Select Committee on Social Security Fifth Report


The Social Security Committee has agreed to the following Report:—



1. The contributory principle which underlies this country's system of National Insurance was the cornerstone of the post-war social security settlement, intended to provide social protection for all through a collective fund to which everyone contributed. Today that system is being eroded. The process of erosion has been gradual and has taken place over decades. It shows no signs of slowing down. Public debate at the demise of contributory benefits has been muted, despite the fact that contributions paid by individuals have risen considerably and the benefits they have paid for have been reduced in value and eligibility tightened. The Committee's inquiry into the contributory principle grew out of an unease that the system of National Insurance is disappearing by default, without proper acknowledgement or debate. One purpose of the inquiry is to stimulate a wider public debate on its future. For if the contributory principle is to survive and be re-invigorated, it will require greater public understanding and active political support. On the other hand, if the contributory principle is to disappear as the underpinning of this country's social security system, we consider it should do so only after the full implications have been properly discussed and agreed to. Our inquiry therefore set out to examine the role of National Insurance within Britain's social security system and to ask, whether, in the 21st century, benefits which are paid on the basis of contributions still have a role.

2. We announced our inquiry and issued terms of reference in April 1999. As well as receiving considerable written evidence, we held seven oral sessions at which the following witnesses gave evidence: Professor Pete Alcock, Professor of Social Policy and Administration, University of Birmingham; Dr Sheila Lawlor Director of Politeia; the Trades Union Congress (TUC); the Low Pay Unit; Child Poverty Action Group (CPAG); Disability Alliance; the Centre for Policy Studies; Ms Fran Bennett, independent social policy researcher; Mr Frank Field MP; the Institute for Fiscal Studies (IFS); the Government Actuary's Department; and Mr Alistair Darling, Secretary of State for Social Security. During the course of the inquiry two study visits were made, one to Norway and Finland in October 1999, and one to Australia in March 2000, where contrasting models for social security systems were explored. Two pieces of research were commissioned as part of the inquiry, one from Ms Holly Sutherland of the Microsimulation Unit at the University of Cambridge and one from Mr Andrew Young, Deputy Government Actuary. We are grateful to all the individuals and bodies who have assisted the Committee during its inquiry.


3. Various definitions of the contributory principle were given to the Committee. The essential elements agreed by everyone were: an eligibility for benefits based on contributions;[1] and a funding mechanism for those benefits based on contributions.[2] Dr Bruce Stafford suggested that "growth in private insurance to cover unemployment, sickness and pensions represents an expansion of the contributory principle."[3] However, for most commentators, the contributory principle was understood as a concept linked to the 'social insurance model' of benefits, and encompassing a broader, more flexible relationship between contributor and benefit than that of private insurance:

    "it has never been [a] ... close insurance based, individual insurance based investment type of relationship...I do not think it was ever intended to be that and perhaps the broader term, social insurance, captures for me what is the essence of the contributory principle and that is more of a kind of quasi-contractual relationship between people and the society in which they live and the notion of social security protection which arises from that."[4]

4. In the context of this report, the term 'contributory principle' is used with reference to the social insurance model of benefits. In its evidence, the TUC identified various key characteristics of the 'social insurance model': an element of compulsion for most employees, and exclusion for others outside the labour market or with low earnings; the absence of a means-test; a system of provision for workers whose earned incomes have been interrupted by commonly recognised contingencies, such as retirement, unemployment, sickness, disability, maternity and widowhood; and, unlike private insurance, a pooling of risk.[5] Most European countries have some version of the social insurance model based on contributions as the basis of their social security system. The report also uses the term National Insurance. It is used to describe the British model of social insurance which has developed over the last century.

