Draft Social Security (Reduced Rates of Class 1 Contributions, Rebates and Minimum Contributions) Order 2011

The Committee consisted of the following Members:

Chair: Sandra Osborne 

† Brake, Tom (Carshalton and Wallington) (LD) 

Corbyn, Jeremy (Islington North) (Lab) 

† Dinenage, Caroline (Gosport) (Con) 

† Evans, Jonathan (Cardiff North) (Con) 

Field, Mr Frank (Birkenhead) (Lab) 

† Greenwood, Lilian (Nottingham South) (Lab) 

Harris, Mr Tom (Glasgow South) (Lab) 

† Hart, Simon (Carmarthen West and South Pembrokeshire) (Con) 

McDonagh, Siobhain (Mitcham and Morden) (Lab) 

Paisley, Ian (North Antrim) (DUP) 

† Raab, Mr Dominic (Esher and Walton) (Con) 

Raynsford, Mr Nick (Greenwich and Woolwich) (Lab) 

† Reeves, Rachel (Leeds West) (Lab) 

† Selous, Andrew (South West Bedfordshire) (Con) 

† Smith, Miss Chloe (Norwich North) (Con) 

† Tomlinson, Justin (North Swindon) (Con) 

† Webb, Steve (Minister of State, Department for Work and Pensions)  

† Wheeler, Heather (South Derbyshire) (Con) 

Mark Etherton, Committee Clerk

† attended the Committee

First Delegated Legislation Committee 

Monday 21 March 2011  

[Sandra Osborne in the Chair] 

Draft Social Security (Reduced Rates of Class 1 Contributions, Rebates and Minimum Contributions) Order 2011 

4.30 pm 

The Minister of State, Department for Work and Pensions (Steve Webb):  I beg to move, 

That the Committee has considered the draft Social Security (Reduced Rates of Class 1 Contributions, Rebates and Minimum Contributions) Order 2011. 

Good afternoon, Mrs Osborne. It is a pleasure to serve under your chairmanship. The order sets out the proposed contracted-out rebate rates that will apply from April 2012. Before going into detail about what those rates will be and why we decided on the method that we have adopted, I shall explain briefly what the rebates are and how the review process works. 

When individuals contract out, they forgo all or part of their state second pension entitlement. In return, they pay reduced rates of national insurance contributions and/or receive an age-related rebate, which is paid into their scheme after the end of the tax year. Employers with contracted-out occupational schemes also pay reduced rates of national insurance. Those reductions and payments are known as the contracting-out rebate. 

The Secretary of State has a statutory duty under the Pension Schemes Act 1993 to review the level of the contracted-out rebates at least once every five years. The Government Actuary assists in the process by providing him with a report recommending what the level of the rebate should be. The legislation requires there to be a full tax year between parliamentary approval of the rebate order and its coming into force. The last full review took place in 2006 for rebates from April 2007. 

The current review process began in August last year, when the Government Actuary issued a consultation paper on the actuarial assumptions that he proposed to adopt in his report to the Secretary of State. He gave careful consideration to the responses in that consultation before drawing up his final report. His advice to the Secretary of State has been taken into account in the proposals before the Committee. 

In his report, the Government Actuary gave his opinion of the factors that affect the cost of providing benefits of an equivalent actuarial value to the state pension forgone as a result of contracting out. These include, for example, increased longevity, rates of investment returns, increases in earning and prices, future changes in the CPI indexation of the state additional pension and future changes to the state pension age. 

Jonathan Evans (Cardiff North) (Con):  I do not want to detain my hon. Friend and make myself unpopular on my own side, but may I point out that the consultation document refers to the fact that the change from the retail prices index to the consumer prices index is expected to lead generally to lower pension provisions? My hon.

Friend will be aware that we were not able to increase state earnings-related pension scheme payments last year because CPI was larger than RPI. If the Government Actuary says that the rebates will be less in such circumstances, does it not follow that they will be greater in instances such as the one that I have highlighted? 

Steve Webb:  I am grateful to my hon. Friend; he brings to the House a great deal of knowledge on pension matters. He is right to say that in the year to September 2009, the CPI was bigger than the RPI—the CPI was positive, while the RPI was negative. My hon. Friend will appreciate that the Government Actuary has to take a longer view. The best estimate is that, in the long run, the CPI will fall short of the RPI by an average of 0.8% or 0.9%. That is the basis on which the Government Actuary calculates his figures. 

