Could a recession be auto-enrolment's biggest test yet?
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Automatic enrolment has been a success story thanks to increased coverage and lower than predicted opt-out rates, but the policy has yet to prove it works as well when the economy turns.
The small amounts saved through auto-enrolment have been criticised in the past, but few have commented on the fact that relatively low opt-out rates – an average of 9% – should be seen against the backdrop of benign economic conditions. If we are in for the next downturn as many predict, will these figures worsen?
To know whether that might happen, it might be useful to get a feeling of the UK population’s general financial situation.
“Although the number of people with unaffordable debt has been on a downward trend, there are still a lot of people who have very little financial resilience, as a result of high debt, low savings or both,” the chairman of the Financial Conduct Authority, Charles Randell, said at the Gleneagles Pensions & Savings Symposium last week.
Randell highlighted figures from the FCA’s Financial Lives Survey 2017, which showed that 26m UK adults have some form of unsecured debt, with the average amount at nearly £10,000. Some might be perfectly able to repay that debt, but around 8.3m people are defined as ‘over-indebted’, meaning they struggle to keep up with domestic bills and credit commitments or have already missed payments.
More than 800,000 UK households have mortgage debt of more than four times their household income; and around a third of adults (32%) have less than £2,000 in cash savings, with one in eight (13%) having none at all.
In 2017, 41% of adults below state pension age had DC pensions only, and 38% had no pension provision at all beyond the state pension, Randell noted, adding that auto-enrolment will “hopefully” have created a savings habit since.
This lack of a financial buffer is particularly worrying when considered in conjunction with the effects of an economic downturn, even if the picture looks ever so slightly less bleak than it did in 2008.
"Now it’s important to emphasize that although saving is weak, the debt picture we see is better, at an aggregate level, than it’s been at times in the past – including when we went into the last recession,” Randell observed.
“But some people have argued that the next recession may look very different from the last. In particular, they’ve argued that in a future downturn more people may lose their jobs than in the last recession, and of course unemployment is a key driver of debt distress and falling savings.”
Will opt-outs remain low?
Steven Cameron, pensions director at provider Aegon, agreed that there are relatively large numbers of people with very little financial resilience. Aegon’s own research shows 36% of people do not believe they could handle a major unexpected expense, while 31% believe their finances control their lives.
“Hopefully a downturn is not on the immediate horizon but for anyone in a precarious financial position, the focus must be on managing down debt and putting money aside where possible,” said Cameron.
Whether the pressures and fears that come with a downturn will lead people to stop saving in a pension is yet to be seen.
Future opt-out figures will in part be driven by people changing jobs, but some people might decide to stop contributing outside the opt-out period.
“There was a fear that we would see people go down this route when contributions went up from 3% to 5% in April but there is no published evidence of that so far,” noted Cameron, but added that “this might be influenced by the economic background”.
Auto-enrolment has to date not been tested in a recession. The first, large, employers enrolled workers in 2012, but staging for small and micro employers only happened between June 2015 and April 2017.
“It’s really hard to predict what would happen to the workplace pension savings rate if the UK economy were to take a dramatic turn for the worse,” said Gregg McClymont, the director of policy at master trust The People’s Pension.
He said auto-enrolment had been successful despite following a deep recession and amid low earnings growth.
“Obviously, there’s the potential for people to stop saving if the economy turns but the evidence so far points to automatic enrolment being more robust than some expected,” he added.
What will likely happen to opt-out rates and saving levels in a recession?