The objectives of a social security system

5. Underlying the discussion of the role of the contributory principle and its future is a wider debate on the purpose of social security and what it is meant to achieve. For some, the social security system should be confined to the narrow aim of poverty alleviation:

For others, social security has a broader role, beyond providing a residual system of financial support for the poor. For example, Ms Bennett suggested that a social security system should aim to:

    "  - help prevent poverty, as well as trying to relieve it after the event;

    - redistribute resources over individuals' and families' own lifecycles;

    - represent a compact of support between the generations;

    - protect people against risks and insecurities;

    - encourage personal autonomy and independence; and

    - help promote social cohesion, by binding people together in a system of mutual support.

    Redistribution between rich and poor will also be an overall aim - but...this should be measured not just by benefit receipt at one point in time, but also by the system of financing and the differential distribution of risks and contingencies."[7]

6. This is a debate which is an underlying theme of our report and one to which we return towards the end of our report.

How the National Insurance system works


  7. National Insurance benefits are funded by a system of compulsory contributions, paid by employees, employers and self-employed people.[8] Until April 2000, employees paid contributions of 10 per cent on earnings[9] between a 'Lower Earnings Limit' (currently £67 a

week) and an 'Upper Earnings Limit' (currently £535 per week).[10] These earnings limits are uprated in line with prices. Employers pay contributions of 12.2 per cent on employees' earnings above a threshold ('the Secondary Threshold') which is linked to the income tax personal allowance level.[11] There is no upper ceiling. Self-employed people pay a flat rate contribution,[12] plus a separate profits-related contribution.[13] Voluntary contributions are also possible to assist people to qualify for basic Retirement Pension and Widows' Pension.[14]

8. Employees' contributions entitle them to the range of contributory benefits, including Jobseeker's Allowance, Incapacity Benefit, Retirement and Widows' pensions. The flat rate contributions of self-employed people entitle them to all benefits apart from Jobseeker's Allowance.

9. Over 20 million employees each year pay some National Insurance contributions - though not necessarily sufficient to qualify for benefits - and employers' contributions are paid by over 1 million employers. Around 2.3 million people pay National Insurance contributions in respect of self-employment (some 300,000 pay both in respect of self-employment and employment). About a quarter of a million people were expected to pay Class 3 (voluntary) contributions in April 1999-2000.[15]

The National Insurance Fund

  10. All national contributions are paid into the National Insurance Fund, except for a small percentage which is allocated to the National Health Service.[16] In the year 1999-2000, net contributions received by the Fund are expected to be £50.4 billion[17]. The benefits due under the National Insurance scheme are all paid for out of the Fund. The National Insurance Scheme is financed on a pay-as-you-go basis, as Professor Disney of the Institute of Fiscal Studies explained:

    "although we have a contributory principle...there is no sense in which contributions are accumulating in a fund except in a book-keeping sense. Unlike, say, a personal pension or a stakeholder pension where contributions are accumulated and the fund, it is hoped, earns a rate of return and the amortised value of that fund is the pension, in National Insurance the money that goes in goes straight out to current beneficiaries on a pay-as-you-go basis.[18]

11. A working balance in the Fund is maintained because the Fund has no borrowing powers and because changes in the contribution levels in response to the needs of the Fund take time to implement. The Government Actuary has confirmed that it is prudent to plan for a minimum working balance of one sixth (16.7 per cent) of annual benefit expenditure.[19] In recent years the balance in the National Insurance Fund at the end of the financial year has grown to represent a substantially larger proportion of annual benefits expenditure. See Table 1 below. The actual surplus in the Fund - representing the accumulating excess of contributions over benefits paid out - stood at around £5.9 billion.[20]

Table 1

Balance in the National Insurance Fund at the end of successive financial years
Balance at 31 March
£ million
As a percentage of benefits payments
in previous financial year

12. Historically, the National Insurance Fund has been financed by three partners: individual contributors, employers and taxpayers, the latter through a Treasury grant. In 1981 policy began of gradually reducing the Treasury grant, leading to its abolition after 1988-89. The Treasury Grant was then reintroduced in a reduced form in 1993 because "this arrangement did not prove flexible enough to meet unexpected demands."[25] Since 1998-99, no Treasury Grant has been necessary to fund benefits. In 1999-2000, 44 per cent of contributions to the Fund were made by individual contributors and 56 per cent by employers.[26] If the structure of contributions remains unchanged in future years, it is expected that the proportion of the Fund financed by employers will increase. This is discussed further in paragraph 58.