The Government Actuary’s report and the report by the Secretary of State were laid before the House on 3 February, together with the order. The Committee may be aware of plans, legislated for in the previous Parliament, to abolish contracting out on a defined-contribution basis on 6 April 2012. Despite that, the order contains rebate percentages for members of salary-rated and defined-contribution schemes. That is because the requirement to review defined-contribution rebate rates under the Pension Schemes Act 1993 will not lapse until the enabling legislation for abolition—primarily section 15(1) of the Pensions Act 2007—comes into force. 

Rebate rates for members of defined-contribution schemes have been provided. However, as the figures are not expected to be used, they have been provided only for one tax year. I shall therefore focus on the reduction in national insurance contributions for those contracted out on a salary-related or defined-benefit basis. 

For this report, unlike for previous ones, the Government Actuary has helpfully provided three alternatives for valuing the cost of the benefits forgone by contracted-out workers in salary-related schemes—a best estimate basis, a typical funding basis, and a gilts basis. Each of those approaches was carefully considered by the Secretary of State. To summarise, each approach is designed to provide the employer with a different level of guarantee that is sufficient to cover the cost of the additional state pension forgone. 

Taking into account the considerable cost to the taxpayer of providing reduced national insurance contributions, we have decided that the “best estimate” approach is the most appropriate to adopt. It provides a degree of certainty, which broadly means that the rebate provided is equally likely to be too much as too little in the long term in respect of the scheme providing benefits equivalent to the additional pension forgone. Furthermore, the assumptions on which the Government Actuary has based his “best estimate” approach are justifiable. The level of guarantee balances the needs of contracted-out employers and employees with obligations to the taxpayer. Although the other approaches would provide greater certainty for employers, that certainty would be at significant extra cost to the taxpayer. 

In his report, the Government Actuary considered the increases in state pension age already provided for in legislation and the Government’s proposed increase in the state pension age to 66 from April 2020. To

redress that factor, he provided two different rates under each of the three approaches that he set out: one based on the existing arrangements for the state pension age; and one that takes into account the proposed changes on which the Government are currently legislating. 

We have decided that the proposed rise in state pension age to 66 needs to be reflected in the revised rebate rate. Hence, we have chosen the rate, under the “best estimate” approach, that takes that into account. That will mean a reduction in the rebate of national insurance contributions from April 2012 from 5.3% to 4.8% of relevant earnings. The balance of the rebate between employee and employer contributions will broadly be maintained—the level of the rebate on employee contributions will change from 1.6% to 1.4%, and the rebate on employer contributions will change from 3.7% to 3.4%. 

For personal pensions and money purchase occupational schemes, we have again accepted the Government Actuary’s proposed rates of reduction in national insurance contributions and age-related payments, which would apply but for the plans to abolish contracting out for defined-contribution schemes in April 2012. That will mean that the flat-rate element for contracted-out money schemes will decrease to 2.4% of relevant earnings for members of those schemes. It will be split between employees at 1.4% and employers at 1.0%. We have also decided to maintain the level of the age-related rebate cap at 7.4%. As I mentioned earlier, the rates are being provided simply to meet an ongoing statutory requirement that will not lapse until the abolition of contracting out for DC schemes. 

I am satisfied that the order is compatible with the European convention on human rights, and I commend it to the Committee. 

4.37 pm 

Rachel Reeves (Leeds West) (Lab):  Thank you, Mrs Osborne. I thank the Minister for his explanation of the order, which sets out the revised national insurance rebates for contracted-out pension schemes. As he has said, although the figures are provided for contracted-out money purchase schemes and appropriate personal pensions, the planned abolition of contracting out on a defined-contribution basis from 6 April 2012 means that they will never come into effect. What we are debating today, therefore, is the new rebate for contracted-out salary-related schemes—that is, schemes contracted out on a defined-benefit basis. 

As we know, the Government Actuary’s report diverged from previous reports in offering three different valuation approaches. As the Minister told us, the Government have chosen the lowest level of rebate, and are proposing that the rebate for defined-benefit schemes should decrease from the current 5.3% to 4.8%, which is at the lowest point of the Government Actuary’s Department’s range of estimates. 

