Prudential is advising customers to contract back in, why not abolish contracting out? - Ros Altmann

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  • Ros Altmann

    Ros Altmann




    by Dr. Ros Altmann





    Financial providers are writing to customers to advise them that they should consider contracting back into the state pension scheme.  This is hugely significant and leads me to the conclusion that this would be an excellent time to consider radically re-shaping our pension system and abandoning the complexity and cost of contracting out.  It is not delivering good value, no-one understands it and it is a huge waste of taxpayer’s money.  It was supposed to work by allowing equity returns to deliver much higher pensions from funded savings, than could be paid out by the state pay-as-you-go scheme.  This ideology has not worked, because investment returns have been too low, costs have been too high and annuities have become hugely more expensive.

    The recent decision by pension providers to ‘throw in the towel’ on contracting out reflects two factors:

    1. That contracting out rebates are not generous enough to offer people a realistic prospect of getting a better pension than the state scheme would pay (even though the government is spending billions of pounds every year on contracting out rebates)
    2. The companies and advisers are fearful of being sued for ‘mis-selling’ if they do not point out to customers that the rebates have been cut, expected investment returns are lower, annuity costs are rising and they may get a better pension from the state.  Some have already been required to pay compensation to people who were not told that they should consider contracting back in, as rebates had fallen.  The last thing the industry wants is another mis-selling scandal and they believe that the FSA and the Government have been unfair in their handling of this situation.

    Why is the Treasury against the idea of ending contracting out?

    1. The official reason is because it believes that long term financing of pensions will be too costly for the State and should be borne by the private sector.  This is not fair on the public, if the cost of opting out of the state system is that they get worse pensions later, but are not told about this.
    2. The real reason is, however, more likely to be that public sector unfunded schemes are contracted out and this saves the Treasury billions of pounds each year.  Even though there is no ‘fund’ that these rebates are paid into, the Government is saving costs in the short-term by having lower national insurance, but is then passing on even higher future pension costs to future taxpayers, to pay for these tremendously expensive public sector pensions.  The notion of contracting out for unfunded public sector schemes makes no sense and is totally illogical.  However, the Chancellor does not want to admit that this has merely pushed the costs of public pensions higher in the future.   It is time to wake up to reality!

    Apart from the objections of the Treasury, I believe that the FSA itself has to take some responsibility for this problem.  There are no financial advisers to give advice to people on contracting out – it is far too complex and they would not be paid for their time!  The FSA knows that people cannot get advice (or it certainly should know!) and yet it has not done anything about this for years.  The last time a Regulator looked at contracting out was over 10 years ago, but rebates have been changed again and again.  The Government Actuary says people should get advice on whether to contract out, but how?  The FSA says people should review their decision each year –  but how?  Given the complexity and poor value, surely it would be best to abandon contracting out as a concept.

    According to the Pensions Commission, contracting out rebates paid to funded pensions are worth £7.7bn a year, which is 17% of total funded pension contributions each year.  This means that the taxpayer is paying financial services companies or private firms £7.7billion each year, to invest in pensions for the future.  However, the FSA and Consumer’s Association have produced clear evidence that these rebates are not providing good value and that people would have been better off staying in SERPS/S2P, because the value of the rebates has been cut by successive Governments since the 1980’s, and because the investment returns earned on private pensions have not delivered enough, some private pension funds have had high charges and because annuity rates have fallen substantially so that the pensions that can be bought with the contracted out rebates are worth far less now than before.  In summary, these billions of pounds of public spending have been a subsidy for financial services companies, but have not delivered good value to the consumer.

    No other country has adopted the principle of contracting out and the Pensions Commission clearly states that, if we did not already have it in place, we would not want to put it in!  In addition, contracting out is unbelievably complex, no-one really understands it.  The UK pension system is the most complex in the world and contracting out is the most complex part of it all.

    If we get rid of contracting out, this will be much better for the public and will also help to simplify our current state pensions system for the future.  The Pensions Commission report does discuss the benefits of abandoning contracting out, but does not go far enough in recommending it should be abolished.  They mention concerns over defined benefit schemes, which are relying on these rebates and may close if they are taken away.  My view is that, if these schemes are being propped up by rebates which are leading to higher long-term liabilities in future, then it surely is better in the long-term if we recognise that this is not sensible.  Employers are already struggling with big deficits and trying to shore them up in the short term with rebates that are not generous enough, is just postponing the  problem but does not  make it go away.  In fact, the contracting out rebates may well be making the long-term funding position of these schemes even worse.

    If we want radical reform, then this would be an excellent first move.

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