House of Commons - Treasury

Select Committee on Treasury Fifth Report

3 The Commission's proposals and other options

25. Having identified the main weaknesses of State and private pension provision in the United Kingdom, the Pensions Commission makes proposals to remedy those weaknesses. The Commission seeks to remedy the failings of the private pension savings market by the establishment of a new long-term savings vehicle. The Commission builds on the insight of the Sandler Review that "the inherent tendencies toward complexity in the savings market, and the consequent need to regulate the sales process, have made it uneconomic for the industry adequately to serve lower-income consumers",[62] an insight which remains valid today, in part because of the experience of Stakeholder pensions. The Commission's proposals are not intended for the lowest earners, who are protected to some extent by current State provision.[63] Equally, those proposals are designed to exclude those with employers that offer better provision than that proposed.[64] Lord Turner told us:

26. The Commission proposes to target these people through a new National Pension Savings Scheme (NPSS), which is intended to be a low cost, national DC pension saving scheme into which employees aged 21 and over without better occupational schemes would be automatically enrolled, with a right to opt out. The minimum contribution in respect of individuals in the scheme would be 8% of gross earnings between the Primary Threshold (currently £5,035) and the Upper Earnings Limit (currently £33,540). This would be composed of an employee payment of 4% of post-tax pay, effective tax relief or tax credit at around 1% and a matching employer contribution of 3%. The employer contribution would be compulsory where the employee remained auto-enrolled and made individual contributions, and it is estimated by the Commission that the compulsory contribution would add about 2% to the cost of employing the median earner.[66] Both employees and employers would be able to make additional, voluntary contributions up to a cash limit of twice the minimum contribution in respect of eligible employees, about 16% of relevant earnings.[67] The individual accounts created by contributions in respect of each participant would be managed by a single national body, probably established by statute for that purpose.[68] There would be a range of investment options available, but these would be limited in number and there would be a default fund available.[69] The rules on decumulation, including the broad requirement to convert amounts saved into an annuity, would be the same as for other pension schemes.[70]

27. The costs of the Scheme are intended to be kept markedly below the overall costs of existing market alternatives by three main factors. First, the national organiser of the Scheme would be the "bulk buyer" of administrative services and fund management in existing, competitive markets.[71] Second, the competitive sales process, with associated commissions, would be removed from the exercise. Third, it is intended that participation in the Scheme could be promoted and secured without the regulated advice which is required for many products in the competitive savings market. Lord Turner told us that this last approach built on the fact that individual decisions were already taken in the occupational pension scheme environment without regulated advice:

State provision

28. The Pensions Commission also makes proposals for reforms to the State pension system to underpin private saving. The Commission analyses the two-tier system as it has developed over the last twenty-five years, with various changes to the State Second Pension and its precursors and a Basic State Pension linked to prices, and concluded, in Lord Turner's words, that "British pension policy ... has been doing two things badly rather than one thing well. We have been doing a Basic State Pension which is getting more and more mean, and an earnings-related pension which has been salami-sliced so many times that nobody understands it."[73] The Commission's aim is to return over time to "focusing on doing one thing well, which is flat-rate pension provision".[74] There are five main components to the Commission's proposed reforms of State pensions:

to build on the current two-tier system and recent reforms by accelerating the evolution of the State Second Pension to a flat-rate pension by freezing the Upper Earnings Limit for accruals to that Pension in nominal terms;
to index the Basic State Pension to average earnings growth in the long-term, "ideally starting in 2010 or 2011 as the public expenditure benefit of the rise in women's State Pension Age begins to flow through";
to raise the State Pension Age gradually, broadly in proportion to the increase in life expectancy, for instance to 66 by 2030, 67 by 2040 and 68 by 2050;
to maintain the reductions in pensioner poverty achieved by Pension Credit, but limit the spread of means-testing by freezing the maximum level of Savings Credit payments in real terms (which implies that the lower Savings Credit threshold increases faster than in line with average earnings); and
to base future accruals to the Basic State Pension on an individual and universal basis—linked to residency—and improve carer benefits within the State Second Pension.[75]

The Commission forecasts that public expenditure on State pensions and pensioner benefits would rise from 6.2% of GDP in 2005 to between 7.5% and 8.0% by 2045 if its proposals were implemented.[76]

