Select Committee on Work and Pensions Fourth Report


6  SHOULD THE STATE PENSION REMAIN TWO-TIER?

246. The Pensions Commission considered that a "key choice to be made is between moving to a single unified state pension (referred to below as an Enhanced State Pension (ESP)), or building on the present two-tier system which combines a Basic State Pension (BSP) and the State Second Pension (S2P)."[339]

247. Having considered the options, the Commission recommended retaining a two-tier state pension - with the Basic State Pension and State Second Pension. It explained that "abolishing S2P immediately would moreover remove from the system the existing element of earnings-related compulsion at the very time that voluntary provision is in serious decline. It would be likely to speed the closure of remaining private sector DB schemes." In addition, it argued that the gradual and evolutionary approach it proposed would have the advantage of reducing transitional complexity and allowing flexibility, for example, to have different pension ages for S2P and BSP. [340]

248. A number of memoranda questioned the proposal to retain two separate tiers, arguing that it did not go far enough in simplifying the system. The Pensions Policy Institute argued that "the gradual transition approach for state pension reform preferred by the Commission has three significant problems: complexity, risk of constant fiddling and distributional inefficiency." [341]

249. Other memoranda, however, were supportive. Age Concern, on balance, favoured two tiers on the grounds that it had "scope to provide certain groups, such as carers, more generous provision from the state" and "given we have to start from where we are, reform to the existing two tier system is likely to be easier and quicker to achieve than moving to a single tier system."[342] The Equal Opportunities Commission strongly supported "the concept of maintaining and extending the second state pension (S2P)" and proposed a "revised and tightly targeted supplementary state pension, designed to deliver combined income of up to £160 from BSP and S2P to those spending their lives in low paid employment (under the middle threshold of £12,116p.a.) or in unpaid parenting or caring roles." [343]

Alternative proposals - the Pensions Policy Institute

250. The Government, as outlined in the White Paper, followed the Pensions Commission in deciding to take a gradual approach to state pension reform, building on the existing two tiers. In oral evidence on 7 June, the Secretary of State warned: [344]

    "I do not think this idea, this Holy Grail that people have searched for, of merging the two is anything like as straightforward or as simple or necessarily as sensible as people suggest, and that is why Turner did not propose it. He took a very long, careful look at it and said, "Do not go there. It is too complicated."

251. The Pensions Policy Institute, however, has consistently argued that "a faster transition to a simpler state system is both possible and affordable, could have a better distributional outcome, and could reduce reliance on means-testing still further".[345] It set out three alternative means for arriving at this objective. In each case, it argued, the end result was:

  • "Single-tier" and so simplifies the pensions system. Accruals to S2P stop and the level of the first tier is increased.
  • Set at Guarantee Credit level (£114 a week for single pensioners in 2006/07) "and so reduces means-testing".
  • Wider coverage than the Basic State Pension. "For the sake of modelling, we have assumed that the single-tier pension would be universal." [346]

252. PPI proposed three options for arriving at this result - a short, medium and longer term transition. PPI explained that the short transition - under which the flat-rate pension would be introduced immediately by increasing the BSP to the new level - could be achieved using the 'offset' method. This "targets gains on those with a state pension income of less than the new pension level of £114 a week." Those with state pension income of less than £114 a week are brought up to that level. Those with more do not gain immediately, but lose nothing. All accrued rights are honoured. The White Paper, broadly following the Pensions Commission, outlined a number of reasons for rejecting the PPI's transition proposal for a short-term transition. Like the Commission, the Government concluded that under the more gradual transitional approaches, "the prize of simplicity is lost."[347]

TRANSITIONAL COMPLEXITY

253. The Pensions Commission's Second Report described the calculation required "as complex and administratively burdensome particularly because the different benefits have different indexation regimes (ESP to earnings, SERPS/S2P price-indexed in retirement, BSP to prices) requiring the calculation to be done separately each year for each individual. The arrangements would be 'possible (though complex)'"[348]