13. In 1999-2000, £46.2 billion was paid out of the National Insurance Fund in benefits[27]. Figure 1 below shows the relative proportions of the National Insurance Fund which were spent on different benefits in that year. By far the largest proportion of the National Insurance Fund spent each year goes on retirement pensions.

Figure 1

Estimated payments from the National Insurance Fund for benefits 1999-2000[28]
*Other: Contributory JSA, £507 million; Christmas Bonus, £120 million; Maternity Allowance, £40 million; Guardian's Allowance and child's special allowance, £2 million.

Contribution conditions

  14. About 12.9 million claimants are at any one time expected to receive benefits financed from the National Insurance Fund.[29] Entitlement depends on satisfying the contribution conditions (as well as other conditions of entitlement) for the particular benefit. The contribution rules are complex, requiring the contributor not only to have paid contributions on a certain proportion of earnings, but also to have paid the contributions during a particular tax year, or, in the case of widows or retirement pensions, over a certain number of years of a working life.[30] For example, for a person on average earnings, it takes about nine weeks of earnings to achieve a qualifying year for pension purposes.[31] Professor Pete Alcock commented:

    "The amount of contributions you have to pay are still relatively complicated, in fact if you teach social security to lawyers and welfare rights workers you have to go through it about four times before they understand it and then you give them a little example to work it out and they all get it wrong. So in that sense it is very complicated."[32]

15. There is very little direct financial relation between what an individual puts into the Fund and what they get out. Most National Insurance benefits are paid at a flat rate whereas contributions are earnings-related. The Government Actuary commented: "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."[33]

Credits and Home Responsibilities Protection

  16. The contributory system is not wholly based on earnings; since the mid-seventies the qualifying conditions have been relaxed so that people can receive credits which supplement paid contributions and assist in qualifying for National Insurance benefits. About 10.5 million people each year are credited with National Insurance contributions.[34] Credits alone are not enough to earn entitlement to benefit; a person must also have worked and paid contributions on earnings in the relevant year. Credits are awarded in a variety of situations. They include credits for approved training; credits for people starting work after completing training or education; caring (if Invalid Care Allowance is in payment), unemployment (if satisfying the conditions for Jobseeker's Allowance), incapacity and maternity.[35] People in receipt of Working Families Tax Credit get credits for the purposes of SERPS (State Earnings Related Retirement Pension).[36] Professor Disney observed:

    "The extension of credits within the system [since 1975] has reduced the simple equation between being in work, contributing and benefit entitlement which the 1948 system entailed. The system is "contributory" only in a much broader sense than that envisaged by Beveridge."[37]

17. Home Responsibilities Protection was introduced to make it easier for people with certain caring responsibilities to qualify for the basic state Retirement Pension and Widows Pension. It works by excluding years of very low earnings and child care from the length of the working life over which the pension is calculated. There were 5.3 million people recorded as having Home Responsibilities Protection in 1995-6.[38]

Distinctions from other types of benefits

  18. National Insurance benefits can be contrasted with two other types of benefits, means-tested benefits and 'universal' benefits paid on the basis of certain contingencies. Means-tested benefits take into account a person's income and capital when assessing eligibility. They are paid out of general taxation. In 1999-2000, an estimated £32.1 billion was spent on means-tested benefits.[39] The third category is benefits subject to neither a contribution nor a means test, but dependent instead on satisfying a specified contingency, for example, having care or mobility needs (Disability Living Allowance or Attendance Allowance), caring for a person with such needs (Invalid Care Allowance) or having a dependent child (Child Benefit). In 1999-2000 an estimated £21 billion was spent on non-contributory, non means-tested benefits, funded by general taxation.

