Examination of witnesses (Questions 282
- 299)
WEDNESDAY 10 NOVEMBER 1999
MR CHRIS
DAYKIN CB, MR
ANDREW YOUNG
and MR DAVID
LEWIS
Chairman
282. May I reconvene the Committee and welcome
Chris Daykin, the Government Actuary, to the next session of our
evidence. He has with him Mr Andrew Young who is the Deputy Government
Actuary. Welcome back, Andrew. And Mr David Lewis, Chief Actuary,
Social Insurance. We are very grateful, gentlemen, that you have
taken the time to come along. We have all been spending the weekend
reading the quinquennial report and your Annual Report, and we
are grateful for that. It would help us enormously if you could
say a short word about your role in the National Insurance Fund
and maybe explain what Mr Lewis and Mr Young do in terms of specific
duties just by way of an opening statement. We have some areas
of questioning that we would like to pursue with you. If you could
do that for us by way of a start that would help.
(Mr Daykin) Thank you, Chairman. I am the seventh
Government Actuary that there has been. The first was appointed
in 1917, a man by the name of Watson who had previously been acting
as Actuarial Adviser to the National Health Insurance Joint Committee
from 1912 onwards. He was appointed as Government Actuary and
shortly afterwards in 1919 given a department. So for the last
80 years there has been a Government Actuary's Department, one
of the principal focuses of which has been to provide advice in
the area of social insurance and to advise the National Insurance
Fund and all the ramifications of that. In addition, GAD is involved
in many other areas including, at the moment, insurance supervision
and public sector pensions and demographic work, producing national
population projections. As far as the social security scheme is
concerned, the role of the Government Actuary is enshrined in
the legislation in respect of the annual uprating of benefits
and contributions. The Social Security Administration Act provides
that any Order to change the benefits or to change the contributions,
or indeed to leave the contributions unchanged, should be accompanied
by a report from the Government Actuary and the minister is required
to lay the Government Actuary's Report before Parliament. The
situation is a little unusual in the sense that, as a professional
adviser, the Government Actuary provides a report which is laid
before Parliament as signed by the Government Actuary; it does
not go through the minister, he has to lay it before Parliament.
Similarly, in relation to the longer term, section 166 of the
Social Security Administration Act 1992 provides for the quinquennial
review of the National Insurance Fund to be carried out by the
Government Actuary, a five yearly look at the operations of the
Fund and at the future of the Fund which historically we have
interpreted as being the very long term future as to where the
thing is heading in the long term. In addition to those statutory
responsibilities there is also a very strong tradition of where
the Government lays new legislation before Parliament in a Bill
which has consequences for the social security legislation then
there would normally be a report by the Government Actuary on
the financial consequences for the National Insurance Fund. Also,
my department is heavily involved in answering parliamentary questions
and answering questions from departments and from ministers on
things they may be thinking about doing in the future with regard
to the National Insurance Fund and its associated benefits. As
regards the structure within GAD, I have three deputies who each
head up the businesses in the different areas. Andrew Young is
my Deputy in the Social Insurance, Pensions Policy and Demography
area, so he is—under me—responsible for all that work
in this area of social security, including work for a number of
other governments, the work we do for the regulators of pensions,
Opra, and the work we do producing the national population projections.
Under Mr Young there are two separate divisions, one of which
deals primarily with occupational pension policy and regulation,
including contracting out, and also the demographic work. The
other division is headed up by David Lewis, on my right, who is
Chief Actuary with responsibility principally for the National
Insurance Fund issues, the things to do with the UK's social security
scheme. He is also involved in some of the consulting work we
do for other governments on pension reform and social security
reviews in all other parts of the world. I think that gives a
little bit of the context. The Government Actuary's Department
is a small department of about 100 people. We are financed through
the parliamentary vote but we are expected to cover the majority
of the costs of our operation from the fees which we charge to
our clients. The net parliamentary vote is only just over half
a million pounds and in addition to that we raise fee income currently
of about seven million pounds from our clients, of which the National
Insurance Fund is one and also the Department of Social Security,
both of which are significant clients from our point of view.
