Select Committee on Work and Pensions Minutes of Evidence

Examination of Witnesses (Questions 124 - 139)




  124. May I welcome Mr Peter Robinson, who is a senior economist at the IPPR, with Mr Richard Brooks who is a researcher at IPPR? You are both very welcome. You are joined this morning by Mr John Hawksworth, who is head of the Macroeconomics Unit at PricewaterhouseCoopers. Gentlemen, welcome and thank you for your help so far. I see from my morning papers that you have been busy and we look forward to reading that very detailed and very interesting piece of work, which you have published this morning. Why do you not just say a little bit about IPPR and the work you and Richard do and then I can invite John Hawksworth to do the same. We have a really long list of technical questions we should like to try to sprint through, if we may. I am interested to make sure that you get a chance to say everything you want to say this morning and you get time to say it. Why do you not start off by introducing what you are doing? It is the same introductory question that I put to Andrew Dilnot. What are the upsides and the downsides that you see in the Government's proposals?

  (Mr Robinson) As people are probably aware, given the media coverage this week, the IPPR has produced a major report on the funding of pensions and long-term care. Richard and myself are two of the three co-authors of that report with our colleague Sue Regan. John Hawksworth from PWC has been working with us in trying to help us develop our ideas and John specifically wrote a paper for us modelling different options for pension reform, which PricewaterhouseCoopers have published separately but which we shall also be publishing as part of a technical report to accompany our main report. The obvious thing to stress is that it is impossible to think about a specific part of the pension system such as Pension Credit without looking at the whole pension system, both public provision and private provision. We have to think of the interactions between the different parts of the pension system. In terms of the Pension Credit, in terms of means testing, we signal in our report that we have no problem with means testing in principle. However, we think that there are four significant problems with the application of means testing to retirement income. What was interesting for us was that the first issue was that from our qualitative work it is clear that people out there believe there is a difference between means testing in retirement and means testing during the working life. If you are a family with children getting some extra help from the Working Families Tax Credit, you see that as a useful extra supplement to your income. If you are a pensioner facing means testing, you see this as an imposition as the Government are taking away a bit of the saving you have worked hard to accumulate. There is an equity issue about how people perceive means testing in retirement which we have to be aware of. The second issue of course is the issues around the incentives to save, which Andrew Dilnot and Tom Clark from IFS addressed earlier in the session today. The third key issue is take up which has also been discussed. Between one fifth and one third of people currently entitled to the Minimum Income Guarantee do not take it up and there have to be concerns about whether take up of the Pension Credit will improve or not. So long as a large chunk of people entitled do not take up means tested entitlements, you will continue to have a pensioner poverty problem. The other issue which has also crept into the discussion so far is the complexity issue. We think that the whole pension system rather fails the doorstep test. If members of your Committee attempt to explain the pension system on the doorstep to individuals, it is not clear that lots of people really fully understand that system and see it as the basis on which they can plan for their own provision in retirement.

  125. I am tempted to ask the same last question I put to IFS in terms of modelling. Has Mr Hawksworth done some modelling? Would there be anything you could help us with in trying to calculate using the Government's own first scenario? What percentage of the general population would be included come 2025 and 2050? Is this something you might be able to help us out with?
  (Mr Hawksworth) In terms of general population?

  126. Yes.
  (Mr Hawksworth) We could calculate the percentage of the pensioners. In terms of the pensioner population the model suggests that by 2050 it would be somewhere between 65 and 70 per cent under their scenario one; by 2030 it would be about 60 per cent, give or take a few per cent. It is not a precise calculation. So in fact quite similar to the figures the Government produced. Strictly speaking that is for single pensioners; it might be slightly lower for pensioner couples.

  127. We should be very interested in anything you have to answer that kind of question. Maybe we could arrange for a note to come to the Committee on that.
  (Mr Hawksworth) Yes, we could write a short note.

  Chairman: That would be extremely helpful.

Andrew Selous

  128. I want to focus on the incentives to save. I am going to address my first question to John Hawksworth, if I may. We know that the marginal rates of tax on savings will fall for some savers under the Pension Credit proposals. In your memorandum you said that the effect on savings would be unclear. Can you elaborate on that?
  (Mr Hawksworth) It is really for precisely the reasons that Andrew Dilnot gave and I would just be repeating exactly what he said, which I totally agree with, that different groups of savers would face different effects. Let us take the 2003-04 numbers, with total non-means-tested incomes between £77 a week and £100 a week for a single pensioner. They would clearly go from 100 per cent to 40 per cent and they would therefore have more incentive to save. For those people between £100 and £135, they would go from 0 per cent to 40 per cent and therefore would have less incentive to save compared with what would otherwise be the case. That is the price effect, sometimes called the substitution effect. There would also be an income effect, whereby if they were going to get more income because of the Pension Credit, that might mean they would decide that they did not need to save so much. Obviously people are not human computers who are going to be churning out these calculations day by day and making their decisions. Therefore it may be that as they get closer to retirement, they would begin to get an idea of whereabouts in the income distribution they would fall and these effects would begin to come through a bit more in terms of their decisions.