Distinctions from European social insurance models

  19. The National Insurance model in Britain differs in several respects from other models of social insurance in Europe. The key difference is that most European models (which vary considerably) are designed around the notion of wage-replacement and thus offer earnings-related benefits. The level of contributions paid has a direct relationship to the protection provided. In Norway and Finland, for example, flat rate basic benefits were supplemented, in most cases, by substantial earning related elements. In contrast, as Professor Alcock pointed out, the primary aim of National Insurance as originally devised by Beveridge "focussed on the prevention of poverty rather than the protection of wage levels."[40] Thus most benefits in Britain are paid at a modest flat rate, with the expectation that people with higher earnings will take out private or occupational social protection to protect their living standards.

1   See, for example, Sheila Lawlor, Ev p 15 para 1, Fran Bennett, Q. 178. Back

2   See TUC, Ev p 34 para 5. Back

3   Appendix 2 para 11. Back

4   Q. 1. Back

5   TUC, Ev p 33 para 4. Back

6   Peter Kellner, Evening Standard 24 May 1999. Back

7   Fran Bennett, Ev p 113 para 5.1. See also Disability Alliance, Ev p 87 para 2.1, and CPAG, Ev p 76 para 2.7. Back

8   A more detailed description of the rules governing the six classes of National Insurance is given by the DSS in their memorandum to the Committee, see Ev p 170-2. Back

9   There is a lower 'contracted out' rate of 1.6 per cent for employees who have opted out of the State Earnings Related Pension Scheme (SERPS) because they are in their employer's pension scheme. Back

10   Rates from April 2000. An additional 'Primary Threshold' (at £76 a week) has been introduced from April 2000 which has raised the earnings level at which employee contributions begin. This is discussed further in paragraph 22. Back

11   Currently £84 a week (from April 2000). Back

12   Currently £2 a week (from April 2000). Back

13   Profit-related contributions for self-employed people are currently 7 per cent of profits falling between £4,385 and £27,820 a year (2000-2001 rates). Back

14   Currently £6.55 a week (from April 2000). Back

15   DSS memorandum, Ev p 168 para 4. Back

16   The NHS allocation from employees' contributions is 1.05 per cent; from employers' contributions 0.9 per cent; and from the self-employed, 15.5 per cent of flat rate contributions and 1.15 per cent of profit-related contributions. National Insurance contributions meet between 6 per cent and 17 per cent of NHS costs at various times. See DSS, Ev p 176 para 54. Back

17   Table 2, Report by the Government Actuary on the drafts of the Social Security Up-rating Order 2000 and the Social Security (Contributions)(Re-rating and National Insurance Funds Payments) Order 2000, Cm 4587. Back

18   Q. 247. Back

19   National Insurance Fund Account 1998-99, HC 146. Back

20   Q. 349. Back

21   National Insurance Fund Account 1997-98, HC 130. Back

22   National Insurance Fund Account, 1998-99, HC 146. Back

23   Table 2, Cm 4587. Back

24   As above. Back

25   DSS, Ev p 176 para 50. Back

26   See Appendix 6 Cm 4587. Back

27   Figures from Appendix 4 Cm 4587. Back

28   Figures from Appendix 4 Cm 4587. Back

29   DSS, Ev p 168 para 4. Back

30   A detailed summary of the contributory conditions for the main National Insurance benefits is given by the DSS in its memorandum to the Committee. See Table 3 Ev p 177. Back

31   DSS Ev p 179 para 58. Back

32   Q. 22. Back

33   Chris Daykin, Q. 294. Back

34   DSS, Ev p 168 para 4. Back

35   DSS, Ev p 173, para 36 lists all the contingencies for which credits may be awarded. Back

36   Government Actuary's Department, National Insurance Fund Long Term Financial Estimates Appendix 1 Cm 4573. Back

37   Ev p 149 para 5. Back

38   DSS, Ev p 174 para 40. Back

39   DSS, Ev p 188 Annex C. Back

40   Ev p 2 para 2.4. Back

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