Pensions reform must deliver for the UK economy and the individual consumer, said Nicholas Lyons, Chairman, Phoenix Group, and Lord Mayor of London 2022-23, in his opening keynote address at Private Markets Investor | Europe 2024 in London on Thursday.
There were, however, numerous obstacles that stakeholders needed to consider — especially around a “bloated public sector”, high levels of government debt, the “grandiose promises” made by political parties, and geopolitical issues, said Lyons. He added that UK pensions were underfunded, with the government woefully misunderstanding the importance and power of compounding.
Another piece of the puzzle was the fact that the UK’s population was ageing, which meant that there were increasing health support and social care needs, but a declining number of younger people who could pay taxes to support.
Lyons gave his opening keynote on “Exploring policy approaches to tackle low UK productivity, stimulate private markets, and improve pension returns.” He said there were four main questions to address — 1) What was the current situation and how did it happen? 2) What levers were available? 3) How could barriers be overcome? 4) What did the “promised land” look like? — and discussed what needed to be done to achieve growth, as well as the broader impact this shift could have on the UK economy.
"We all know there are massive headwinds [for the industry], and, if you read British newspapers, it seems we may as well turn off the lights."
The UK is currently hovering around 0-0.1% growth and entered into a technical recession in 2024.
“We all know there are massive headwinds [for the industry], and, if you read British newspapers, it seems we may as well turn off the lights,” he said, setting the scene for why reforms were needed.
There was also the issue of the very high level of debt as an amount of GDP, “which of course there are reasons for”, he said, but was “still worrying”. “[As a result] governments don’t have the means to tax and spend, or cut and spend, to get themselves out of this situation,” he said. There had been “chronic infrastructure underinvestment”, not just on public services and housing, but also food and energy security in the country. The significant expenditure on the NHS, on the other hand, had brought no significant improvement.
Lyons had previously spoken with Insurance Investor on this topic, highlighting the UK’s challenges around growth. One area where this lack of growth and investment was particularly worrying, he said, was the UK’s import reliance on food – especially in light of the Russia/Ukraine conflict – which meant the country was over-reliant on import/export and distribution supply chains, proven of course to be fallible over the course of the pandemic and the subsequent economic fall-out.
Stepping away from macro issues, Lyons highlighted a few problem areas in UK financial markets – as well as offering some hope. “We have a hollowed-out UK equity market,” he noted, saying that while the UK has a high growth tech sector it wasn’t properly supported in an ecosystem of capital that would enable it to see further growth.
He also highlighted that the UK should have had a sovereign wealth fund similar to Norway’s when it first started pumping North Sea Oil, which he said showed that this lack of planning had been rooted in decades of inaction around the problem. If the UK did have one, he added, the pension timebomb might not be as severe.
“The defined benefit (DB) pension fund market, which is worth £1.8 billion, now has £1.5 billion effectively closed."
One of the major areas that had a negative effect, said Lyons, was the removal of the dividend on credits paid to pension funds, which was done by Gordon Brown in the 90s. The effects of decisions such as that one were detrimental, with pension reform key to the future health of the industry and country.
“The defined benefit (DB) pension fund market, which is worth £1.8 billion now, has £1.5 billion effectively closed,” he said. “We’ve created a trillion-pound put on the UK investment market over the last 20 years.” This, Lyons added, added to the depression of UK equity performance.
With such fundamental issues facing the market, Lyons was also able to give clues as to where the UK could see shoots of growth. One of the was tackling the ‘risk averse’ attitude that had proliferated after the Great Financial Crisis (GFC).
Since 2008, regulators had been extremely focused on making sure there wasn't another collapse, but that in turn meant the increase of risk aversion in the UK financial sector’s mindset. As the wider “risk management” sector, however – insurers, banking, and pensions – they had the expertise and knowledge to balance the need for growth and innovation without repeating past mistakes or endangering wider societal prosperity.
Lyons said there were many levers the UK had to get it back to a positive keel. “We have positive tools of value – such as real estate and pension,” he said. “Real estate is not the most liquid of markets, so ultimately it’s pension we have to focus on.”
He added that: “the UK has second largest pension market in the world and has deep roots and a varied savings market – for example, a trillion pounds nearly in ISAs – but we are not delivering the returns that pension holders need.”
“We need to invest in infrastructure and green sustainable finance, and we need to use pensions to do that; therefore, we need to improve pensions."
This underperformance was a big problem, said Lyons. UK pensions were currently averaging a “1.7% underperformance per annum”, which over several years would add up to several percentage points and create a more dramatic loss.
“We need to invest in infrastructure and green sustainable finance, and we need to use pensions to do that; therefore, we need to improve pensions,” he said. “The private sector must do more as the public sector can’t do it. The financial sector must do it, but the reins need to be loosened.”
Lyons continued that only certain regulatory aspects needed to be eased. He emphasised the need for good regulation and constructive dialogue with regulators to enable more freedom to invest. Otherwise, he said, there would be a ticking timebomb for younger people, who had been largely moved to defined contribution (DC) pensions. The risk is that they won’t have the amount of money they need to retire, which will strain public sector services.
DC pensions, Lyons said, and how they’ve been given to younger people, will mean a different way of working compared to previous generations and DB schemes, in terms of the length of time of contributions, sensible macro-level investment strategy, and the “power of compounding”.
Lyons said the UK should look to and learn from – but not necessarily copy – some of the successful pension markets, such as Canada and Australia. One of the key differences, he said, which could increase cash into UK pensions, was investment in unlisted assets. “Canadians invest in unlisted assets massively,” he said, while the UK only does 1% in unlisted. With appropriate changes, Lyons added, there could be real improvement.
Lyons’s main point, however, on how the UK could really up its game in terms of pension returns and providing more for the country was the Mansion House Compact, which he has helped spearhead. The idea has now gained traction and goodwill in the market as larger institutions continue to sign on believing in what it can achieve.
Lyons said that the compact currently has 11 members, representing more than 70% of DC market share. All members have signed up with the idea to allocate 5% to unlisted assets.
“We can learn from Australia and Canada.”
This, Lyons said, would enable more money to be funneled into lots of small funds that are invested in late-stage Venture Capital (VC) and DC, and help create more impetus around funding UK start-ups, particularly in the fintech sector. The additional funding could be key for reinvigorating the market, especially for listed companies on the London Stock Exchange. “If you go into an asset class like this you need scale to go through late series funding stages,” he said, adding that it would be “a vehicle that can channel lots of money” into the places where it can earn big returns.
“We can learn from Australia and Canada,” he reiterated while emphasising that the UK had a great and deep pension market with lots of knowledge and ideas, such as the Local Government Pension Schemes. If these continued to pool their assets, he said, they could create economies of scales and really make a difference.
Despite the numerous issues mentioned, Lyons said the London market and the wider UK were still a great place to invest. “We can overcome these barriers,” was one takeaway.