  129. May I ask Richard Brooks and Peter Robinson whether they would like to add anything to that or do you fundamentally share John Hawksworth's views on that?
  (Mr Robinson) We share John's views completely.

  130. Last week the Committee heard from the ABI and they identified three groups that they were concerned about as far as savings were concerned: those without a full Basic State Pension; the self-employed; and those with small amounts of savings. Would you agree with the ABI's concern for those particular three groups? Are there any other groups you would add to that list?
  (Mr Brooks) One of the groups which will remain facing the 100 per cent withdrawal rate under the new Pension Credit will be women between the age of 60 and 65, although we understand that is a transition issue until women's retirement age equalises with men's.
  (Mr Robinson) In terms of the three groups you identified: yes, obviously problems will persist for people who have not accrued full entitlement to the Basic State Pension, although that problem ought to be ameliorated over the medium term as more and more women in particular begin to accrue fuller entitlement to the Basic State Pension. The self-employed, yes, that is a concern too because their building up of State Pension entitlements generally is less secure than for the employee population. The Government's Pension Credit is designed to try to help those with small savings in the way that Andrew Dilnot has described, so that is clearly a group the Government's reform should assist. There are other groups which will not benefit as much.
  (Mr Hawksworth) The ABI was making quite a technical point about those with small savings, about the fact that it was not so much they would not gain but the rate of return could still be relatively low once you took into account other potential effects. They have proposed that there could be an initial disregard in terms of a small amount of savings income, which would not actually be hit even by the 40 per cent. In other words the Pension Credit makes it better for the small savings because you go from 100 to 40, but you still have that 40 and once you take into account that the rate of return on quite a small investment may not be worth while. So you could have a small disregard as for earnings where there is a small disregard. Obviously that would cost the Government money. I do not know how much it would cost. You would have to ask the DWP. It is a question as to whether or not they think that it is worth spending another something of the order of £100 million type figure in order to introduce that small savings disregard into the system.

  131. Are there other ways that you think savings could be better encouraged, which have not yet been looked at in this area?
  (Mr Robinson) We think the best way to encourage savings would be a dramatic simplification of the overall State Pension system. That is what we discuss in the report which has been published this week. We do not think there is much you can do further within the current system, given its complexities.

  Chairman: I should like to come back to that later on.

Rob Marris

  132. We talked to the ABI, who were concerned because of the complexity issue, the doorstep issues—I have to say they talk of little else on the doorsteps of Wolverhampton—that their pension advisers, their member groups, would have difficulty in deciding what would be appropriate advice to someone, particularly a younger person now, but anyone below pension age, as to what to do about savings. Do you have any comments on how that might be clarified for their advisers who are in a sense going to be trying to flog policies to people to encourage them to save, which is what we are talking about?
  (Mr Hawksworth) All I would comment is that I am glad I am not an independent financial adviser having to advise on this because it is phenomenally complicated now to make a decision for someone on moderate income whether to go for a stakeholder pension, for example, or whether to contract out of the State Second Pension. That calculation can now depend on so many imponderables about the precise life history of that person from that point on, the precise return on investment, the precise annuity rates at retirement, whether they were allowed flexibility on those annuity rates, all sorts of other things that any kind of advice you would have to give would have to be caveated extremely heavily. There is certainly a concern that it is making their job very difficult for people in the target group for stakeholders.
  (Mr Robinson) The single biggest advice problem is the decision about whether to contract in or out of SERPS, or the State Second Pension. That is an issue I take professional advice on before making a decision. It is an almost impossible decision for many ordinary people to make without professional advice. Of course with the stakeholder regime, it is very difficult for organisations to provide advice on those kinds of issues. What has been interesting to see over the last year is how far the financial services industry has in a sense rolled back in believing that it can no longer advise very many people to contract out any more. We shall probably see a drift back to contracting in to the State Second Pension scheme.
  (Mr Brooks) There is also a very real question about being able to advise people with very low incomes whether to save at all, additionally to that saving which they are compelled to do through their National Insurance contributions. As we have heard from many of the people who have submitted evidence to this Committee, some of those people face very high benefit withdrawal rates as a result of making their own provision. Whilst it may be technically true that under the new system, under the proposed Pension Credit, it will always pay to save in that your income will be higher having saved in retirement than it would be had you not saved, there is a very real worry over what the return on your savings will be and whether it always pays to save; it may be seen as a misleading statement in that people may see very poor returns on their savings despite the fact that their income will in fact be higher. Advisers are certainly concerned that they may be accused of allowing people to mis-buy financial products, to mis-save as a result of that advice.