We have a significant team dedicated to providing actuarial services
to them.
283. Thank you, that is extremely valuable.
Do you not feel ignored? I confess that before I started taking
an interest in social security I had no idea. This is not the
first quinquennial report I have got but the one I got five years
ago when I read it first was a revelation, I had no idea that
anybody sat down and produced all this stuff. It must be a frustrating
situation for you to watch, for example, the uprating debate to
be conducted, as it is, every February, and it has now boiled
down to three hours although last year it was curtailed even from
that because one of the major parties was going to its annual
ball so people had to go dancing, and yet this stuff is here and
it very rarely gets referred to. Do you not think that to that
extent Parliament is not taking advantage of the work that you
do?
(Mr Daykin) To the extent that happens I would agree
but I think it has always been a tradition that the information
we provide is on the table to inform parliamentary debate. To
that extent we are probably ahead of most other countries in terms
of the availability before Parliament when these things are discussed
of quite substantial amounts of information about the possible
future. I think those who are interested in these topics and follow
them and seek to develop policy, both within and outside Government,
usually know about the existence of this material and use it as
a source of information about the long term and, indeed, about
the past as well because there are a lot of statistics and other
relevant information there which people can mine when they are
looking for something.
284. You find that Government ministers pay
attention to what you are saying?
(Mr Daykin) Yes. They do not need to wait for the
QR to come out because they have access all the time to us being
able to do projections and calculations for them. The importance
of the quinquennial review is that it is a line in the sand. Every
now and then we have a full study of all the aspects and the data
is reviewed and updated, so we have the latest information then
available for people to use.
285. Finally from me, we are looking at the
Contributory Principle in the round and the social issues and
all of that but there are some people who say "why bother
with the National Insurance Fund?" What would your response
be? The Government are going fast in the direction of tax credits
and developing a pragmatic modernising approach, and whatever
adjectives they use, does that not leave the National Insurance
Fund a bit marooned as a redundant vestige of what went before?
(Mr Daykin) Clearly there are some changes which tend
to reduce the significance of the Fund. I think the National Insurance
Fund still has importance in relation to the integrity of the
way in which the National Insurance contributions are used. Personally
I still have a regard for the importance of that principle, that
eligibility for benefits depends on having paid a certain number
of contributions or having been in the scheme and having contributed
for a period rather than on some other criteria that might be
adopted such as period of residence or need from a financial point
of view. From the point of view of parliamentary control I would
say that the National Insurance Fund has a very important function
because it does focus through the uprating process, the annual
review and the reports that we do in connection with that, on
whether there is a proper approach being taken to the benefits
uprating, whether they are being considered adequately in relation
to the income, and that gives Parliament quite a good influence
in principle over the way in which the scheme is developing in
a way which would be much less so if there was not a Fund and
this was all general budget expenditure.
Mr Dismore
286. Can you tell us what proportion of the
Fund is met by employees, employers and Central Government in
the current year and what your explanation is of the reasons why
the percentage shares have changed over the years?
(Mr Lewis) I do not know if you have got a copy of
our uprating report but in the back of the Annual Report there
is an analysis of contribution income which breaks down the income
between the employers and the employees. If anyone has got a copy
of this Report and looks at page 22 you can see both the gross
contributions primary and secondary, the primary being the employee
and the secondary being the employer. You can see the relative
sizes of them. In 1999-2000 the primary contributions are shown
to be £22 billion and the secondary £31 billion. There
is a significant difference between them. The ratio will change
over time because there are different effects on the amounts of
the contributions, mainly because the employees only have to pay
contributions up to the Upper Earnings Limit whereas employers
have to pay on all contributions. Depending how the Earnings Limits
move with the earnings distribution, this can affect the proportions
of the contributions paid by employees and employers. Indeed,
of course, from time to time the contribution rates get changed
by the Chancellor which has a direct effect on the proportions
that are paid by each class.
287. There is a surplus in the Fund at the moment
which appears to be growing, why is that? Is that simply a reflection
of the economy being stronger or weaker and the money comes and
goes or are there more structural reasons why you are getting
into surplus?