254. Alison O'Connell said that the Pensions Policy Institute had talked "to officials in the Inland Revenue who administer this stuff and we felt that it was quite straightforward, because all the information exists" [349] The Secretary of State explained that it was not just a question of administrative complexity, he was "sure it could be done"[350], it was also a problem for individuals, with people having "no clear idea of what the state would provide."[351]

255. However, as evidence to the inquiry indicated, lack of clarity is a problem with the present system, particularly as regards the State Second Pension (see para 236 above). Christine Farnish of the National Association of Pension Funds thought it was more of a political judgement: [352]

    "Clearly, there are transition issues and it would be complicated to achieve, but I would set against that the huge risk and the complexity and length of the transition that we are going to go through now, in moving forward with the reforms set out in the White Paper. I think it is some pain for a very big gain, if you have more of a 'big bang' approach, but clearly these are political judgments that politicians need to make."

256. As previously explained, an element of complexity continues under the present system. Pension forecasts, however, could assist people in understanding what they could expect from the state. Administrative complexity should not be a reason for rejecting the proposals.

COST

257. The White Paper explained that the offset method would "still result in a considerable immediate increase in expenditure. Costs using the offset arrangements would be an additional £10 billion in 2010, and £8 billion in 2015. Costs would peak at around 0.9% of GDP around 2040, falling back to 0.3% of GDP by 2050."[353]

258. PPI, on the other hand, argues that its proposal for a "faster move to a simpler state pension" is affordable "within the Pensions Commission cost envelope."[354] There are a number of possible explanations for the difference in view as to affordability. One is that the cost will depend on exactly what is being modelled. In the PPI proposal, for example, individuals in couples would get 80% of the single rate. The other is that the costing for the PPI proposal takes into account the money raised from abolishing contracted out rebates for both DB and DC schemes (£11 billion in 2010 in 2006/7 prices).[355]

DISTRIBUTIONAL OUTCOMES

259. The White Paper stated that: [356]

    "whatever the precise design, there are concerns about the fairness of any kind of Citizens' Pension: some people would get the same pension despite having paid in very different amounts over the last 50 years, based on an understanding that their contributions would affect their retirement incomes. For example, the self-employed - who have not contributed to the State Second Pension - would get the same outcomes as employees who have."

260. As the Pensions Commission acknowledged, this requires a "judgment on what is the 'fair' way of dealing with the fact that different people not only have different accrued rights, but also have made different contributions".[357] Alison O'Connell argued that an increase in state pension for the self-employed would be one advantage of the PPI's proposals, given that they are one of the under-pensioned groups.[358]

261. In oral evidence, the Secretary of State took the following view: [359]

    "Coming back to the wider S2P point, if we were to take the advice of some and merge the two, actually the biggest losers would be middle income. It will be middle Britain that would take a real pounding if we were to do that".

262. Again, it will depend on exactly what is being modelled. PPI argued that its own proposals had better distributional outcomes than those of the Pensions Commission and those in the White Paper. Of the White Paper proposals, PPI stated that "overall, the income distribution of people over State Pension Age will change very little as a result of the White Paper proposals. The better-off will benefit slightly more than the less well-off. The problem of unequal outcomes will remain." In comparison, its own short transition was "progressive. The least well-off 10% stand to gain around £15 a week, while stopping S2P accruals mean that the most well-off would have around £10 a week less than they would under the current system."[360]

263. As regards the question of distributional outcomes, therefore, the offset method has the advantage of protecting accrued rights. However, some people, such as those who had been self-employed would get an immediate increase in state pension entitlement despite having paid less NI in working life. Whether this is desirable is a question of judgement on what is 'fair' and what should be the priority for the state pension system.

THE IMPACT ON EARNINGS-RELATED PENSION PROVISION

264. A further reason given by the Pensions Commission for retaining S2P was that abolishing it immediately would: [361]

    "remove from the system the existing element of earnings-related compulsion at the very time that voluntary provision is in serious decline. It would be likely to speed the closure of remaining private sector DB schemes. We therefore believe that it is risky to abolish S2P before establishing and proving the success of the proposed National Pension Savings Scheme."

