Select Committee on Work and Pensions Fourth Report


4  STATE PENSION REFORM: THE BASIC STATE PENSION

Introduction

182. When the Pensions Commission was set up in 2002, it was with the remit of keeping the "regime for UK private pensions and long-term savings" under review and to recommend whether there was a "case for moving beyond the current voluntarist approach."[251] However, the Commission determined that the "bewildering complexity of the UK pension system" acted as a barrier, among other things, to the success of a voluntary pension saving system. In particular, it concluded "means-testing within the state system both increases complexity and reduces, and in some cases reverses, the incentives to save via pensions."[252]

183. The Commission's Second Report, therefore, recommended that "reforms to the state system [were] needed not only to address the significant gaps in provision for people with interrupted careers and caring responsibilities, but also to create a more understandable, less means-tested platform on which individuals and employers can build private provision."[253] In evidence to the Committee, the Secretary of State endorsed this approach.[254]

184. The Commission suggested that the state pension (BSP and S2P) should ensure a minimum income level. Earnings-related provision, on top of this, would be encouraged through auto-enrolment in the new system of personal accounts. Its view was that the introduction of the State Earnings Related Pension Scheme had not been accompanied by a "consensus in favour of the significant growth in public expenditure" which would inevitably result.[255]

185. The Pensions Policy Institute commented that the broad construct of the Commission's approach was in line with "the consensus among pensions experts that has emerged in the last year or so."[256] The majority view of pensions experts was that the "currently muddled view of the state's role in pension provision should be clearly delineated", so that it had two distinct responsibilities: "to deliver better on the one role that only the state can do - poverty prevention" and "to enable and incentivise the private sector to do what it does best - provide earnings-related pensions on a voluntary basis."[257]

186. Support for this approach is not, however, universal. Tony Lynes, in recent years adviser to the National Pensioners Convention and pensioners' groups in Southwark, argued that "the Commission has failed to produce convincing arguments for abolishing state earnings-related pensions, to explain why the earnings-related S2P cannot or should not be maintained and improved, or to compare the cost with that of the alternative it proposes."[258]

The Pension Commission's proposals

187. In order to meet its proposed objectives, the Commission recommended: [259]

  • Accelerating the evolution of the State Second Pension (S2P) to a flat-rate system (in order to concentrate resources on "the provision of as generous and non-means-tested, flat-rate provision as possible."
  • Over the long-term, linking the value of the Basic State Pension (BSP) to earnings and freezing in real terms the maximum amount of Savings Credit payable. "This would stop the spread of means-testing which would occur if present indexation arrangements were continued indefinitely."
  • Moving accrual of future Basic State Pension rights onto a residency basis. "This would ensure that all people, including those with interrupted paid work records and caring responsibilities, can be certain of a significant floor of non-means-tested state provision."

The Government's proposals

188. The Government's White Paper followed the Commission's broad approach to state pension reform, although there are differences in the details of the proposals (see, for example, paragraph 16).[260] We decided that the key questions to consider regarding the state pension reform proposals set out in the White Paper were:

  • whether they went far enough in reducing means-testing;
  • arrangements to re-link the Basic State Pension to average earnings;
  • the implications of the proposed measures to improve coverage of state pensions; and
  • whether it was right to reject alternative proposals to move more quickly to a simpler, flat-rate pension.

The level of the Basic State Pension and restoring the link to earnings

189. The White Paper proposed that the level of the Basic State Pension should in future be re-linked to earnings. As a result, by 2050, it "could be worth twice as much as if it had been linked to prices."[261]

190. The principle that the level of the Basic State Pension should be linked to earnings received widespread support.[262] As the White Paper stated, it will help people to "predict with confidence what they are likely to receive from the State when they retire."[263]

191. However, it was also pointed out that the level of the Basic State Pension would remain low. Sally West of Age Concern told us that "when you talk about a more or less generous system, we have to be aware that we are not talking about a very high level of basic pension."[264] In evidence to the Treasury Select Committee, Lord Turner commented that "our proposals for the state pension, whatever the debates about affordability, would still leave the UK with one of the meanest and most Basic State Pension systems in the OECD."[265] A number of witnesses argued that, as well as restoring the earnings link, a significant increase in the Basic State Pension was needed.[266]

192. Moreover, the White Paper proposes restoring the link to earnings at a later date than the Commission. While the Commission said this should ideally be in "2010 or 2011 as the public expenditure benefit of the rise in women's SPA begins to flow through,"[267] the White Paper says that: [268]

    "Our objective, subject to affordability and the fiscal position, is to do this in 2012, but in any event by the end of the Parliament at the latest. We will make a statement on the precise date at the beginning of the next Parliament."