(Mr Daykin) There are factors relating to the strength
of the economy and the growth of earnings in the economy and,
indeed, the fall in unemployment which both have a positive impact
on the balance in the Fund. At the same time there are structural
changes, as you can see from the quinquennial review, that have
taken place over time which will result in the possibility of
the contribution rates needing to be changed if we are to avoid
the Fund building up. On the whole I think there has been a desire
to maintain some stability in the contributions to the Fund. In
principle the contribution rate could be changed every year just
to keep it in very close balance but that has not been the case
and, therefore, we have had some years where there has been a
surplus. The balance in the Fund is now running up towards about
30 per cent of the year's benefit payments and could well go over
30 per cent in the year after, 2000-01.
288. In the longer term is that difficult to
balance out? I am not sure if I have read the quinquennial review
right but it seemed to me that you were saying in about 20 years'
time it would be about 0.3 per cent difference to maintain the
present level of pensions. Is that the sort of scale you are talking
about and that is why you need to build up a surplus for rainy
days ahead, or are you effectively robbing today's taxpayers to
pay for benefits which I suppose they will benefit from in the
longer term?
(Mr Daykin) I would say first, in reply to that, that
the level of the Fund we have in the United Kingdom is one of
the lowest in the world even in terms of pay as you go schemes.
The pay as you go schemes which operate on a similar basis to
ours such as they have in the United States and Canada are building
up quite large Funds, in principle possibly up to five or six
years of benefit payments. That raises quite different issues
from what we are talking about here where we still have only a
very small buffer fund which helps to provide the liquidity and
the cash flow for payments from month to month. It is certainly
not going to keep the thing going if contributions cease or anything
like that; it is not a large fund in any sense. As far as the
projections are concerned, in the quinquennial review our projections
are on a price uprating basis, which is current legislation for
both the basic pension and the SERPS pensions in payment. We are
projecting that the necessary contribution rate will actually
fall from now on fairly gently for the first 20 years or so and
then quite steeply after 2030. There will come a time when the
issue will have to be raised if the balance of the Fund is getting
too high and should it then be accompanied by a reduction in contribution
rate or a change to the benefits?
289. On your present assessment for the foreseeable
future anyway the balance in the Fund is not a crock of gold where
we can start dramatically increasing levels of benefits or inventing
new ones?
(Mr Daykin) One would only want to look at that in
the long term context. I do not think one can ever think in terms
of the current balance in the Fund as just being the issue there.
If one is looking at any change to the benefit structure one has
to have a combination of looking as to whether the Fund would
afford it now and what the implications would be for the contributions
structure and what the longer term implications would be and whether
that would leave the scheme still viable in the longer term or
facing the sorts of problems that other countries face with escalating
benefit costs which they now regard as unaffordable.
290. The answer is that it is not a crock of
gold?
(Mr Daykin) No.
Mr Leigh
291. On the percentage shares of financing in
the National Insurance Fund, employers are declining from 52.3
per cent in 1989 to 51.9 per cent now and the employees from 44.3
per cent in 1999 to 43.9 per cent in 1997-98. The financing from
taxpayers has gone up from nought to 3.2 with an alarming blip
of 19.7 in 1993-94, presumably because of the recession. Why is
there this steady trend of it going up? Why is the taxpayer having
to contribute more?
(Mr Daykin) So far as I am aware the taxpayer is not
contributing. There is no Treasury grant at the moment.
(Mr Lewis) There have been Treasury grants in the
past where there is provision if the Fund has not got a sufficient
crock of gold, as has been expressed, or a sufficient balance,
and we aim to have a minimum balance in the Fund. If for any particular
year the contributions are not sufficient to maintain that balance
because they do not meet the benefits then there is provision
for the Treasury to make a grant into the Fund. The amount of
that grant will vary from year to year depending on what happens
to the benefits and what happens to the contribution rates, etc.
