Select Committee on Social Security Minutes of Evidence

Examination of witnesses (Questions 282 - 299)




  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.


  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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