IN this week’s article we will continue to explore the concept of a national pension fund (NPF) designed to provide an earnings-related pension to every citizen when they retire.

To summarise the main points we have discussed in our previous articles:

  • An NPF would become

“Pillar 1” of a new pension system. The state pension would be a

“Pillar 2” supplementary pension designed to ensure nobody receives a pension below an agreed minimum

  • The NPF could start to be created by consolidating local government pension scheme (LGPS) funds into one and then transferring in other large pension funds such as the Scottish universities’ funds (currently part of the very big UK Universities Superannuation
  • Scheme –USS)
  • Everyone would get only one pension instead of separate pensions from a number of separate schemes.
  • Changing employer would not mean any need to change pension scheme
  • The level of contributions required will depend on the design of the scheme involving:

What level of pension is to be paid compared to earnings?

How much pension rights are accrued every year (the “accrual rate”)?

How long is the period of employment and what is the normal retirement age?

What is the dependency ratio (the number of active workers relative to retired pensioners)?

  • Compulsory pension contributions would eliminate National Insurance Contributions. NICs are a form of tax and are not required to fund the state pension element.

Here is a simplified illustration of how much pension contributions are needed to finance one set of design choices

  • Accrual rate 1/70 of earnings for each year of employment
  • Joining age 18, normal retirement age 65
  • Pension = 50% of earnings
  • Dependency ratio 3)1.

If average earnings in the economy are £20,000 then the average pension is £10,000. There are three workers per pensioner so contributions based on £60,000 of earnings are required to support £10,000 of pension benefits. The contribution rate is 1/6 of earnings (16.6%).

This can be reduced to take account of investment returns earned by investing the pension fund.

A contribution rate of 15% could be split between employer 10% and employee 5% . Contributions of 15% of £60,000 produces £9000, leaving £1000 to be derived from investment returns. How would investment returns be earned?

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The NPF will also be an investment fund which has the objectives of providing investments primarily to support a productive domestic economy. This means it is a National Pension and Investment Fund (NPIF).

The main focus of the investments will need to be to provide “productive finance” rather than speculative finance, so instead of buying and selling financial assets such as stocks and shares and seeking to make money out of trading them, the fund would make productive financing the main priority.

Here is a suggested “capital allocation hierarchy”:

1. Equity direct partnership investments

2. Government bonds, National Investment Bank bonds, local authority bonds, cash

3. ESG (environmental, social, and governance) screened stocks – (primary market) – new share and corporate bond issues

4. ESG screened stocks (secondary market) – shares, corporate bonds, including selected divestment

5. Commodities subject to rigorous criteria relating to third country development

6. Currency (risk hedging)

7. No hedge funds, private equity, derivatives, stock lending

The top priority is providing equity directly through partnerships with Scottish infrastructure developers and operators and Scottish businesses across diverse sectors of the economy, with particular emphasis on strategically important sectors and companies identified by an industrial strategy. This is long-term, patient capital which will provide long-term returns for the fund.

Next are investments which support spending by central and local government and state banks. Bonds and cash are important for providing the “liquidity” the fund needs to meet its obligations to pay pension benefits and cover its operating expenses.

The third priority is to buy, and then keep for the long term, carefully selected stocks and shares issued by companies whose products and services are important for our economy, which meet the needs of our people and support the transition to zero carbon. ESG criteria are applied to select the investments.

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It is likely that not all the available funds can be fully allocated to the top three priorities so a certain amount of buying and selling stocks and shares will have a part to play. Again, though, what is bought, kept or sold is to be determined by applying strict ESG-based selection criteria. This would, for example, preclude the acquisition or keeping of fossil fuel-based assets.

No investments in hedge funds, private equity or credit based derivatives should be permitted and stock lending should also be prohibited. Stock lending is a significant contributor to “short selling” operations where speculators take bets on falling markets and is tantamount to financial gambling at its worst.