These can be quite variable because what you are essentially doing
is taking the difference between very large numbers, the incomings
and the outgoings. The difference can vary quite a lot. It can
be quite sensitive to economic developments, changes in contribution
rates, contribution structures, earning limits, etc. All of these
have a significant impact on the amount of money that can be paid
into the Fund from various sources. If you want to understand
precisely why the changes take place there is a lot of detailed
analysis that you would have to go into because the contribution
rates are always changing in one way or another. There have been
a number of significant changes over time and to understand the
progression you would have to do quite a lot of analysis work.
292. So the concept is that the employers and
employees contribute 100 per cent towards the Fund over a number
of years?
(Mr Lewis) Yes.
293. Presumably then the employers and employees
get 100 per cent out of the Fund as the taxpayer contributes nothing?
(Mr Daykin) Yes. All of the money held in the Fund
is used for the payment of benefits subject to a small amount
which is used to pay the administration but it is a very low percentage
compared to the administration costs of any other pension arrangement.
(Mr Lewis) The self-employed also have to pay something
to get something out, although not on the same basis as the employees.
Mr Pond
294. Presumably following that line of questioning,
the Exchequer contribution can also be used as a buffer, for instance,
on the Government decision to contract in certain groups of employees,
or indeed the self-employed, whose contributions would not otherwise
meet the costs of the benefits that they claim? We have seen recently
the contracting in of low paid women so they are entitled to maternity
provision and we have seen proposals on the second state pension
to contract people in as if they earn £9,000 a year and they
earn less. Is the Exchequer contribution part acting as a buffer
in those decisions?
(Mr Daykin) I think it is not really regarded as that
at the moment although historically it did play that sort of role.
When the Exchequer contribution was first introduced, which goes
right back to the early days of the current post-war scheme, it
was a way of topping up the contribution income in respect of
people who were being given accelerated entitlement to benefits.
Originally the idea was that the contribution rate would be set
at such a level that when the individual paid that contribution
rate throughout their working life, together with their employer's
share, that would pay for the cost of their benefits. It was much
more an actuarial concept such as one would have in a private
fund. Very rapidly, however, they began to increase the benefits
more than was built into that provision and to give entitlement
to people who had not contributed for very long and much of the
cost of that was met by a Treasury grant which was, therefore,
the way in which the Government was putting in money from the
general budget to meet these additional costs which it was thought
not fair to load on to the employees and employers. Over time
the link between the benefit and the contribution of the individual
has been loosened so that now it is very clearly on a pay as you
go basis and contributions are set to meet the benefits in that
year rather than the benefits of the individual in the future.
There was a time when the Treasury supplement was effectively
dropped and then it was reintroduced simply as a mechanism to
allow a bit more flexibility in the contribution rate. It could
philosophically be used in the future for providing benefits which
it is felt not fair to put directly on to the cost of employee/employer
contribution rates.
295. On the earnings limits, we know that this
year and next the proposals for the Lower Earnings Limit will
go up by more than inflation, possibly also the Upper Earnings
Limit. Traditionally there has been this link, has there not,
between the basic state pension and both the Upper and the Lower
Earnings Limits? Also in recent years there has been the uprated
basic state pension in line with prices rather than earnings which
has a knock-on effect in terms of the earnings limits and National
Insurance. That has meant presumably that you have got a different
effect. At the lower end, if I understand this right, you are
getting more people drawn into National Insurance as a result
but you will have a leakage of revenue at the upper end of the
earnings distribution because the Upper Earnings Limit is not
increasing so much in line. Could you just comment on that and
also the mirror image of that? Given that there is now the decision,
certainly over the next couple of years, to raise the limits by
more than inflation, what are the implications of that for the
Fund and, indeed, the different groups of contributors to it?
(Mr Young) Perhaps I could just correct you on one
interpretation of what you have said. There is a distinction in
the future between the Lower Earnings Limit and the threshold
at which people will pay National Insurance Fund contributions.
The Lower Earnings Limit, which effectively determines benefit
entitlement in the future, will remain as now and increase in
line with prices, so falling if you like relative to earnings,
whereas the threshold for paying contributions in due course will
be aligned to tax levels. Subject to that your analysis is absolutely
correct. There will be more people drawn into National Insurance
by the Lower Earnings Limit falling. More people will be drawn
into it by the minimum wage. Inevitably a lot of people at the
bottom end of the earnings distribution, apart from part-timers,
are obviously low earners and that will have some effect there.
