Memorandum submitted by the Actuarial Profession (TPP 18)
SUBMISSION TO THE WORK AND PENSIONS SELECT COMMITTEE INQUIRY INTO TACKLING PENSIONER POVERTY IN GREAT BRITAIN
· State pension provision was introduced a century ago and, during that time, the proportion of pensioners remaining 'below the poverty line' has remained largely the same, with some 40% of pensioners currently being eligible for Pensions Credit.
· The effects of the current financial crisis could increase the proportion of pensioners being eligible for Pensions Credit, as interest rate cuts may cause them to use their savings to supplement income. Increasingly, individuals are working on past retirement age, often in a part-time capacity, and this trend seems set to continue. Going forward, flexibility between savings, pensions and part-time working will be crucial.
· Foundations for a future system should focus on the need to be realistic, flexible (to reflect that things change over time) and to reduce complexity. Long term strategic planning for the future of pension provision is also important so that the pensioners of tomorrow can plan reliably for their own futures today.
· Increasing reliance on personal savings (whether in a pension or other vehicle) may result in serious under-provision and/or an increased reliance on means tested benefits as those on low incomes will be unable to afford to save enough.
· As a general point, care should be taken to structure any change to avoid disincentives to save.
1. The Actuarial Profession welcomes this Inquiry into tackling pensioner poverty in Great Britain and is pleased to be able to offer this submission. It considers how the present position has been reached and suggests what we can learn from history. Our submission draws heavily on the book 100 Years of State Pension Provision recently published by the Actuarial Profession.
Basic state pension
2. The first state pension scheme was the 1908 Scheme with payments commencing to be paid from 1 January 1909. It was a means tested arrangement for the population aged 70 and over and was funded by the Treasury. The great majority of payments were at the maximum weekly rate of five shillings (25p) - this representing about 18% of national average earnings.
3. In 1926 the National Insurance Scheme, which already provided unemployment, sickness and medical benefits, was extended to provide pension benefits linked to the insured person's contribution record. The means tested arrangements of the 1908 Scheme remained in force since the new scheme covered only part of the adult population; contributions were paid by the insured, their employers and the Treasury.
4. In 1948 the National Insurance Scheme as we know it today was established providing a universal basic state pension funded by contributions from the insured, the employers and the state. The scheme covered the whole adult population with the amount of state pension received linked to the person's contribution record. By means of employed (employee and employer), self- employed and voluntary contributions, all at flat rates, together with credits in certain circumstances being granted in lieu of contributions, all working age adults could build up a full contribution record. This entitled them to receive the full weekly basic state pension of £1.30 (18.5% of national average earnings). However many of working age, who were not in employment and not entitled to receive credits in lieu of contributions, failed to make relevant voluntary contributions and so their entitlement to the basic state pension was reduced and in some circumstances became nil. This still applies today although the changes applying from 2010 will improve the position significantly but only over time.
5. Over the next 30 years, the basic state pension, as measured against national average earnings, gradually improved and rose from about 18.5% in 1948 to 26% in 1979; since then it has been falling and by 2008 was just under 16%. The basis of uprating the basic state pension is due to be altered from the Retail Prices Index to national average earnings but this is planned not to occur until 2012 at the earliest, by which time the basic state pension may well have fallen further relative to national average earnings.
6. The 1948 Scheme had fixed rate contributions for fixed rate benefits so that all those making contributions were treated alike. However, by the 1950s, it was clear that National Insurance contributions were being kept at a low level so that they could be afforded by the less well off members of society and this kept the benefits low. Ultimately it led in 1975 to earnings related contributions for a flat rate basic state pension, thus seeking to provide an adequate basic pension for all via a cross subsidy from higher earners to those on low incomes.
7. If the basic state pension continues to decline in relation to earnings, people will increasingly have to rely on making personal savings for their retirement. However, assuming those on low incomes do not have sufficient disposable cash, relying on personal savings (whether in a pension or other vehicle) may result in serious under-provision as those on low incomes will be unable to afford to save enough for retirement.
