Only pension reform can save the economy

Fiscal events like today’s Autumn Statement have a predictable drumbeat. In the days before the statement, analysis on the public finances feeds a media frenzy where businesses, politicians and commentators all have their say on what the Chancellor should do.

The Chancellor, in turn, briefs out the vast majority of their priorities, and on the day trumpets a delay to fuel duty rises, a small bump in alcohol duties and tweaks to business taxes. The statement is capped off with a surprise tax or spending give away. It’s all normally very familiar.  

Yet today, the Chancellor has the rare opportunity to do something truly transformative: a radical reimagining of the UK’s broken pension-savings system.   

Three reasons for poor returns

Currently, the UK has one of the largest pensions markets in the world. Despite this advantage, returns from UK pension funds have been among the poorest in the industrialised world. Our analysis at the Tony Blair Institute (TBI) shows three reasons for this. 

First is a lack of scale. The UK’s defined benefit pensions industry is fragmented, with over 5,200 schemes with an average size of £330 million. Their investment strategies have typically pursued a zero-risk approach.

There are also over 27,000 defined contribution schemes, 90% of which have fewer than 12 members. This leaves UK pension funds too small to diversify their asset allocation and generate better returns by investing in infrastructure, growth capital or public equities.  

Second is shorter investment horizons, especially for defined benefit (DB) funds. Closing DB schemes to new members gave them finite time horizons, making it harder to recover from the impact of poor investments. This limited their appetite for risk and excluded investment that would generate returns over the longer run.  

Last is a lack of professional management. Over the past few years, the returns of defensively manged pension funds have been far lower than those managed by in-house professional teams.

Internationally, the best large scale pension funds like the Canadian Pension Plan (CPP) have investment portfolios managed largely by in-house teams with a small proportion (typically around 20%) managed by external teams.

The CPP Investment Board has generated 12% annualised returns per year over the last decade. By contrast, the average DB scheme in the UK has delivered only six percent annualised returns per year over the last decade. Average returns for DC schemes are typically even lower.  

Priorities for reform

The UK’s pension savings system is long overdue for sweeping change. TBI recommends three priorities for reform.  

First, we should create “GB Savings”, a £400-billion superfund with a 100-year investment horizon. Instead of a UK company having to become bankrupt for its pension fund to be transferred to the PPF and professionally managed at scale, it would simply have the voluntary option of transferring itself in with a required payment or scheduled payments of a capital buffer for continuity of benefits. This capital buffer would replace the employer covenant with assets and liabilities transferred to GB Savings, with no further recourse by the fund to the original sponsor nor any further inclusion in its balance sheet. 

Second, we would incentivise wider consolidation in both defined benefit and defined contribution pension funds.To encourage competition in the market, we would incentivise wider consolidation in the def pension fund industry by making pension fund tax advantages dependent on consolidation.  

Third, we propose exploring options for future GB Savings superfunds.Having established GB Savings, the government should explore the opportunity to establish further replica GB Savings Funds that participate in consolidation in parallel to the original GB Savings (and modelled on its operations).

Primary candidates for such GB Savings Superfunds include the eight local government schemes, the troubled Universities Superannuation Scheme (which is currently having a fight about the accounting method for determining its liabilities), the 27,000 DC schemes, and ultimately, the unfunded DB public sector pension schemes.  

In addition, the Chancellor should deliver on the Mansion House Compact, accelerating the flow of domestic growth capital and late-stage financing into the UK’s world-class start-up ecosystem.  

If we want to be serious about addressing the lack of investment and innovation in the country, the Autumn Statement should be an opportunity to seize an obvious advantage and invest in growth. 

While the taxpayer might be tapped out, the UK has the capital we need for investment. The Chancellor doesn’t need to be bold or be brave, or resort to gimmicks. He just needs to do what every other country does, and deploy our pension savings into the infrastructure, entrepreneurs and technologies that can deliver productivity gains across the economy.  

In this case, the radical choice of pension reform is the practical one for the future of Britain.  

Jeegar Kakkad is director of government innovation at the Tony Blair Institute.