193. There was some support for this sort of flexibility, with the CBI arguing that "any link with average earnings must be reviewed in the light of economic circumstances."[269] A number of witnesses, however, expressed concern at both the delay and the element of uncertainty. Age Concern said: [270]

    "we are concerned that the link will not be restored for at least 6 years. The intention is that this will happen in 2012 but as the commitment is to do this by the end of the next parliament in theory this could be as late as 2015. Every year the pension is not linked to earnings it will continue to lose its relative value. For future pensioners the platform on which to build up savings will be lowered while current older people will see the value of their pension fall each year."

194. The Secretary of State explained the reasons for the Government's position: [271]

    "on affordability grounds it saves extra money for the taxpayer, and we should not discount that […] Secondly, I think it does make sense, as far as possible, to tie the restoration of the earnings link with the introduction of the National Pension Saving Scheme, the personal accounts. Turner thought we could do personal accounts in 2010. I think that is very optimistic."

195. The Pensions Commissioners considered that "the delay to 2012 represents an acceptable compromise given affordability concerns. But a longer delay could undermine the balance of the overall policy package"[272] because "the less progress that is made towards the abolition of means-testing, the higher the minimum employer contribution would need to be."[273]

196. The Secretary of State agreed that a delay beyond 2012 was "not desirable."[274] However, he added "it is only sensible and reasonable for the Chancellor, nearer the time, to make an express judgment about the timing of this change, because I think that is the only sensible way that any government can manage public spending, looking ahead over six years."[275]

197. The Committee questioned, however, what action the Government would take if, having assessed the position, it considered the re-link to earnings to be unaffordable at the end of the next Parliament. Which would come first, "the affordability question or the importance of making sure these reforms are not put at risk?"[276] The Secretary of State said that "affordability" would come first[277] but added: [278]

    "It is not going to be unaffordable and we have made it very clear […] We believe it is going to be affordable in the next Parliament; so the premise on which your question is based simply does not arise."

198. In response to a request from the Committee, the Department provided figures to explain the cost of restoring the earnings-uprating of BSP from 2010, 2012 and 2015 (see Table 1).

Table 1: Cost of earnings-uprating the BSP from…

   200820092010 201120122013 201420152020 203020402050
…20100.00.0 0.51.11.8 2.43.03.7 7.119.936.3 50.3
…20120.00.0 0.00.00.6 1.21.82.4 5.617.733.3 47.0
…20150.00.0 0.00.00.0 0.00.00.5 3.514.529.1 42.1


Source: Department for Work and Pensions

All figures in £ billion, 06/07 price terms.

The table contains the additional costs of reforms to the Basic State Pension over and above the current (price-uprated) system. It includes earnings-uprating the BSP, coverage measures from 2010, and abolition of ADIs from 2010. Savings from increasing State Pension Age are excluded.

The reforms proposed in the White Paper are a complete package, and varying one aspect may require others to change too.

These costs assume that the only change is the date of earnings-uprating the BSP, with everything else held constant.

All other footnotes as per Figure 9 of the White Paper apply.

199. Restoring the BSP earnings link (together with measures to increase coverage of the State Pension and the abolition of Adult Dependency Increases) in 2010 would cost £50.3 billion in 2050 in 2006-07 prices, compared to £47 billion if it was restored in 2012. Delaying the restoration of the link to 2015 would cost £42.1 billion. There is a relatively modest impact on the proportion of pensioners entitled to Pension Credit in 2050: 28% if the link is restored in 2010, 29% if it is restored in 2012 and 32% if it is restored in 2015. [279]

200. The Committee welcomes the decision to re-link the Basic State Pension to earnings but is concerned by the inconsistency between the unequivocal statement that the link will be re-established by the end of the next Parliament "in any event" and the Secretary of State's statement that affordability will come first. We ask the Government to clarify this. In our view, the link should be restored as soon as possible, and certainly no later than April 2012.