  133. Do you think that financial advisers, if we are trying to get them to be able to advise people in that lower income group, are going to start advising people to use different saving instruments, for example ISAs rather than, subject to what you said, pension schemes so that they can at least spend the capital in their retirement, which you cannot with an annuity based system unless the Private Member's Bill goes through?
  (Mr Robinson) The problem is that they are going to have to hedge everything they say so much.

  134. They do that anyway.
  (Mr Robinson) They are probably going to create as much confusion for their potential customers as clarity because they cannot offer clear advice. They have to say, "If you do this, the consequences could be X, Y, Z. If you do this, the consequences could be A, B, C". It is very difficult for them to give clear advice, given the whole way in which the State Pension system interacts with private savings of various kinds. That is why the pensions industry is coming around to viewing a dramatic simplification of the whole system as a first order priority for them.

  135. So they can advise.
  (Mr Robinson) Yes.

Mrs Humble

  136. Picking up a point you made about the State Second Pension, may I ask you the question which has been asked of other people who have given evidence to us? How do you see the new Pension Credit interacting with the State Second Pension?
  (Mr Robinson) Once the whole system has matured someone who works their entire life making contributions to accumulate rights to the State Second Pension will retire on a combined income from their State Second Pension and Basic Pension, which is below the level of what we now call the MIG. They will automatically fall into means testing from day one of retirement, which makes you question what the State Second Pension is for.

  137. Does it also make you doubt the role of the Basic State Pension as the foundation of our pension system?
  (Mr Robinson) Yes. If you continue to price index the Basic State Pension, it continues to fall in relation to average earnings down to 7 per cent or less by the middle of the century, it is very hard to see how one can then continue to regard that as the bedrock on which other pension provision is made.
  (Mr Hawksworth) Just to give some figures, we are talking about the MIG, if it is earnings indexed, which is current Government policy at least for this Parliament and probably an aspiration beyond that, it stands at 21 per cent of average earnings. The Basic State Pension, depending on exactly what you see about real earnings growth, will probably go down by 2050 to 6 or 7 per cent of average earnings. The mature State Second Pension in its second stage flat rate will probably give you, according to some calculations, about 11 per cent of average earnings. You will be talking maybe at best about 17, 18 per cent of average earnings therefore compared with the 21 per cent falling 3 to 4 per cent of average earnings below the MIG. That obviously was not the original intention. The State Second Pension was meant to raise people above the MIG, but by making the MIG more generous, you inevitably fall into that situation which is may be why Mr Dilnot was making some of the comments he made about the tensions within the current system.

Ms Buck

  138. The estimates which have been made, the DWP's and indeed your own, about the cost of the Pension Credit. Obviously you accept that there has to be a wide range of target figures because it is based on assumptions particularly about the take-up of private pensions. What assumptions have you made, what assumptions have you built in to your calculations and are these the same as the Government's?
  (Mr Hawksworth) Not exactly. They are detailed in a paper which I sent to the Committee three weeks ago and also to some extent an earlier paper I wrote in December 2000. Effectively we assume that productivity growth in the economy is 2 per cent per year. That is a typical trend rate; the Treasury typically assumes that. Therefore real earnings growth is the same as productivity growth in line with the assumption that labour share of national income remains constant in the long run. We then made certain assumptions about employment rates, which effectively come down to saying that the average employment rate per age group, averaged across men and women, will stay broadly constant over time, except for some assumed increase for women between 2010 and 2020, for older women, as a result of the increase in state retirement age. That then generates a series of numbers for GDP growth. Broadly speaking, on average over time, GDP growth is about two per cent over the whole period, slightly higher initially, slightly lower later. It also generates, using the Government Actuary's Department's population projections, a figure for the ratio of workers to pensioners. This is the key figure. At the moment we have about two and half workers per pensioner. By 2040 it will be about 1.75. Now we have 10 workers to provide for every four pensioners where in future we might have seven. That will flatten off after 2040 as the baby boom retirement bulge works its way through the system. Fundamentally that is the issue, that is what drives the numbers. We then assume in our main case that the MIG or Pension Credit guarantee is linked to earnings so it goes up by 2 per cent in real terms. The Basic State Pension goes up in line with prices; effectively policy scenario one here which seemed to me most plausible when I originally read the DWP paper. We also assume certain things about the income distribution going forward. We assume that pensioners on lower incomes will have a higher than average increase because of the State Second Pension and we assume that pensioners at the very top of the income scale will tend to have a higher than average increase in line with historic trends. Pensioners in the middle will have a broadly average increase in their incomes over the Basic State Pension

  139. What about the assumptions about private pension take up, in particular, to set that in context, the point about the estimate that 70 per cent of all pensioners will be entitled to the Pension Credit?
  (Mr Hawksworth) Up to 70 per cent; 65 per cent.

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