Examination of Witnesses (Questions 124
WEDNESDAY 6 MARCH 2002
124. May I welcome Mr Peter Robinson, who is
a senior economist at the IPPR, with Mr Richard Brooks who is
a researcher at IPPR? You are both very welcome. You are joined
this morning by Mr John Hawksworth, who is head of the Macroeconomics
Unit at PricewaterhouseCoopers. Gentlemen, welcome and thank you
for your help so far. I see from my morning papers that you have
been busy and we look forward to reading that very detailed and
very interesting piece of work, which you have published this
morning. Why do you not just say a little bit about IPPR and the
work you and Richard do and then I can invite John Hawksworth
to do the same. We have a really long list of technical questions
we should like to try to sprint through, if we may. I am interested
to make sure that you get a chance to say everything you want
to say this morning and you get time to say it. Why do you not
start off by introducing what you are doing? It is the same introductory
question that I put to Andrew Dilnot. What are the upsides and
the downsides that you see in the Government's proposals?
(Mr Robinson) As people are probably
aware, given the media coverage this week, the IPPR has produced
a major report on the funding of pensions and long-term care.
Richard and myself are two of the three co-authors of that report
with our colleague Sue Regan. John Hawksworth from PWC has been
working with us in trying to help us develop our ideas and John
specifically wrote a paper for us modelling different options
for pension reform, which PricewaterhouseCoopers have published
separately but which we shall also be publishing as part of a
technical report to accompany our main report. The obvious thing
to stress is that it is impossible to think about a specific part
of the pension system such as Pension Credit without looking at
the whole pension system, both public provision and private provision.
We have to think of the interactions between the different parts
of the pension system. In terms of the Pension Credit, in terms
of means testing, we signal in our report that we have no problem
with means testing in principle. However, we think that there
are four significant problems with the application of means testing
to retirement income. What was interesting for us was that the
first issue was that from our qualitative work it is clear that
people out there believe there is a difference between means testing
in retirement and means testing during the working life. If you
are a family with children getting some extra help from the Working
Families Tax Credit, you see that as a useful extra supplement
to your income. If you are a pensioner facing means testing, you
see this as an imposition as the Government are taking away a
bit of the saving you have worked hard to accumulate. There is
an equity issue about how people perceive means testing in retirement
which we have to be aware of. The second issue of course is the
issues around the incentives to save, which Andrew Dilnot and
Tom Clark from IFS addressed earlier in the session today. The
third key issue is take up which has also been discussed. Between
one fifth and one third of people currently entitled to the Minimum
Income Guarantee do not take it up and there have to be concerns
about whether take up of the Pension Credit will improve or not.
So long as a large chunk of people entitled do not take up means
tested entitlements, you will continue to have a pensioner poverty
problem. The other issue which has also crept into the discussion
so far is the complexity issue. We think that the whole pension
system rather fails the doorstep test. If members of your Committee
attempt to explain the pension system on the doorstep to individuals,
it is not clear that lots of people really fully understand that
system and see it as the basis on which they can plan for their
own provision in retirement.
125. I am tempted to ask the same last question
I put to IFS in terms of modelling. Has Mr Hawksworth done some
modelling? Would there be anything you could help us with in trying
to calculate using the Government's own first scenario? What percentage
of the general population would be included come 2025 and 2050?
Is this something you might be able to help us out with?
(Mr Hawksworth) In terms of general population?
(Mr Hawksworth) We could calculate the percentage
of the pensioners. In terms of the pensioner population the model
suggests that by 2050 it would be somewhere between 65 and 70
per cent under their scenario one; by 2030 it would be about 60
per cent, give or take a few per cent. It is not a precise calculation.
So in fact quite similar to the figures the Government produced.
Strictly speaking that is for single pensioners; it might be slightly
lower for pensioner couples.
127. We should be very interested in anything
you have to answer that kind of question. Maybe we could arrange
for a note to come to the Committee on that.
(Mr Hawksworth) Yes, we could write a short note.
Chairman: That would be extremely helpful.
128. I want to focus on the incentives to save.
I am going to address my first question to John Hawksworth, if
I may. We know that the marginal rates of tax on savings will
fall for some savers under the Pension Credit proposals. In your
memorandum you said that the effect on savings would be unclear.
Can you elaborate on that?
(Mr Hawksworth) It is really for precisely the reasons
that Andrew Dilnot gave and I would just be repeating exactly
what he said, which I totally agree with, that different groups
of savers would face different effects. Let us take the 2003-04
numbers, with total non-means-tested incomes between £77
a week and £100 a week for a single pensioner. They would
clearly go from 100 per cent to 40 per cent and they would therefore
have more incentive to save. For those people between £100
and £135, they would go from 0 per cent to 40 per cent and
therefore would have less incentive to save compared with what
would otherwise be the case. That is the price effect, sometimes
called the substitution effect. There would also be an income
effect, whereby if they were going to get more income because
of the Pension Credit, that might mean they would decide that
they did not need to save so much. Obviously people are not human
computers who are going to be churning out these calculations
day by day and making their decisions. Therefore it may be that
as they get closer to retirement, they would begin to get an idea
of whereabouts in the income distribution they would fall and
these effects would begin to come through a bit more in terms
of their decisions.