8. The actuary Ralph Price Hardy estimated in 1891 that more than 40% of old people at the time became chargeable to the poor rates. Although standards of poverty have changed since 1891, nevertheless a significant and similar proportion of the aged population is still below what might be considered the poverty line.
9. Over the past 100 years, various means tested arrangements have been in force to protect the less well-off but one of their consequences has been to deter those on low incomes from saving as they would lose entitlement to means tested benefits. A number of measures for determining poverty have been adopted with the current one underpinning Pension Credits being roughly 22% of national average earnings
10. On this measure, the DWP estimated that there were 2.72 million Pension Credit claimants (3.32 million including partners) at August 2008. In addition it has been estimated that there could be a further 1.8 million who, although eligible, do not claim the benefit. This suggests that about 40% of pensioners qualify for the means tested Pension Credit; this may increase over time as the National Pensioners' Convention estimates that currently as many as nine million workers may have no pension arrangements outside the state scheme. It is often heard that the complexity of the system deters many from claiming benefits to which they are entitled, along with, for many, the stigma of doing so. Despite this, the current financial crisis could further increase dependency on Pensions Credit as falling interest rates cause pensioners to use their savings to supplement their income. Indeed, over time, dependency may increase even further as low interest rates cause savers to dip into their capital prior to retirement, reducing their available nest egg.
11. Any benefit system, if it is to meet its purpose, should be simple and capable of delivering what it seeks to achieve i.e. does not overpromise. In practice, this will always need to be balanced against providing a disincentive to save and against the very real pressures on government finances which could result in rising taxes and a reduction in the resources for means tested benefits.
Pension provision additional to the basic state pension
12. Since 1961, there have been successive additional state pension arrangements sitting on top of the basic state pension. They started with the graduated scheme (1961 to 1975), the state earnings related pension scheme (SERPS - 1978 to 2002) and S2P (2002 onwards). None of these arrangements applied retrospectively and consequently gave no benefit improvement to existing pensioners.
13. In addition, over recent years we have also seen a decline in private sector final salary schemes with three quarters of them closing to new entrants and the expectation that many will cease future accrual of benefits for existing members. Defined contribution schemes will have been badly hit by the recent turmoil on the world's stock markets as members of such schemes will have seen the value of their retirement pot shrink dramatically, eroding public confidence in stock market investment. In time, this could also lead to a reduction in saving, as for some the uncertainty of the value of the pension pot at retirement is a disincentive to save at all, which would result in even more individuals being drawn into the means tested Pensions Credit.
14. It is currently not clear the impact that Personal Accounts, to be introduced in 2012, will have. Personal Accounts, together with individual and employer sponsored money purchase schemes, have their fund values linked directly to stock market performance, thus placing the risk on the individual, who may have little or no choice as to when they retire. Lifestyling or switching funds gradually as expected retirement approaches can partially address this. However, for the individual retiring when the stock market is low, the problem is compounded by annuity rates which are linked to interest rates at the time. It could be argued that Personal Accounts will make saving easier for many who might otherwise lack the discipline of regular saving. However, there is likely to be a proportion of low and middle income earners who either do not have the spare income to save in whatever form or who are otherwise poorly equipped to handle Personal Accounts.
15. The current economic crisis has brought into sharp focus for many the need to consider their finances and to address current needs as well as, if possible, make provision for the longer term. Thus we are seeing an increase in those working on past retirement age simply to make ends meet, although the facility to continue to work is impacted by higher unemployment rates. Conversely, with more older members of the population continuing to work (either full- or part-time) the stigma which might once have been associated with working beyond retirement age seems to be diminishing.
Measurement of pensioner poverty
16. Since the introduction of a universal basic state pension with the 1948 Scheme, its amount has been below the level that would eliminate the need for means tested support for pensioners, currently Pension Credit.