Inevitably too if the Upper Earnings Limit falls relative to earnings
the employee's contributions, not the employer's but employee's
contributions, they would be lower than they would otherwise be.
I do not know if David can give you an indication of the financial
effect.
(Mr Lewis) I think the financial effect at the moment
is if you were to abolish the Upper Earnings Limit for employees
it would probably add something of the order of four billion pounds
to the income.
Chairman
296. Four billion?
(Mr Lewis) Four billion.
297. Annually?
(Mr Lewis) Yes. Depending what you do about contracting
out. If people are going to get contracted out rebates as well
on this extra bit then it would not be as much as four billion,
you might have to knock something of the order of a billion or
so off that, so you might end up with something of the order of
three billion or something annually. It is not an insignificant
question but I think it unlikely that it could be abolished just
like that overnight I would imagine. As we have already seen in
the past there has been this drift down of the earnings limits
that we have all referred to and to some extent the Chancellor
has addressed this at the Upper Limit by announcing two increases
in the Upper Earnings Limit over and above price inflation. So
by 2001 it will have gone up significantly more than price inflation
but still probably not back to levels relative to earnings that
it was in earlier years but he has recovered some of the ground.
What may happen in the future, on that we really do not know at
the moment, that is in the Chancellor's, the DSS's and anybody
else who is interested, hands essentially.
(Mr Daykin) The quinquennial review at figure 3.8
looks at one aspect of this for the future which is the balance
between the proportion of costs paid by the employer and that
paid by the employee. It shows that over the 60 year projection
period the employer's share effectively goes up from 58 per cent
to 72 per cent. This is largely arising from the Upper Earnings
Limit falling relative to the earnings distribution whereas the
contributions paid by employers are not capped at the Upper Earnings
Limit and are not affected by that change.
Mr Pond
298. Can I ask one final question on the point
that Mr Young raised about the distinction between the primary
threshold and the Lower Earnings Limit and you will have a gap
over which people will be entitled to benefits who were not making
contributions. Presumably you have looked at the revenue implications
of that although they will not be fully known until the new rates
are announced. Can you give us some indication of the revenue
costs of the Fund?
(Mr Lewis) I do not have it in my head, we have the
number in the department.
(Mr Daykin) We can write with the details if you would
like that.[2]
Chairman: Thank you very much, that would be
helpful.
Mr Swayne
299. In the quinquennial report you point out
that there is the possibility that contributions could fall despite
the fact that there is a growing number of pensioners because
of the contributions being related to the growth in earnings but
the benefits being related to the growth in prices. What is your
role in advising the Government on their options on the basis
of the potential growth in the Fund and the potential for reducing
the contributions?
(Mr Daykin) I think our role is principally to set
out the consequences of any particular policy line in this respect.
The quinquennial review in particular, but other work we do also,
will draw attention to the short and long term consequences of
following a particular route. Our role is not to make policy nor
necessarily to seek to influence policy but to provide the decision
makers with the tools they need in order to come to appropriate
decisions. We have been pointing out for some while through our
reports the consequences of the price indexation for the Lower
Earnings Limit and the Upper Earnings Limit in terms of the way
in which it will affect the balance of contributions between different
people. I think that is a matter for the Government and Parliament
to consider in the context of the scheme as a whole. It is quite
possible to conceive of a scheme where you have earnings limits
for contribution purposes which go up in line with earnings and
maintain their relativity to the earnings distribution whereas
some different criteria apply to the earnings which are taken
into account for the benefit calculation, they do not have to
be linked together in the way that they have traditionally been.
2 Note by Witness: The reduction in contribution
receipts to the National Insurance Fund as a result of raising
the starting point for primary contributions from the LEL to £76
in 2000-01 and to the level of the single persons tax allowance
in 2001-02 is estimated to be £740 million in 2000-01 and
£1,550 million in 2001-02. The effect on National Insurance
Contributions which are allocated to the National Health Service
is excluded. Back
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