Memorandum submitted by the Pensions Reform
Group (PEN 67)
1. THE COMMITTEE'S
INQUIRY
The Committee is to be congratulated on conducting
this inquiry at such a crucial time for UK pensions. Through
their work, the Committee have the chance to shape how this country's
pensions system looks throughout the coming decades.
Pension provision in this country has strengths.
Occupational retirement provision, in particular, was the great
pensions success story of the last century. It has both contributed
to, and been a beneficiary of, the UK's highly developed financial
services and capital markets.
But the Committee's inquiry comes at a time
of unprecedented challenge for retirement provision. As has been
well documented, the coming decades will see very substantial
and unprecedented changes in the ratio of financial dependents
to the working population.
Demographic change is perhaps the most fundamental
of a number of challenges facing the UK system. This submission
is not the place for a detailed analysis of these, but the main
issues are worth listing briefly:
1. high levels of pensioner poverty that
are unlikely to decline much in the foreseeable future;
2. state retirement provision that is as
untrusted as it is poorly understood;
3. means-tested benefits that discourage
saving;
4. an occupational pensions sector that has
been the spine of UK retirement provision for several decades
but which, for a number of reasons, is set to provide substantially
less generous benefits in years to come;
5. a personal/stakeholder pensions sector
that, while sophisticated and offering choice, is unsuitable for
the task of providing a basic level of income above the state
pension;
6. a low savings ratio and, in particular,
very low levels of pensions saving;
7. the likelihood of lower real rates of
return on assets in the future; meaning that people will have
to save more than in the past for an equivalent standard of living;
8. a £15 billion system of tax reliefs
that fails to persuade large numbers of those on modest and low
earnings to save.
2. THE PENSIONS
REFORM GROUP
The Pensions Reform Group (PRG) was brought
together under the chairmanship of Frank Field to propose sustainable
pensions reform that would eliminate pensioner poverty.
Pages 7 and 8 of the report Universal Protected
Pension: The Follow-Up Report detail both the membership of
the Group and the process by which the conclusions have been reached.
The original PRG includes experts such as Tom Ross, who chaired
the Government's Pension Provision Group, and Kate Barker, now
of the Bank of England's Monetary Policy Committee.
As well as this original group, three working
parties were invited to examine key aspects of the proposals.
Again, these groups contained some of the UK's leading experts
on pensions and investment including Paul Myners, who undertook
the review of institutional investment for the Treasury, Sir Steve
Robson, a former Second Permanent Secretary at the Treasury, and
Roger Urwin of Watson Wyatt, who is one of the UK's foremost global
investment consultants.
3. THIS SUBMISSION
This paper forms one part of the submission
by the PRG. The report by the PRG, Universal Protected Pension:
The Follow-Up Report, forms the remainder, and gives much
more detailed information on the central proposal of the group—the
Universal Protected Pension (UPP).
There is now a growing consensus that resolving
many of the problems listed above requires a higher level of first-tier
pension. In addition to the PRG, variations on this theme have
been promoted by the National Association of Pension Funds, the
Trades Union Congress, and the Institute for Public Policy Research.
A significantly increased first-tier pension
could potentially address all but one of the eight pensions challenges
listed above. But although there is a growing consensus around
this solution, there remain differences of opinion with respect
to:
1. the design of the scheme to deliver this
improved pension;
2. the level at which the pension should
be set.
In the report Universal Protected Pension:
The Follow-Up Report, the PRG set out five principles around
which a major reform could be built. The remainder of this paper
looks at these in more detail. We hope that the Committee will
consider these principles carefully and that they might be used
to help guide both the Committee's deliberations and its final
report.
4. FIVE PRINCIPLES
FOR REFORM
1. A Pension of 25-30 per cent of National
Average Earnings throughout Retirement
A fundamental question the Committee should
investigate is: why have a state pension? The PRG's answer to
this is: so that everybody ending a working life—or those
who have qualified through, for example, caring for others—is
guaranteed an income above the poverty line throughout retirement.