Increasing coverage

201. A previous Secretary of State, the Rt Hon Alan Johnson MP, commented to our predecessor Committee that "My enthusiasm has not waned for tackling a real and substantial problem which is that women's pensions are, in a sense, a national scandal."[280]

202. The Pensions Commission recommended "moving BSP accruals looking forward onto a universal basis, with a residency test."[281] The aim was to address the fact that women will, for many years, "be less likely than men to enjoy a full BSP in their own right." While it considered that some of the "problems and gaps" could be addressed by making "changes to the current system", others could not. One key problem, for example, was where a person earned "less than the Lower Earnings Limit (LEL)) on any one job" and therefore did not accrue BSP entitlement. This was "difficult to fix without more significant system changes."[282]

A RESIDENCE TEST?

203. Witnesses to the inquiry were divided on the merits of a residence test. Those who supported it stressed its role in providing certainty as regards what people could expect from the state in the future. The Equal Opportunities Commission and Help the Aged, for example, stressed its importance in giving women, in particular, confidence in being able to accrue "a full BSP, and thus have a strong and secure platform upon which to build their private saving."[283] IPPR stressed its potential to simplify the pensions system.[284] Others emphasised the importance of improving coverage for those already retired and suggested this might be easier to achieve through a residence test.[285]

204. As noted in the White Paper, a residence test does not necessarily provide universal coverage. A long-term residency test (for example, where pension entitlement is pro rata to a working life of 45 years) would minimise the entitlement of those with "little connection to the UK" but would "not necessarily improve outcomes."[286] The White Paper set out the Government's reasons for preferring to retain the contributory system.

205. The Secretary of State said in oral evidence "I believe very, very strongly, and the Government does, that the contributory principle, which has always been at the heart of the State Pension system in this country, is the right one. It is the one that commands overwhelming public support and we should stick with it."[287]

206. However, as the National Association of Pension Funds pointed out, at the National Pensions Day organised by DWP, "half of the participants agreed that years living in the UK, regardless of what the individual was doing (i.e. working or not), should count towards the Basic State Pension. Just over one third (35%) disagreed with this." [288] Mervyn Kohler of Help the Aged said that "you generally get the impression that the contributory principle is important for men and you very seldom get it from women."[289]

207. It could be argued that the 'contributory principle' is weakened by the reduction in the number of years required to qualify for a Basic State Pension to 30 years, out of a possible 49 years of working life.

208. As the Pensions Commission noted, the UK does not have "an established population register."[290] It concluded that the absence of a UK population register meant the test would be "very hard if not impossible to apply retrospectively". For this reason, it proposed that the residence test should apply to future accruals only. [291]

209. The Secretary of State was clear when giving evidence that the "proxy indicators" which were available - tax and NI records - were "not as robust as many people would think."[292] This, in the Government's view, was a further reason for rejecting the residence test.

210. IPPR agreed that any such register "would have to be built up over several years before such a scheme could go ahead. Nonetheless, the Citizen's Pension is a potential option for reform in the medium to long term (say, 2020 or later)."[293]

THE WHITE PAPER PROPOSALS

211. The Department provided the Committee with a breakdown of the impact of the different measures to extend state pension coverage, as follows:[294]

  • The reduction to 30 in the number of qualifying years needed for a full Basic State Pension. This is expected to deliver "a step change" in BSP entitlement, with around 70% of women expected to reach SPA in 2010 with a full BSP (compared to around 50% without the reform);
  • Replacing Home Responsibilities Protection with weekly credits. This "does not significantly alter" the estimate that around 70% of women reaching SPA in 2010 will be entitled to a full Basic State Pension. The new weekly credits are to apply to people with care of a child up to 12 (compared to 16 for BSP and 6 for S2P.) While this means that people caring for children aged between 12 and 16 will no longer get credits for BSP, the effect of this is "offset by the reduction in the number of qualifying years needed."
  • Abolishing the requirement to have gained at least one qualifying year through paid contributions and to be entitled to at least 25% of the full BSP. Up to 100,000 a year reaching SPA could benefit.
  • Introducing credits for people who undertake care for 20 hours or more for people with severe disabilities. Around 70,000 people a year could gain a credit for Basic State Pension from this proposal (half of these will be women.) 110,000 more women and 50,000 more men will be accruing entitlements to the State Second Pension.