265. However, it is possible that the success of the scheme might be better assured if people were clearer about what they could expect from the state and more confident that they would be lifted free of means-testing in the future. [362]

266. Moving to a simpler, single-tier system more quickly than the Government and Pensions Commission proposed would appear to be possible, using the 'offset' method. It would, however, require difficult decisions to be made - for example, whether to abolish contracted-out rebates for Defined Benefit schemes. It also requires a judgement on priorities and the extent to which moving more quickly to a simple, single-tier flat-rate state pension should take precedence over other objectives. We recommend that the Government conducts further work on the costings and on the feasibility of the offset method.

Alternative proposals - the Pension Reform Group

267. A further alternative policy model considered by the Pensions Commission was the Universal Protected Pension proposed by the Pension Reform Group, chaired by the Rt Hon Frank Field MP. This involved: [363]

  • Maintaining the existing Basic State Pension linked to prices during a person's working life.
  • Building up a funded provision alongside the existing basic pension which combined will guarantee a minimum income of 25% of average earnings during retirement.
  • The funded provision will cover the cost of uprating the BSP component of this guarantee in line with earnings only at retirement while meeting the overall cost of a pension of not less than 25% of average earnings and maintaining this overall pension in line with earnings throughout retirement."

268. The Pensions Reform Group argued that its proposals had the following advantages:

  • They would provide a "guaranteed pension" for all who contribute to society, including carers
  • The scheme would be compulsory for all in work, but there would be no new form of compulsion, contributions would be collected through the NIC system by the Contributions Agency.
  • The scheme would be redistributive as is the Basic State Pension scheme - over the relevant National Insurance bands, everyone puts in the same percentage of income for the same monetary pension at the end.
  • The scheme would be funded - to distance it from Government - 'it is our/my money: they cannot fiddle with or expropriate it'.
  • It would be independent. "It is critical that there should be a governance structure that puts significant distance between the scheme and politicians. We propose a governance model based on the Monetary Policy Committee of the Bank of England."

269. The Pension Reform Group had its proposals costed by the Government Actuary's Department. The GAD report noted that "leaving additional contributions to be settled at a later date when the Chancellor believes it prudent to increase national insurance contributions, the [contracted out] rebate alone, invested in the UPP, for the whole of the person's working life, together with the Basic State Pension, would deliver a pension of a little over the Pension Reform Group minimum target of 25% of national average earnings."[364]

270. The Pensions Commission analysed the Pension Reform Group's proposals and noted advantages, including:

  • People might be more willing to pay into an explicit fund than to pay taxes (even if the contributions/benefits relationship was to a degree redistributive). A more generous flat-rate state pension could therefore be sustainably afforded if the funded route was chosen.
  • The arm's-length governance structure might ensure continuity, reducing the likelihood of the continual changes which have increased the complexity of the British state system and undermined trust in it.

271. The Commission concluded, however: [365]

    "that these advantages are not sufficiently compelling to justify such a major change in policy which would carry with it some offsetting disadvantages. In particular we are unconvinced that it is politically feasible or acceptable to hand over to an arm's length independent body the huge and inherently political decisions which would need to be made about the appropriate level of the flat-rate BSP in the event that asset values oscillated significantly".

272. Asked about this in oral evidence, the Rt Hon Frank Field MP, Chairman of the Group, argued that there was:[366]

    "a huge trust factor here and that increasingly over the next decade we as politicians, if we want to take voters with us to part with their money, are going to have to surrender some of our sovereignty over how we as politicians spend that money."

273. He added that the objection to an "arm's length independent body" making "huge and inherently political decisions" "could have been a valid point if we had not had the experience of the Monetary Policy Committee", the decisions of which can have:

    "an immediate and quite devastating effect on many people's household budgets, and therefore we have already got a body that can have a much more immediate impact on people's living standards." [367]

274. Howard Reed of IPPR, however, argued that there was a significant difference between the two bodies:[368]

    "I think the analogy Frank has drawn with the Monetary Policy Committee is defective in the key sense that the MPC set one variable interest rate and the Government can change its target if it wants and get it to set, say, an employment target as well as an inflation target if it wanted. This body, the kind of arms-length pension management body that Frank is proposing, will be running a redistributive scheme, using national insurance contributions which effectively are an income tax [...] we feel that it is the Government's direct role to do that."