17. The poverty line, which reflects a threshold of need below which people are counted as poor for the purposes of social security, is generally conceived in terms of an income standard, typically a proportion of median or average incomes. Whilst this has the merit of simplicity and is useful for international comparison, it can be somewhat arbitrary (e.g. Pension Credits kicking in at 22% of national average earnings). Other alternatives, such as household budget standards (a specified basket of goods and services which represent particular living standards) could also be used.
18. In order to address poverty effectively (across the population, not simply in relation to pensioners), it is necessary to define how it should be measured. Only once a definition has been agreed can a system be developed to address it.
19. State pension provision was introduced a century ago and the provisions of the Pensions Acts 2007 and 2008 are bringing about positive changes in state pension entitlement particularly for parents, carers and those with interrupted careers. However these changes will take time to have effect.
20. Over the last century, the proportion of pensioners remaining 'below the poverty line' has remained largely the same, with some 40% of pensioners being eligible for Pensions Credit. This raises the questions (a) whether we have the balance right between social insurance, means testing and personal provision through individual and employer sponsored schemes and (b) the equity between generations.
21. The effects of the current financial crisis could increase the proportion of pensioners being eligible for Pensions Credit, as drastic cuts in interest rates are likely to cause them to use their savings to supplement their income. As turbulence in the world's stock markets reduces the value of the pensions pots of members of defined contribution pension schemes, increasingly, individuals are working on past retirement age, often in a part-time capacity, and, subject to the impact of higher unemployment rates, this seems set to continue. Going forward, flexibility between savings, pensions and part-time working will be crucial. Long term strategic planning for the future of pension provision is also important so that the pensioners of tomorrow can plan for their own futures today.
22. Since the 70s, if not before, governments have indicated their desire to eliminate means testing in retirement but so far this has not been achieved. It is for the Government to determine how it wishes to address pensioner poverty but it would seem logical that any changes to the system should be realistic, flexible (to reflect that things change over time) and aim to make the system less complex.
23. Assuming those on low incomes do not have sufficient disposable cash to save enough for retirement, increasing reliance on personal savings may result in serious under-provision and/or an increased reliance on means tested benefits as those on low incomes will be unable to afford to save enough.
24. The interaction between pensions and savings is critical and, as a general point, care should be taken to structure any change to ensure that people are not discouraged from saving otherwise, for most, the changes would merely result in different sources of retirement income rather than in an overall, higher level of income in retirement.
About The Actuarial Profession
The Actuarial Profession is governed jointly by the Faculty of Actuaries in Edinburgh and the Institute of Actuaries in London, the two professional bodies for actuaries in the United Kingdom. A rigorous examination system is supported by a programme of continuing professional development and a professional code of conduct supports high standards reflecting the significant role of the Profession in society.
Actuaries' training is founded on mathematical and statistical techniques used in insurance, pension fund management and investment and then builds the management skills associated with the application of these techniques. The training includes the derivation and application of mortality tables used to assess probabilities of death or survival. It also includes the financial mathematics of interest and risk associated with different investment vehicles - from simple deposits through to complex stock market derivatives.
Actuaries provide commercial, financial and prudential advice on the management of a business' assets and liabilities, especially where long term management and planning are critical to the success of any business venture. A majority of actuaries work for insurance companies or pension funds - either as their direct employees or in firms which undertake work on a consultancy basis - but they also advise individuals, and advise on social and public interest issues. Members of the Profession have a statutory role in the supervision of pension funds and life insurance companies as well as a statutory role to provide actuarial opinions for managing agents at Lloyd's.
The Profession also has an obligation to serve the public interest and one method by which it seeks to do so is by making informed contributions to debates on matters of public interest.
In January 2009, the Actuarial Profession published a book 100 Years of State Pension: Learning from the Past. This submission draws on the research undertaken for that publication and also on the expertise of the book's authors. A copy of the book will be sent to the Select Committee's Clerk along with a hard copy of this submission.