4 Ending of contracting-out |
84. A key element of the single-tier reforms is the
abolition of the State Second Pension (S2P). This means that contracting-out
of the S2P will also end. This is, in general terms, the ability
to forgo entitlement to S2P on the basis of the individual being
eligible for broadly equivalent occupational pension provision
to which the individual and/or their employer contributes. Contracting-out
entitles both the employer and the employee to pay lower National
Insurance contributions (NICs). DWP estimates that 80% of people
reaching State Pension Age in the next 20 years will have been
contracted out at some point in their working lives.
85. The Government says that key considerations in
the arrangements for ending contracting-out are: minimising the
impacts on employers, employees and pension schemes; ensuring
that amounts accumulated in occupational schemes up to the introduction
of the Single-tier Pension continue to be paid; and ensuring that
the sustainability of Defined Benefit occupational schemes is
Impact on employers
THE STATUTORY OVERRIDE
86. The White Paper states that, for employers, the
end of contracting-out will mean an increase in NICs paid for
each contracted-out employee of 3.4% of relevant earnings.
DWP acknowledges that employers are likely to want "to reduce
the level to which they must fund their [pension] scheme by the
same amount as the increased National Insurance contributions"
when contracting-out ends, either by reducing future pension benefits
or by increasing employee contribution rates to pension schemes,
or a combination of both. However, some private sector employers
are limited by their scheme rules in the extent to which they
are able to modify scheme benefits and in many cases scheme rules
can only be changed by the scheme trustees or with the trustees'
consent. As the changes are likely to be seen by trustees as detrimental
to scheme members, they may not be willing to give their consent.
87. Provisions in the draft Bill would give employers
a statutory power ("the statutory override") to amend
the terms of their workplace pension schemes to increase member
contributions or to reduce future service benefits, without trustees'
consent if necessary. This power will only apply to changes necessary
to deal with the impact of the ending of contracting-out. Employers
will have five years from the introduction of the STP in which
to make the changes to pension schemes, but they will only be
allowed to use the statutory override power once. 
STATUTORY OVERRIDE FOR PROTECTED PERSONS REGULATIONS
88. There is a specific issue affecting employers
in private sector companies which currently employ people who
worked for these companies when they were nationalised industries.
This group of private sector employers are limited in their ability
to change pension scheme rules by legislation made at the time
of privatisation, generally referred to as the "Protected
Persons Regulations" (PPRs).
89. The Government launched a separate consultation
in January 2013 on whether employers who sponsor pension schemes
which have "protected persons" as members should be
permitted to override the rules relating to this group. The consultation
closed on 14 March.
We expect the Government will therefore set out its preferred
way forward in response to the consultation, so that Parliament
can consider this as the Bill progresses.
Impact on Defined Benefit (DB)
90. The NAPF set out the context for DB pension schemes
in which the ending of contracting-out will be taking place. A
recent survey had shown that only 13% of private sector DB schemes
are open to new members; 55% are closed to new members but open
to future accrual. 83% of DB schemes which are open to new accruals
are contracted-out. Of the 13% which are still open to new members,
one in five expects to close their scheme to current members and
switch to a Defined Contribution (DC) scheme in the next five
years. 12% expect to retain their DB scheme but on less favourable
terms for existing members.
91. Hymans Robertson, a firm of pension consultants,
says that "for the 1 million private sector workers still
lucky enough to have DB pensions, the prospects don't look rosy
due to the end of contracting out." It believes the extra
cost that this will place on employers "may speed up the
demise of what remains of DB pensions".
EEF (the manufacturers' organisation) agreed that the abolition
of contracting-out and the loss of the NIC rebate could lead employers
to close DB schemes.
92. DWP acknowledges that "the removal of the
contracted out rebate without any mitigating response may create
the need for additional funding from DB sponsors [ie employers]".
But it believes that "there are much bigger influences on
the future of DB schemes, and loss of the [NI] rebate on its own
should not, in general, trigger scheme closures."
The Minister told us that the decline in DB which had already
taken place meant that it could be considered as a "coffin
that has got enough nails in it already", but he did not
believe that the impact of ending contracting-out would be "seismic"
for these schemes. He emphasised that employers who continued
to offer DB schemes did it because it was something their employees
valued, and as a retention and recruitment tool.
93. Neil Carberry of the Confederation of British
Industry (CBI) agreed with the Minister both that "it is
debateable whether [DB schemes] have been finished off for good
already" and that the cost of the ending of contracting-out
on its own was unlikely to "finish off schemes". 
Otto Thoresen of the ABI told us "I do not see this in itself
as something that will trigger a huge further decline in DB".
When Joanne Segars of the NAPF gave oral evidence in early March,
she said that she also believed that DB schemes would continue.
She was clear that contracting-out had to end with the introduction
of the STP "because "there is nothing left to contract
out of". Her view then was that the key issue for pension
schemes was to ensure that the change was implemented in a way
that "does not add increased burdens on already hard-pressed
scheme sponsors working hard to keep Defined Benefit pension schemes
94. In oral evidence, representatives of both employers
and the pensions industry made clear that they were satisfied
with the level of engagement they had had to date with the DWP
on the detailed arrangements for contracting-out. They told us
that the negotiations had taken place over a long period and that
they were broadly content with the relevant provisions in the
draft Bill. The IoD said "we are delighted at the way the
Department for Work and Pensions and others are working with industry
to understand and work through the issues."
95. The NAPF said that the draft Bill provisions
"seek to ensure that employers and schemes are able to administer
these changes and the transition to a new system in the most cost
effective manner" whilst avoiding placing additional burdens
on employers who still offer DB schemes.
It said that it was now "working very closely with DWP"
on the detailed arrangements for contracting-out, to be set out
in secondary legislation.
