CURRENT STRENGTHS AND WEAKNESSES
33. Despite the obvious difficulties and problems
that have attracted so much media attention recently, the UK pension
system has a number of strengths and in many ways is in a stronger
position to deal with the challenges ahead than many EU countries.[40]
Unfortunately, the UK pension system is also bedevilled by some
serious weaknesses. In evidence, witnesses emphasised different
weaknesses, but in the main there was a large degree of agreement
over the main strengths and weaknesses.
Strategic strengths
Reasonably high average income
34. An overall strength of the UK system could be
seen in what it delivers for the majority of people. Professor
Disney told us that the mixture of public and private provision
that we have "has generated quite a high level of income
for retired people relative to when they were at work, comparable
with other European and OECD countries."[41]
According to the Government:
"Current pensioners have, on average, an income
that is equal to around twothirds of the average earnings
of workingage people just before retirement. This suggests
that their own replacement rates in retirement might be close
to around twothirds of their own earnings. This rate is
high by historical standards. Pensioners' incomes have outstripped
average earnings consistently over the past 20 years due to growth
in the coverage of private (especially occupational) pensions,
the maturing of SERPS and strong returns on investments. Twenty
years ago, the replacement rate was lower around 60 per
cent."[42]
Reasonably wide coverage
35. There are currently 10.1 million employees acquiring
rights to occupational pensions and around 3.4 million with personal
pensions.[43] In Great
Britain, 57 per cent of all employees are contributing to a nonstate
pension, leaving 43 per cent of all employees who are not currently
contributing.[44] Mr.
Jory (B&CE) said that a strength of UK pension provision was
"the comprehensive range of different types of pension arrangements,
which means that most people have access to some kind of pension
arrangement".[45]
Ms O'Connell (PPI) said that the mixed economy nature of pension
provision was also a strength of the payasyougo
state pensions and a big funded private system. The CBI told us
that:
"We have a lot of success, we have got over
five million members of private sector occupational pension schemes
and they are providing already pensions for five million pensioners.
Employers have played a role, they will want to continue to play
a role, but the key challenge for us now is how we can bring more
people to the party and address some of those issues about the
outsiders, people outside the party, and how we can bring more
of those in."[46]
36. Mr O'Halloran (FSB) considered that a strength
of the United Kingdom's pension scheme was that both State and
the private sector had built up the system over years.[47]
The Minister for Pensions, Ian McCartney, also identified the
mixed nature of the present system as a strength:
"there is no such thing as a perfect pension
system, whether it is one that is dictated solely by the state
or, in our instance, a quite sophisticated partnership. We are
one of the few [countries] who have got that strength and many
of our overseas counterparts are now struggling because they do
not have this mixture."[48]
37. It was pointed out that every country is trying
to get the mix right between state pension provision and private
pension provision. Professor Disney told us that another success
of the UK system is that on occasion it has been possible "to
reform the whole pension programme, without the upheavals and
political difficulties of some other countries."
Relatively affordable over the medium
term
38. Arguably the main strength of the state pension
system is that it imposes a relatively low burden on the Exchequer
and national income and has not created any fiscal problems. Professor
Disney told us we have not got ourselves into the "fiscal
difficulties that many countries on the continent have that are
overreliant on payasyougo state provided
pensions".[49]
39. A number of witnesses also mentioned the affordability
of UK state pensions and the forecast that state pensions will
rise from about 5 per cent of GDP to about 6 per cent over the
next 50 years. Ms O'Connell (PPI) contrasted this with the position
in other countries where costs are expected to "grow from
10 per cent to about 15 per cent". She said that the UK was
"constraining costs at a time of changing demographics".[50]
Professor Blake told us that relative to the rest of the continent,
our system is in pretty good shape, if it can be simplified, compared
with the systems in continental Europe. Their "pay as you
go systems are close to bankruptcy and ours is not."[51]
Ms Drake (TUC) also identified that the UK system was:
"relatively cheap as a percentage of GDP compared
with the rest of Europe¼
[and that there had been]¼some
good initiatives taken by the Government, for example: Winter
Fuel Payments, free TV licences and free eye sight tests."[52]
40. The Faculty and Institute of Actuaries (FIA)
identified that "the issue for the UK is thus not the affordability
of state pensions but their adequacy". Table 1 shows that
spending on public pensions as a share of national income is currently
lower in the UK than any other EU country, and moreover that every
other country's expenditure is forecast to rise whereas the UK's
expenditure is forecast to fall, excluding the costs of Pension
Credit.
Strategic weaknesses
Pensioner poverty
41. Despite the strengths outlined above, witnesses
identified a series of weaknesses. Firstly, pensioner poverty
and inequality of pensioners' incomes were identified as weaknesses
by some witnesses who pointed out that over the last quarter of
a century pensioners in general have done very well, with pensioners'
real income (gross or net, before or after housing costs) of all
pensioner units growing by more than the growth in earnings. For
example, the FIA told us that over the period 1979 to 199697
pensioner incomes grew by approximately 60 per cent compared with
a growth of 36 per cent in real earnings over the same period.
Although more recent figures may be less reliable, the picture
is likely to be similar with the real increase in pensions greater
than the real increase in earnings. The better off pensioners
are likely to be those who are in receipt of occupational pensions.
It is estimated that the average real income from occupational
pension schemes has increased by 152 per cent between 1979 and
199697 compared with 39 per cent for benefit income. To
a large extent this explains the inequality in pensioners' incomes
and underlines the success of occupational pension schemes. Peter
Robinson (IPPR) told us that despite a lot of sympathy for the
Government's objective to tackle existing pension poverty, there
was evidence that it was not meeting its objective. He said "the
Department's Fourth Annual Report Opportunity for all'
shows that despite the introduction of such reforms as the more
generous MIG, pensioner poverty did not decline during the first
term of the Labour government, although this is likely to be explained
by the fact that the most uptodate statistics on pensioner
poverty do not take account of more recent Government proposals
such as the Pension Credit.