The current state system fails to achieve this, and even with
the growth in entitlement to SERPS/State Second Pension will continue
to fail to meet this fundamental objective.
The latest official statistics suggest that
a pensioner couple with a combined net income below £176
per week or a single pensioner with an income below £107
per week would officially be classed as living in poverty[192].
On this basis roughly a fifth of pensioners are living in poverty.
The PRG's view is that a pension at this level, indexed to earnings
in retirement so as to keep recipients above the poverty line,
should be the minimum first-tier provision.
Some recent contributions to the pensions debate
have suggested a level pitched just below this in line with the
Minimum Income Guarantee. This would remove much of the disincentive
to save in the current system, but a closer analysis of pensioner
incomes reveals that disincentives extend above the Minimum Income
Guarantee due to help with other costs of living including Housing
Benefit and Council Tax Benefit. Moreover, the PRG believe that,
as a fundamental principle, the universal contributory pension
in return for a lifetime's contributions should be more generous
than the means-tested safety net.
The PRG therefore suggest that an earnings-indexed
pension of between £120 and £140 per week is a realistic
and affordable target. The Committee should note that while this
pension as set out by the PRG is based on a 2 percentage point
increase in employee National Insurance contributions and that
other contributions to the debate have suggested that their schemes
are "revenue neutral", such proposals have invariably
assumed a reallocation of resources away from planned expenditure
on schemes such as the Pension Credit, whereas our proposals make
no such assumptions. Our feeling is that Committee's inquiry
will be a much greater stimulus to positive change if it acknowledges
that better pensions will cost more, and then concentrates on
the principles of reform rather than the minutiae of various proposals.
In the course of their inquiry the Committee
will hear evidence from those favouring compulsory contributions
to personal or stakeholder pension type contracts. The PRG believe
that this approach is misguided.
To compel people on low to moderate incomes
to contribute into a defined contribution pension on top of their
Basic State Pension will lead to most of the income needed to
enjoy an acceptable standard of living being at the mercy of the
stock market. We have seen recently how sudden stock market falls
can ravage individuals' funds. Of course a collective fund would
suffer too, but the size of large fund enables a fall in the market
to be offset by increases at other times; the result being that
no matter when individuals retire in the business cycle they will
get the defined benefit they expected. The crucial point is that
individual pots create what is effectively a random process of
winners and losers and that this is only acceptable for income
that is not necessary for a minimum standard of living.
A system along these lines is in operation in
Chile and has previously been the subject of inquiry by the Social
Security Select Committee. The current Committee could usefully
return to one of the main conclusions of that inquiry which was
that when the Government compels people to contribute it must
take some responsibility for the outcome—as it does under
the existing arrangements with the Basic State Pension and SERPS/State
Second Pension.
2. Redistribution
It is a simple fact that those with low average
levels of income throughout their lifetime cannot afford to save
enough for a decent pension. This fact is acknowledged implicitly
by the redistribution in the Basic State Pension and the State
Second Pension. The Universal Protected Pension offers redistribution
through a flat rate pension in return for earnings related contributions.
This is not to say that those on low incomes
cannot save. Members of the Committee will know from their constituency
experience that this is not so. However they will recognise that
currently the poor face a very high savings hurdle if they are
to improve on benefit levels of income in retirement, and that
many simply cannot afford to clear this hurdle for quite legitimate
reasons.
In the course of their inquiry the Committee
will hear from those claiming to be against further compulsion
and those arguing in favour. The Committee would do well to weigh
these arguments carefully given that as a result of the rapidly
increasing expenditure on means-tested benefits we have increasing
compulsion in the current system. The Committee might like to
further consider whether in the long-term compulsion to pay for
means-tested benefits and/or very significant incentives to save
is less sustainable than compulsory contributions to a pension.
3. Universal Membership
Our five principles for reform are interlinked.
A pension of 25-30 per cent of national average earnings implies
redistribution which in turn implies compulsory membership. Redistribution
would not be sustainable if those on higher incomes were not in
the scheme.