96. However, these views were expressed before the
Government's decision to bring forward the starting-date for the
STP by a year. In response to this announcement, the NAPF reiterated
its support for the reforms but emphasised that "the Government
has to ensure that the implementation of these changes is workable
for pension funds". It highlighted that the new implementation
date created a "very tight timetable" and expressed
concern about "whether it can be delivered". Joanne
Segars argued that "it is essential to give pension funds
the flexibility and time to adapt and make the changes".
She believed that "if the Government gets it wrong it risks
a fresh round of final salary pension closures in the private
sector. Business which get caught on the wrong side of these changes
will lose a significant rebate from the end of contracting out,
and they will question whether they want to continue running these
The NAPF believed "it would be a shame if big mistakes were
made in a rush to implement the changes".
97. The Government's
decision to bring forward the implementation date for the Single-tier
Pension after we had finished taking oral evidence and within
a week of the deadline for us completing the scrutiny process
meant that it was not possible for us to seek the views of employers
and the pensions industry about the implications for them of this
major policy change. However, it is self-evident that having one
year less to prepare for the ending of contracting-out will impose
a significant burden on both groups of stakeholders. Having previously
appeared to listen and respond to the concerns of pension schemes
and employers about the impact of the STP, the Government has
now sprung this earlier implementation date on them. We believe
it is therefore the Government's clear responsibility to work
with these key stakeholders to ensure that the transition to the
ending of contracting-out is as smooth as possible and that already
beleaguered Defined Benefit private sector occupational schemes
do not suffer further adverse consequences.
DEFINED AMBITION PENSION SCHEMES
98. The NAPF highlighted that the ending of contracting-out
might provide an opportunity for further developing the Minister's
ideas for a new form of pension scheme which combined elements
of both DC and DBknown as "Defined Ambition".
Joanne Segars emphasised that if Defined Ambition was going to
be encouraged, this should be done in parallel with contracting-out
ending, so that employers did not have to go through two major
changes in their pension schemes in rapid succession.
In oral evidence, the Minister accepted that he would need to
have Defined Ambition in operation by 2017 and said that "we
are working non-stop" on the plans.
It is clear that the Government's revised implementation date
will place even more time pressure on DWP to develop its Defined
Ambition proposals. We will explore the potential for Defined
Ambition schemes in more detail in our forthcoming report on governance
and best practice in workplace pension provision.
Impact on employees
99. Employees starting to pay full National Insurance
Contributions as a result of the ending of contracting-out will
see an increase equivalent to 1.4% of relevant earnings.
The TUC calculates that on average employees will have to pay
about £350 a year in additional NI contributions.
The PPI estimate was that the maximum additional NICs for employees
would be £480 a year.
100. The Government points out that "around
90 per cent of those reaching State Pension age in the first two
decades after implementation will gain enough extra state pension
over retirement to offset both the increased National Insurance
contributions they will pay over the rest of their working lives
and any potential adjustments to their occupational pension."
101. However, the TUC believes that "removing
the need for trustee consent creates a significant risk of material
losses for individual members". It accepts that "higher
NICs will generally represent good value for money for people
currently contracted out" and acknowledges that, on average,
scheme members will not be worse off because in general they will
be compensated for reduced benefits or higher contributions through
higher State Pension outcomes. But it points out that "because
offsetting measures will be calculated at scheme level, rather
than based on the impacts on individual members, it is highly
likely that some members will be made worse off through this process".
It believes that these changes "will have an immediate detrimental
impact on individual welfare following a long period of wage stagnation,
and alongside higher pension contributions in the public sector".
A number of other trade unions made similar points in their written
102. The Minister emphasised that the private sectors
employers concerned were not "out to do over their employees"
but were simply seeking to offset the additional pension liabilities
arising from the ending of contracting-out. They were "the
good guys. These are the people who are still running final salary
103. We accept
that, on average, employees who were previously contracted-out
will not lose out in the longer term from having to pay increased
National Insurance and pension scheme contributions, because most
will gain enough in increased State Pension to compensate for
this. However, within this average, some individual employees
could lose out and some may face difficulties in the shorter term,
especially if current wage restraints continue. We recommend that
the Government undertakes more analysis of which employees might
fall into this category, so that Parliament can properly consider
what measures, if any, might be put in place to limit losses.
83 DWP White Paper, p 38 Back
DWP White Paper, p 10 Back
DWP White Paper, p 39. Relevant earnings are earnings between
the Lower Earnings Limit (LEL) which is currently £5,564
pa and the Upper Accrual Point (UAP) which is £40,080 pa. Back
DWP White Paper, pp 39-41; see also DWP, Impact Assessment
of Abolition of contracting out - consultation on a statutory
override for Protected Persons Regulations, January 2013,
paras 12-13 Back
DWP White Paper, pp 40-41 Back
DWP, Abolition of contracting out - consultation on a statutory
override for Protected Persons Regulations, January 2013 Back
Ev 73-74 Back
Ev w26 Back
Ev w18 Back
DWP, Impact Assessment for Abolition of Contracting Out -
Consultation on an override for Protected Persons Regulations
, January 2013, paras 57-58 Back
Q 245; see also Q 241 Back
Q 136 Back
Q 78 Back
Q 76 Back
Q 153; see also Qs 76-7 Back
Ev 72 Back
Q 77; see also Q 80 Back
Ev 96 Back
Daily Telegraph, 18 March 2013, "Pension firms warn of threat
to private plans" Back
Q 79 Back
Q 247 Back
DWP White Paper, p 42 Back
Qs 16-17 Back
Q 66 Back
DWP White Paper, p 10 Back
Ev 87 and 89-90 Back
See for example Ev w45 (PFEW); Ev w21 (GMB); Ev w56-7 (Unite) Back
Qs 241 and 243 Back