212. A further measure is the phasing-out of 'auto-credits' currently awarded to men aged between 60 and 64 so they do not have to 'sign on as unemployed' to gain credits for their pension (and to be extended to women as their State Pension Age increased). This "has the effect of marginally lowering" the proportion of women reaching SPA in 2010 entitled to a full BSP.

213. As a result, from April 2010, around 70% of women reaching State Pension Age (SPA) would be entitled to a full Basic State Pension, compared with around 50% under the current system.[295] From 2025, the proportion will be over 90% of men and women, compared with around 80% under the current system.[296] Under the Pensions Commission's proposals, "the same outcomes would not be achieved much before 2050."[297]

214. The Committee agrees that the focus should be on the outcome of increasing the numbers of people entitled to a full Basic State Pension. The Government has said that it is more practical to do this, with greater effect on outcomes, through changes to the current system of contributions and credits than through the introduction of a residence test. The reduction to 30 in the number of years required for a full BSP should go some way to providing people with more confidence about what they can expect from the state in the future. We therefore welcome the Government's proposals.

WHO ARE THE MISSING 10%?

215. The Committee was interested to probe further who would be among the 10% still "left out" of full BSP entitlement by 2025. Analysis conducted by DWP for its 'Women and Pensions: The Evidence' report, indicated that those not engaging in an activity likely to qualify them for BSP tended to be those with low family income and included people describing themselves as sick or disabled but not in receipt of a qualifying benefit and women who described themselves as "looking after the home" but were without children.[298]

216. It seems likely that many of these people will be helped by the reduction in the number of qualifying years needed for a full BSP to 30 (which the Secretary of State explained "by far and away has the biggest effect on outcomes of all of the changes."[299]) However, it is unclear who will be among the 10% still excluded from full BSP entitlement and, therefore, whether there is a good justification for this. The Secretary of State explained that DWP would be doing further analysis to establish who fell into this group.[300] This should help to clarify whether the Government has got the balance right with its proposed package of reforms. Help the Aged, for example, asked "what rationale is there for 30 years as against, say, 25?"[301]

217. We welcome the Secretary of State's undertaking that the DWP will do further analysis to establish which groups reaching State Pension Age after 2025 will not be entitled to a full BSP. We recommend that the analysis covers entitlement for those reaching SPA in 2010, and includes an assessment of the amount by which people will fall short of full entitlement.

THE 2010 CLIFF EDGE

218. The changes to increase coverage are to be implemented on 6 April 2010 and will not apply to women reaching State Pension Age before that date. Not only does this mean that current pensioners will not benefit but, as Help the Aged pointed out, it will introduce a "cliff-edge" between those reaching State Pension Age before and after 6 April 2010. The Secretary of State explained that there were a number of reasons for this:

219. The Secretary of State explained that women would not be able to bring themselves within the scope of the new rules by deferring claiming their Basic State Pension entitlement and retiring after 5 April 2010. [305]

220. Other witnesses stressed the difficulties that might arise from this. Teresa Perchard of Citizens Advice said there might be a group of people "who feel particularly unfairly treated" as a result.[306] She added that it was possible that some of the cost would be offset against Pension Credit entitlement and that it would be useful to see analysis from the Department on this point. One advantage of this would be that those who were not claiming Pension Credit would benefit.

221. The Committee accepts that it might be difficult to apply the carer's credit retrospectively, but is concerned about those with interrupted work records reaching State Pension Age between now and April 2010 who will not benefit from the proposals to increase coverage. We recommend that consideration be given to mitigating the gap in entitlement of those born before April 1950 compared with those reaching SPA under the new rules.