The order also provides that the new rebate of 4.8% will be split—3.4% for employers and 1.4% for employees, which brings me to my first question. That is a 0.2 percentage point reduction for both employers and employees but, as a proportion, it implies a greater cost for employees, whose rebate will be reduced by 13%, compared with that for employers, who will see a reduction of 6%. Was it the Government’s intention that employees should bear more of the cost? If so, will the Minister explain the rationale behind that? 

More widely, I ask the Minister what estimates he has made of the impact of the new level of rebate on contracting out as a whole. For example, has he any estimate of the threshold level or rebate at which an employee would begin to think that it was not worth contracting out? That is a very important element in this debate. At a time when we are concerned about under-saving for retirement, should we not at least be wary of deterring people from doing so? We need to debate that in the context of the saving to the Exchequer, but also to bear in mind the wider issues about the incentives—or otherwise—to save. What assessment has the Minister made of the impact on the participation rate in occupational schemes as a result of the changes? 

That leads me to two further questions. To the extent that a reduction in the rebate will deter participation in occupational schemes, what assessment has the Minister made of the implications for future liabilities on the Exchequer, if contracting-out rates in DB schemes do indeed to start to fall? Could that not have a significant effect on the Government’s exposure in future liabilities to pay the set state second pension? 

What about the viability of occupational pension schemes—in particular, public sector schemes that operate on a pay-as-you-go basis? If people start opting out, could that not make the gap larger between what is paid in and what is paid out? If a full impact assessment had been produced for the order, I would have found out at least some of the answers. The explanatory notes state that 

“a full impact assessment has not been published...as it has no new impact on the private sector”, 

but I do not understand how that can be so. How is that different from the public sector, when it is confirmed that there will be a small increase in NI contributions by each? 

Indeed, the notes also state that there will be an annual £600 million saving to the Exchequer. Will the Minister explain why it is not a new impact when much of the cost is borne by private individuals and businesses that have defined-benefit schemes? In any case, there are likely to be other impacts further down the line due to possible changes in participation rates. I should be grateful to the hon. Gentleman if he clarified the position on the impact assessments. As for the £600 million saving, will he explain the average impact in monetary terms on the basic rate taxpayer? What assessment has he made of how much each person affected will be, on average? Indeed, does he know how many people will be affected by the changes? 

In the past, the Government have referred to national insurance as a “tax on jobs”. Does the Minister think that this, too—an increase in national insurance for employers and employees with DB pensions—is a tax on jobs? The National Association of Pension Funds has described the reduction in the rebate as a stealth tax. Joanne Segars, head of the NAPF, said: 

“This is a stealth tax on people saving into a pension and a further squeeze on the employers trying to help them. Cutting the value of the rebate will raise the operating costs of final salary schemes, and is likely to spur more employers to close these pensions to staff. The government should be supporting workplace pension schemes, not saddling them with extra costs”. 

The pensions consultants, Towers Watson, called the decision 

“another blow for employers sponsoring final salary pensions”. 

The consultants reminded us that the Secretary of State for Work and Pensions, when Leader of the Opposition, attacked the “miserly” rebates that we were then offering, branding them a 

“tax on the hard-pressed pensions sector”. 

Does the Minister share that opinion, and does the Secretary of State still hold that view? 

I wish to pick up on something that the noble Lord Freud said in the debate on the order the week before last in the other place. In reference to the fact that the proposed rise in state pension age to 66 is reflected in the revised rebate, he said 

“If, however, it becomes apparent that the proposed state pension age changes will not take place, we will consider conducting a further review of rebate rates before the end of a further five-year period”.—[Official Report, House of Lords, 9 March 2011; Vol. 725, c. GC272.] 

I am sure that the Minister did not expect me to let that go unnoticed. Can he confirm that I can take that as an indication that the Government are thinking again about the timetable to accelerate women’s state pension age, against that to which they were committed in the coalition agreement? The order is significant, and I should be grateful to receive answers to my specific questions. 

4.43 pm 

Steve Webb:  I am grateful to the hon. Lady for her questions, and I hope that I can offer her the clarification that she seeks. I shall take the issues in the order that she raised them. On the split between the employer and the employee, I should say that we have mirrored the current split; broadly speaking, the employer gets about 70% of the rebates and the employee about 30%. That is the basis on which we have allocated the split. We have not deviated from the past allocation. 