129. May I ask Richard Brooks and Peter Robinson
whether they would like to add anything to that or do you fundamentally
share John Hawksworth's views on that?
(Mr Robinson) We share John's views completely.
130. Last week the Committee heard from the
ABI and they identified three groups that they were concerned
about as far as savings were concerned: those without a full Basic
State Pension; the self-employed; and those with small amounts
of savings. Would you agree with the ABI's concern for those particular
three groups? Are there any other groups you would add to that
(Mr Brooks) One of the groups which will remain facing
the 100 per cent withdrawal rate under the new Pension Credit
will be women between the age of 60 and 65, although we understand
that is a transition issue until women's retirement age equalises
(Mr Robinson) In terms of the three groups you identified:
yes, obviously problems will persist for people who have not accrued
full entitlement to the Basic State Pension, although that problem
ought to be ameliorated over the medium term as more and more
women in particular begin to accrue fuller entitlement to the
Basic State Pension. The self-employed, yes, that is a concern
too because their building up of State Pension entitlements generally
is less secure than for the employee population. The Government's
Pension Credit is designed to try to help those with small savings
in the way that Andrew Dilnot has described, so that is clearly
a group the Government's reform should assist. There are other
groups which will not benefit as much.
(Mr Hawksworth) The ABI was making quite a technical
point about those with small savings, about the fact that it was
not so much they would not gain but the rate of return could still
be relatively low once you took into account other potential effects.
They have proposed that there could be an initial disregard in
terms of a small amount of savings income, which would not actually
be hit even by the 40 per cent. In other words the Pension Credit
makes it better for the small savings because you go from 100
to 40, but you still have that 40 and once you take into account
that the rate of return on quite a small investment may not be
worth while. So you could have a small disregard as for earnings
where there is a small disregard. Obviously that would cost the
Government money. I do not know how much it would cost. You would
have to ask the DWP. It is a question as to whether or not they
think that it is worth spending another something of the order
of £100 million type figure in order to introduce that small
savings disregard into the system.
131. Are there other ways that you think savings
could be better encouraged, which have not yet been looked at
in this area?
(Mr Robinson) We think the best way to encourage savings
would be a dramatic simplification of the overall State Pension
system. That is what we discuss in the report which has been published
this week. We do not think there is much you can do further within
the current system, given its complexities.
Chairman: I should like to come back to that
132. We talked to the ABI, who were concerned
because of the complexity issue, the doorstep issuesI have
to say they talk of little else on the doorsteps of Wolverhamptonthat
their pension advisers, their member groups, would have difficulty
in deciding what would be appropriate advice to someone, particularly
a younger person now, but anyone below pension age, as to what
to do about savings. Do you have any comments on how that might
be clarified for their advisers who are in a sense going to be
trying to flog policies to people to encourage them to save, which
is what we are talking about?
(Mr Hawksworth) All I would comment is that I am glad
I am not an independent financial adviser having to advise on
this because it is phenomenally complicated now to make a decision
for someone on moderate income whether to go for a stakeholder
pension, for example, or whether to contract out of the State
Second Pension. That calculation can now depend on so many imponderables
about the precise life history of that person from that point
on, the precise return on investment, the precise annuity rates
at retirement, whether they were allowed flexibility on those
annuity rates, all sorts of other things that any kind of advice
you would have to give would have to be caveated extremely heavily.
There is certainly a concern that it is making their job very
difficult for people in the target group for stakeholders.
(Mr Robinson) The single biggest advice problem is
the decision about whether to contract in or out of SERPS, or
the State Second Pension. That is an issue I take professional
advice on before making a decision. It is an almost impossible
decision for many ordinary people to make without professional
advice. Of course with the stakeholder regime, it is very difficult
for organisations to provide advice on those kinds of issues.
What has been interesting to see over the last year is how far
the financial services industry has in a sense rolled back in
believing that it can no longer advise very many people to contract
out any more. We shall probably see a drift back to contracting
in to the State Second Pension scheme.
(Mr Brooks) There is also a very real question about
being able to advise people with very low incomes whether to save
at all, additionally to that saving which they are compelled to
do through their National Insurance contributions. As we have
heard from many of the people who have submitted evidence to this
Committee, some of those people face very high benefit withdrawal
rates as a result of making their own provision. Whilst it may
be technically true that under the new system, under the proposed
Pension Credit, it will always pay to save in that your income
will be higher having saved in retirement than it would be had
you not saved, there is a very real worry over what the return
on your savings will be and whether it always pays to save; it
may be seen as a misleading statement in that people may see very
poor returns on their savings despite the fact that their income
will in fact be higher. Advisers are certainly concerned that
they may be accused of allowing people to mis-buy financial products,
to mis-save as a result of that advice.