The rival options

29. Following the publication of the Second Report of the Pensions Commission, responses have focused particularly on the desirability and deliverability of the NPSS. Several rival options to that Scheme have emerged. There has been less extensive debate on the proposed reforms to the State system. Alternative proposals in this area "have come almost entirely from interest groups and experts who believe that the Commission should have argued for more radical and more rapid action to improve the generosity of the State pension, to simplify it, and to make it less means-tested, even if this implied a much more significant increase in the percentage of national income devoted to State pension expenditure".[77] For example, the Pensions Reform Group, led by the Rt Hon Frank Field MP, has proposed a Universal Protected Pension which would involve a higher Basic State Pension than proposed by the Pensions Commission and entail compulsory contributions for all in work. Lord Turner told us of some of his concerns about these proposals.[78] We have not considered the merits of these proposals by the Pension Reform Group, which go beyond the remit of our inquiry.

30. The first main option proposed as an alternative to the NPSS has been presented by the NAPF. Their proposal would involve the establishment of a number of Super Trusts run to protect the interests of members and with individual accounts for each member. The contribution levels and auto-enrolment arrangements of the NPSS would be reflected in the provisions for the Super Trusts. Employers who did not offer a superior scheme would be obliged to join a Super Trust, but the choice of Trust would be for the employer not the employee, who would also be constrained in choices relating to asset allocation. The NAPF is not wedded to a particular number of Super Trusts, although management charges would be expected to rise with a greater number of such Trusts.[79] Ms Farnish told us that the NAPF's approach would "be a more evolutionary one ... to build on more of what we already have".[80]

31. The second model proposed as an alternative to the NPSS is the ABI's concept of "Partnership Pensions". This seeks to build on the existing retail market model, but with many of the costs associated with the competitive market, including commission, marketing expenditure and the costs of regulated advice, removed.[81] The levels of minimum contributions in respect of employers and the arrangements for auto-enrolment would be carried forward from the NPSS proposals, but there would be a range of competing, licensed providers. The choice of insurance company provider would be primarily driven by employers, but with the possibility of individual choice override. Where the employer or employee did not choose a provider, one would automatically be allocated on the basis of a "carousel" similar to that already operating in respect of Child Trust Funds. There would be a wide range of asset choices. The ABI envisages a new economic regulator—the Retirement Income Commission—to monitor and promote the new system, and license providers.[82] As with the NAPF proposals, those of the ABI seek to build on the experience and expertise of current market participants.

32. In their written evidence to us, the Treasury and the Department for Work and Pensions stated that they were also considering a further model, which would use a national clearing house to manage and deliver the enrolment, reconciliation and collection functions, but with a competing market of pension providers.[83] Lord Turner told us that he had not discussed this model in detail with the Department for Work and Pensions, but he viewed it as closer to the retail model with competing insurance companies advocated by the ABI than to the wholesale model that he was advocating.[84]

Towards a consensus on auto-enrolment

33. Endeavours to promote long-term saving up to and including Stakeholder pensions have relied on a voluntary approach. Both the NPSS and the rival options proposed by the ABI and the NAPF involve a substantial move away from voluntarism towards automatic enrolment, but stopping short of compulsion, so that an individual employee stands to be included in a national system, but has the freedom to opt out.[85] The Pensions Commission, in their final Report, noted that

Lord Turner told us that he was generally satisfied with the response to the Commission's proposals, and particularly with the "very considerable across-the-board support for … the principle of automatic enrolment rather than going with either full compulsion or leaving it to entire voluntarism … as the appropriate way forward".[87] The Pensions Commission is to be congratulated for bringing about a broad consensus in favour of auto-enrolment as the basis for securing a major advance in the level of private pension saving among middle earners. A move to auto-enrolment is an essential precondition if the NPSS or any rival option is to be implemented.

62 Sandler Review, p iv Back

63 A New Pension Settlement, p 62 Back

64 Ibid, pp 36, 362-364 Back

65 Qq 194-195 Back

66 A New Pension Settlement, pp 7, 36, 355-356. The figures for the Primary Threshold and the Upper Earnings Limit are those for 2006-07, not those for 2005-06 given in the Second Report of the Pensions Commission: see www.hmrc.gov.uk/rates/nic.htm and www.hmrc.gov.uk/rates/it.htm. Back

67 A New Pension Settlement, pp 358, 360 Back

68 Ibid, pp 37, 402-403 Back

69 Ibid, pp 372-378 Back

70 Ibid, p 37 Back

71 Implementing an integrated package, p 10 Back

72 Q 211 Back

73 Q 223 Back