Rachel Reeves:  But there must be a change in the split. The rebate for employees has changed by 13% and for employers it has changed by 6%, so there must be a change in the split under the order. 

Steve Webb:  The rebates are rounded to one decimal point, which is why the figures are as they are. 

The fundamental issue that underlies a lot of what the hon. Lady says is whether the change means that a lot of people will stop contracting out—is it the final nail in the coffin of DB and so on? I understand that a contracted-out rebate is designed to be actuarially neutral. It is not designed to be a reward or a punishment; it is a quid pro quo. All the Government Actuary has done is said what is our latest estimate of the quid pro quo and also said, “You, as a scheme, contract out of the state scheme and provide benefits of at least equivalent value. What is the cost to you of doing that?” This is the answer to that question. 

Firms have made decisions about defined-benefit pensions over decades for a whole raft of reasons, with which I am sure the hon. Lady is familiar. There has been a long trend away from DB, final-salary pension provision. Interestingly—I know the Committee will be fascinated by this fact—we can tell that rebates are not

the central issue, because we can look at non-contracted-out DB schemes in which the same trends are evident. There is no evidence that such incremental changes to the rebate, which are actuarial and neutral, are anything to do with the long-term trend. People are moving out of DB because of longer life expectancies, the volatility of the costs on balance sheets and a range of other factors. 

The hon. Lady asked about participation and people contracting in. In the case of DB, schemes contract out, but individuals do not. Employers will make that judgment. We have preserved the status quo—we have kept the rebate so that, on average, it is equally likely to be favourable as unfavourable. It is the actuarially neutral number. We are not changing the long-running incentives for schemes, but many other factors will cause schemes to cease contracting out, if that is what they are thinking of doing. 

Likewise, the hon. Lady’s issue with the long-term Exchequer impact of the regulation does not arise. It is correct that there are long-term Exchequer impacts in DB schemes closing and people contracting back in, but the draft order does not change that, because it is about actuarial neutrality and catching up with future changes in state pension liabilities. 

The hon. Lady was right to ask about public sector schemes because contracting out is overwhelmingly a public-sector phenomenon, although I think she tried to imply that it was a burden on private business as well. From memory, getting on for four fifths of the rebate is public sector. She asked for some figures and, to reassure the Committee about the modest scale of the proposals, I should say that for someone on average earnings—£26,000 a year—the employer will have to find an extra £1.20 per week and the employee an extra 80p. 

The hon. Lady asked about the absence of an impact assessment. Her party when in government never produced impact assessments for such instruments because they are a long-standing statutory obligation. There is no policy shift; we are simply asking the Government Actuary to give the latest equivalent value of the rebates. Impact assessments tend to be done for new policies and new statutes. There is nothing new about the draft order; it is just the latest answer to the same question. 

The hon. Lady mentioned “saddling” workplace schemes with extra contributions. I do not know whether she intends to oppose the regulations on that basis. 

Rachel Reeves:  I was only quoting the NAPF. 

Steve Webb:  Fair enough. I understand where the NAPF is coming from, but it will appreciate, as I am sure the hon. Lady does, that we are simply resetting the rebate to match the liabilities forgone. The process is neutral: as the rebate falls, so too does the promise that has to be matched. Schemes could, if they wanted to—this is a substantive point—reduce their accrual rates within the scheme. [Official Report, 31 March 2011, Vol. 526, c. 7MC.] If they are getting less rebate, they could say, “Oh well, we are getting less money coming in. Because of the promise we have to match from the state scheme, we will accrue in our scheme by a slightly smaller rate.” If they wanted to offset any costs on the scheme, they would have a mechanism for doing it. Some might do so, although the majority probably will not. 

The hon. Lady’s final question was about what would happen if the state pension age schedule in the Pensions Bill did not pass. If it did not go through, we would have to ask the Government Actuary to have another look at the rebate. We have based the rebate figure on the assumption of the legislation before the House. That is the reason why we chose the figure. 

I hope that that response was helpful to the hon. Lady. I commend the draft order to the Committee. 

Question put and agreed to. 

4.48 pm 

Committee rose.