Adult Dependency Increases

222. The White Paper proposes removing Adult Dependency Increases (ADI) from 2010. These are additional allowances paid in respect of certain other financially 'dependent' adults who can be below pension age. The rate of the ADI in 2006-07 is £50.50 - 60% of the recipient's entitlement to the BSP. ADIs were to have been extended to women in respect of their husbands and to civil partnerships in 2010.[307] However, the White Paper proposes to abolish them from 6 April 2010. The Government's "conclusion is that the concept of 'dependency' on which the ADI provisions are based has little relevance in today's society in which partnerships of equals are the norm." The net cost of Adult Dependency Increases in 2015 would be £0.5 billion. By 2020, the cost would be expected to rise to £1.2 billion as the increase in women's State Pension Age meant more women would qualify.[308]

223. In its report on Incapacity Benefit and Pathways to Work, the Committee noted that "the abolition of the dependency and age allowances was felt by some who gave evidence to be particularly harsh as they provide a valuable source of income for disabled people". The Committee urged the Government to "work closely with disability organisations to ensure a proper assessment is made of the structure of the new benefit."[309] The Committee did not take evidence on this issue in the course of its current inquiry.


251   Pensions Commission, First Report, October 2004, p ix Back

252   Pensions Commission, First Report, October 2004, p 205 Back

253   Pensions Commission, Second Report, November 2005, p 2 Back

254   Q 248  Back

255   Pensions Commission Second Report, November 2005, p 118 Back

256   Ev 390, para 8 Back

257   Ev 390, p 6 Back

258   Ev 349 Back

259   Pensions Commission, Second Report, November 2005, p 10 Back

260   White Paper executive summary Back

261   White Paper, para 20 Back

262   Ev 135; Ev 187, para 4.1; Ev 196, para 1.3; Ev 256, para 2.3; Ev 316, para 2.8 Back

263   White Paper, para 3.21 Back

264   Q 97 Back

265   Treasury Committee, Fifth Report of Session 2005-06, The Design of the National Pension Savings Scheme and the Role of Financial Services Regulation, HC 1074-I, Q 194 Back

266   Ev 135; Ev 389, para 4.1; Ev 282 Back

267   Pensions Commission, Second Report, November 2005, p 21 Back

268   White Paper, p 17 Back

269   Ev 350, para 5 Back

270   Ev 326, para 2.1 Back

271   Q 307 Back

272   "The Pensions Commissioners welcome White Paper", Pensions Commission press release, 25 May 2006 Back

273   Pensions Commission, Final Report, April 2006, p 40 Back

274   Q 329 Back

275   Q 322 Back

276   Q 326 [Justine Greening MP] Back

277   Q 326 [Secretary of State] Back

278   Q 327 [Secretary of State] Back

279   Ev 383, 380 and 383 Back

280   Oral evidence taken before the Work and Pensions Committee on 20 October 2004, HC (2003-04) 1171, Q 35 Back

281   Pensions Commission, Second Report, November 2005, p 270 Back

282   Pensions Commission, Second Report, November 2005, p 206 Back

283   Ev 131; Ev 163 Back

284   Ev 125, para 8 Back

285   Ev 304, para 63, Q 111 Back

286   White Paper, p 126 Back

287   Q 282 Back

288   Ev 305, para 36  Back

289   Q 106 Back

290   Pensions Commission, Second Report, November 2005, p 206-7 Back

291   Pensions Commission, Second Report, November 2005, p 209, White Paper, para 1.26 Back

292   Q 280 Back

293   Ev 282, para 8 Back

294   Ev 377 Back

295   White Paper, Volume 2, para 4.29 Back

296   White Paper, Volume 2, para 4.21 Back

297   White Paper, para 3.79 Back

298   DWP 2005, Women and Pensions: The Evidence, p 76-7 Back

299   Q 285  Back

300   Q 273  Back

301   Ev 168 Back

302   Q 275 Back

303   Q 275, 279 Back

304   Q 275 Back

305   Q 279  Back

306   Q 531 Back

307   White Paper, Annex B Back

308   HL Deb, 6 July 2006, col WA 73 Back

309   Work and Pensions Committee, Third Report of Session 2005-06, Incapacity Benefits and Pathways to Work, HC 616-I, para 146- 50 Back


 
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