133. Do you think that financial advisers, if
we are trying to get them to be able to advise people in that
lower income group, are going to start advising people to use
different saving instruments, for example ISAs rather than, subject
to what you said, pension schemes so that they can at least spend
the capital in their retirement, which you cannot with an annuity
based system unless the Private Member's Bill goes through?
(Mr Robinson) The problem is that they are going to
have to hedge everything they say so much.
134. They do that anyway.
(Mr Robinson) They are probably going to create as
much confusion for their potential customers as clarity because
they cannot offer clear advice. They have to say, "If you
do this, the consequences could be X, Y, Z. If you do this, the
consequences could be A, B, C". It is very difficult for
them to give clear advice, given the whole way in which the State
Pension system interacts with private savings of various kinds.
That is why the pensions industry is coming around to viewing
a dramatic simplification of the whole system as a first order
priority for them.
135. So they can advise.
(Mr Robinson) Yes.
136. Picking up a point you made about the State
Second Pension, may I ask you the question which has been asked
of other people who have given evidence to us? How do you see
the new Pension Credit interacting with the State Second Pension?
(Mr Robinson) Once the whole system has matured someone
who works their entire life making contributions to accumulate
rights to the State Second Pension will retire on a combined income
from their State Second Pension and Basic Pension, which is below
the level of what we now call the MIG. They will automatically
fall into means testing from day one of retirement, which makes
you question what the State Second Pension is for.
137. Does it also make you doubt the role of
the Basic State Pension as the foundation of our pension system?
(Mr Robinson) Yes. If you continue to price index
the Basic State Pension, it continues to fall in relation to average
earnings down to 7 per cent or less by the middle of the century,
it is very hard to see how one can then continue to regard that
as the bedrock on which other pension provision is made.
(Mr Hawksworth) Just to give some figures, we are
talking about the MIG, if it is earnings indexed, which is current
Government policy at least for this Parliament and probably an
aspiration beyond that, it stands at 21 per cent of average earnings.
The Basic State Pension, depending on exactly what you see about
real earnings growth, will probably go down by 2050 to 6 or 7
per cent of average earnings. The mature State Second Pension
in its second stage flat rate will probably give you, according
to some calculations, about 11 per cent of average earnings. You
will be talking maybe at best about 17, 18 per cent of average
earnings therefore compared with the 21 per cent falling 3 to
4 per cent of average earnings below the MIG. That obviously was
not the original intention. The State Second Pension was meant
to raise people above the MIG, but by making the MIG more generous,
you inevitably fall into that situation which is may be why Mr
Dilnot was making some of the comments he made about the tensions
within the current system.
138. The estimates which have been made, the
DWP's and indeed your own, about the cost of the Pension Credit.
Obviously you accept that there has to be a wide range of target
figures because it is based on assumptions particularly about
the take-up of private pensions. What assumptions have you made,
what assumptions have you built in to your calculations and are
these the same as the Government's?
(Mr Hawksworth) Not exactly. They are detailed in
a paper which I sent to the Committee three weeks ago and also
to some extent an earlier paper I wrote in December 2000. Effectively
we assume that productivity growth in the economy is 2 per cent
per year. That is a typical trend rate; the Treasury typically
assumes that. Therefore real earnings growth is the same as productivity
growth in line with the assumption that labour share of national
income remains constant in the long run. We then made certain
assumptions about employment rates, which effectively come down
to saying that the average employment rate per age group, averaged
across men and women, will stay broadly constant over time, except
for some assumed increase for women between 2010 and 2020, for
older women, as a result of the increase in state retirement age.
That then generates a series of numbers for GDP growth. Broadly
speaking, on average over time, GDP growth is about two per cent
over the whole period, slightly higher initially, slightly lower
later. It also generates, using the Government Actuary's Department's
population projections, a figure for the ratio of workers to pensioners.
This is the key figure. At the moment we have about two and half
workers per pensioner. By 2040 it will be about 1.75. Now we have
10 workers to provide for every four pensioners where in future
we might have seven. That will flatten off after 2040 as the baby
boom retirement bulge works its way through the system. Fundamentally
that is the issue, that is what drives the numbers. We then assume
in our main case that the MIG or Pension Credit guarantee is linked
to earnings so it goes up by 2 per cent in real terms. The Basic
State Pension goes up in line with prices; effectively policy
scenario one here which seemed to me most plausible when I originally
read the DWP paper. We also assume certain things about the income
distribution going forward. We assume that pensioners on lower
incomes will have a higher than average increase because of the
State Second Pension and we assume that pensioners at the very
top of the income scale will tend to have a higher than average
increase in line with historic trends. Pensioners in the middle
will have a broadly average increase in their incomes over the
Basic State Pension
139. What about the assumptions about private
pension take up, in particular, to set that in context, the point
about the estimate that 70 per cent of all pensioners will be
entitled to the Pension Credit?
(Mr Hawksworth) Up to 70 per cent; 65 per cent.