that decisions must prioritise the interests of policyholders over those of the shareholders, does little to solve the governance deficit.
As a comparator, the governance requirements for the Australian private pension system have been toughened up recently. It is a sad reflection on my character that I spent a significant number of days over the Christmas holidays ploughing through the regulatory requirements under the Australian system—I promised in my new year’s resolutions to get a more exciting life in future. The Australian Prudential Regulatory Authority enforces a range of prudential standards on pension providers, including an unequivocal requirement that conflicts of interest must be resolved in the beneficiaries’ interests and a specific duty to deliver value for money.
The advent of auto-enrolment raises the bar on governance. I welcome the Government’s decision to impose quality and governance requirements on pension schemes, but I think that it is necessary to make it explicit that those requirements should provide for the identification, avoidance and management of conflicts of duty and interest. Conflicts of interest go to the heart of the problems in the private pension system. The regulations, when addressing governance requirements, must address the issue of conflicts of interest. Amendment 62GA, without being prescriptive, seeks to do that. I beg to move.