275. He also questioned the extent to which the pensions provided would actually be "protected."[369]

    "One point is that from reading the Pensions Reform Group material it seems to me that they are not totally up front about the fact that any system which invests in equity markets involves risk […] It says it is a protected pension, but I am not clear exactly if there is a huge crash in the stock markets and the fund finds it cannot provide 25 to 30% of earnings without big borrowing or whatever, the Government will have to underwrite the system somehow, either by borrowing or by raising taxes."

276. The Committee notes that there are some advantages in the model proposed by the Pension Reform Group, in that it might restore trust in pensions by establishing a guaranteed pension overseen by an independent body at arms length from Government. However, we consider that other means might be adopted to reduce the risk of parameters of the pension system being successively changed over time - for example enshrining those that are most important in primary legislation.

Conclusion: a pragmatic consensus?

277. The Government has given a number of reasons for not adopting proposals to move faster to a simpler, single-tier state pension. The most significant reason is, perhaps, that of cost and the proposal that these be met entirely by abolishing rebates for DB schemes, something the Government has rejected. This issue is considered further in chapter 3.

278. Some organisations giving evidence to the inquiry, such as Help the Aged and the National Association of Pension Funds said they would prefer a faster transition to a simpler state pension. However, Help the Aged said that it:[370]

    "would have much preferred the Citizen's Pension model - the Enhanced State Pension in the Commission's report - to have found favour, but if there is no consensus around that, then the Commission's suggestions become the next best way forward, provided they are implemented in full (ie including the residential eligibility test for a full Basic State Pension for everyone at 75) and with due speed."

279. Christine Farnish of the National Association of Pension Funds took a similar view.[371]

280. The Pensions Policy Institute, in a memorandum submitted after publication of the White Paper, suggested that the streamlining of some of the qualifying criteria of BSP and S2P (see para 238) means that "it would be easier in future to merge the two into a single-tier. The logic of doing this will become clearer once contracting-out has been abolished and S2P has flattened further. Legislation could set a date, say 2015, for a review to examine the feasibility of merging BSP and S2P."[372]

281. The Committee recommends that the Government sets a date at which the feasibility of merging BSP and S2P should be examined, possibly as part of the further independent review we recommend should be commissioned by the end of the next Parliament.



339   Pensions Commission, Second Report, November 2005, p 8 Back

340   Pensions Commission Second Report, November 2005, Executive Summary, p 9 Back

341   See Ev 394, para 32; Ev 122 Back

342   Ev 318, para 6.1 Back

343   Ev 126, para 19 Back

344   Q 349 Back

345   Ev 389 Back

346   Ev 394, para 33 Back

347   White Paper, p 117-8, Box 3a Back

348   Pensions Commission, Second Report, November 2005, p 246 Back

349   Q 22 Back

350   Q 350 and 354 Back

351   White Paper p 118 Back

352   Q 494 Back

353   White Paper, p 118 Back

354   Ev 395, para 35-6 Back

355   Ev 396, para 14 Back

356   White Paper, Box 3a, p 118 Back

357   Pensions Commission, Second Report, November 2005, p 248 Back

358   Q 16 Back

359   Q 354 Back

360   Ev 397, para 49 Back

361   Pensions Commission, Second Report, November 2005, p 9 Back

362   Ev 396, para 40 Back

363   Ev 143, para 14 Back

364   Pensions Reform Group, The Chance of a Lifetime, 24 April 2006, p 12 Back

365   Pensions Commission, Second Report, November 2005, pp 68-70 Back

366   Q 145 Back

367   Q 145 Back

368   Q147 Back

369   Q147 Back

370   Ev 163, summary Back

371   Q 493 Back

372   Ev 407, para 23 Back


 
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