It is the universality of the Basic State Pension
that is responsible for its considerable public support. Because
it is universal it is well known by the public and has a broad
coalition of voters to uphold it. If a pension covers only the
poor, as with the State Second Pension, it is likely to be more
vulnerable to attacks by politicians.
The PRG believe that building a more generous,
sustainable first-tier pension will require universal membership.
One of the issues the Committee will have to consider is how
rapidly any such reform encompasses the working population. Further
discussion of the possible ways of rolling out a new reform is
to be found in Universal Protected Pension: The Follow-Up Report.
4. Independence from Government
A lack of trust is now a dominant characteristic
amongst public attitudes to pensions. This climate of distrust
encompasses Government, employers and private providers. The Committee
would do the country a great service if they considered both whether
the reforms suggested to them are viable given this distrust and
whether they do anything to help break it down. Given the low
standing of the state on pensions issues, crucial to the success
of any reform will be the extent to which it is not seen as "just
another Government scheme".
How pensions reform might break through this
ever-more formidable barrier was a central concern of the PRG's
deliberations. We came to the view that a new structure needs
to be put in place that is neither the state, nor an employer,
nor a private provider, but which borrows the necessary or best
aspects of all three.
We suggest in Universal Protected Pension:
The Follow-Up Report that the UPP will be at arms length from
the state and will be governed by a structure of "democratic
trusteeship".
The challenge was to find a structure that both
provides expert trustees and allows members a genuine say in the
running of their scheme. Our suggestion is for trustees to be
nominated by an appointed board of governors. These nominated
trustees would then be put to the membership for approval or rejection.
Of course, at the limit no Government can bind its successors
and nor should there be a bar to a democratically elected Government
changing these arrangements. But this fact of sovereignty is
in no way incompatible with a recognition that the timescale involved
in pension planning requires structures removed from day-to-day
politics.
One of the great successes of the Government
during the last Parliament was the granting of operational independence
to the Bank of England's Monetary Policy Committee (MPC). One
result has been greater public understanding of the setting of
interest rates. The MPC has shown that a body established by
the state to perform a task of fundamental economic importance
can do so with independence from the state. Although the nature
of the work would be quite different, we believe that the governance
structure proposed for the UPP would lead to a similarly respected
decision making body.
Restoring trust in pensions will require a more
widespread understanding of what a pension fund is, and how it
goes about trying to achieve its goals. A governance model along
the lines suggested above could frequently engage people with
the running of their national pension scheme and thereby both
engender a sense of ownership and control and greater financial
awareness in general.
5. Funded
Accrued pension rights are a claim on future
national income or wealth. There are risks attached to both funded
and pay-as-you-go pensions. It is a sensible diversification of
risk that total retirement provision should be a combination of
the two.
With this is mind the UPP delivers 25-30 per
cent of national average earnings throughout retirement through
a combination of the Basic State Pension and a new funded element.
As well as diversifying risk, funding gives
the opportunity for greater returns, especially through investment
in markets with higher rates of economic growth.
Finally, funding reinforces the arms length
nature of the scheme. The trustees of the UPP will be charged
with appointing fund managers to invest members' contributions.
5. TWO APPROACHES
TO REFORM
As stated earlier, there is now a growing body
of informed opinion that as a country we need a simplified pensions
framework centred on an improved universal first-tier pension.
The Pensions Reform Group's proposals are located
within this body of opinion but are distinctive in that they advocate:
1. a pension set somewhat above the poverty
line and above the level at which means-tested assistance is paid;
2. a governance structure that ensures independence
from Government as a way to improve both the scheme's viability
and the public's trust in it;
3. an element of funding as a way to diversify
risk, improve investment opportunities, and increase protection
from political attacks.
As the Committee reviews the evidence for and
against an improved first-tier pension we very much hope it will
keep these points in mind and offer their expert opinion on these
proposals.
Rt Hon Frank Field MP
Chairman
November 2002
192 Household Below Average income 2000-01, Department
of Work and Pensions. Back
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