42. However, the figures in the Fourth Annual Report
contradict Mr Robinson's claim, showing that absolute poverty
has fallen significantly and that relative poverty has either
stabilised or fallen, depending on the measure employed. The number
of pensioners in absolute poverty has fallen both before and after
housing costs - from 27 per cent in 1996-97 to 15 per cent in
2000-01 for the latter measure. This is a substantial achievement,
with the poorest third of pensioners set to be £1,500 a year
better off in real terms by 2003-04. In terms of relative poverty,
i.e. the incomes of pensioners compared to average earnings of
the population, the picture is less clear. Relative poverty amongst
pensioners has been on a long term increase - with 29 per cent
of pensioners earning less than half of average incomes in 1996-97,
up from 17 per cent in 1979. Since 1996-97, relative poverty amongst
pensioners has fallen from 27 per cent to 25 per cent using the
measure of income after housing costs. Taking the measure before
housing costs, pensioner poverty rose from 21 per cent in 1996-97
to 23 per cent in 1998-99, before falling back down to 22 per
cent in 2000-01, following the Government's decision to peg the
Minimum Income Guarantee to earnings. The introduction of the
Pension Credit should mean that relative pensioner poverty will
start to fall on this measure too.[53]
We commend the Government on their commitment to tackle pensioner
poverty, and their achievement in reducing poverty on three of
the four measures in the Fourth Annual Report, but believe that
there are still too many pensioner households in poverty, and
call on the Government to continue to improve their incomes, in
relative and absolute terms.
Excessive complexity
43. One dominant theme throughout the evidence submitted
to our inquiry was the excessive complexity of pensions. According
to Professor Disney, the complexity covers both public and private
programmes. As regards state pensions, he said the complexity
involves interaction between Minimum Income Guarantee and the
Basic State Pension, SERPS which will be replaced by the Second
State Pension, and the Pension Credit guarantee. He added that
it was "an incredibly complicated structure" and was
not clear "what it is designed to do exactly."[54]
44. As regards private pensions, Professor Disney
pointed out that there is "a vast variety of instruments
for purchasing pensions, remaining contracted in or contracting
out of the state pension, money purchase, defined benefit and
so on, so a large array of very complex, probably over complex,
alternatives."[55]
We were told that the complexity was such that it was difficult
even for experts to understand the legislation and the complications
around accumulating pension entitlements.[56]
Lack of understanding
45. Related to the weakness of complexity is the
lack of understanding that many people have about the workings
of their own pensions, especially for people not in a defined
benefit scheme. We heard that many people would be unclear about
their future pension benefits.[57]
Ms O'Connell (PPI), who pointed out that benefits were not guaranteed
in advance, told us that:
"We are not certain what we are going to get,
and that is a problem that is getting worse as means testing increases
because means testing can be changed much more quickly than pensions
rights which are more enshrined in legislation."[58]
46. Although a degree of uncertainty is attached
to any form of investment, it seems to be more problematic when
attached to pensions. Ms O'Connell (PPI) told us that:
"People do not understand the true cost of pensions
and people do not understand that that increases as we live longer.
People have implausible expectations of early retirement as well.
I think we have a crisis of unclear responsibilities among the
three components of the system the state, the employer
and the individual. It is not clear that each one of those knows
what it should be doing and what the others are doing. It is not
clear that the right amount of money is being put into the system."[59]
Disincentives
47. Another general weakness in the pension system
was said to be the conflicting message that is being given to
the low to moderate earners, i.e. those people for whom Stakeholder
Pensions were targeted with regard to the Minimum Income Guarantee.
We heard that a number of workers were discouraged from joining
pension schemes by the complexity of the legislation that surrounded
different pension plans and by "the prevalence of meanstested
benefits".[60] Mr
Jenkins told us:
"We find a lot of our members are fully pension
aware and they are not joining pension schemes because they are
pension aware; they have made the calculations and they know it
will be of little benefit to them."[61]
48. One particular problem that may result from targetting
resources through meanstesting, which we also identified
in our report on Pensioner Credit,[62]
is that poorer pensioners may find that they are no better off,
or not much better off, by having saved compared with the position
if they had not saved at all for their retirement. The Minister
confirmed in a supplementary memorandum to us that some pensioners
could face 'marginal deduction rates' of 40% or even 100%; that
is, they could be only 60 pence better off, or no better off at
all, for each £1 of extra pension income they have generated'.
For example, he told us that pensioners with incomes below the
level of the Basic State Pension who will be receiving the guarantee-only
element of Pension Credit "will continue to face a marginal
deduction rate of 100%, although compared to the situation under
the Minimum Income Guarantee (MIG) the numbers facing 100% marginal
deduction rates are expected to reduce considerably."[63]
Given that the vast majority of those with income below the Basic
State Pension will have been poor or not working before retirement,
it is unlikely that it would have made financial sense for them
to save towards a pension. The State guarantees them a far higher
retirement income than they would have been able to afford through
saving. The Minister pointed out that under Pension Credit around
half of those eligible who will be entitled to both the guarantee
and savings credit will see their withdrawal rate fall from 100%
to 40%."[64] The
Minister also confirmed to us that those pensioners receiving
the savings credit element only of Pension Credit, who also pay
rent and receive Housing Benefit and Council Tax Benefit "will
face a combined taper of 91%" whereas pensioners who pay
rent who have income beyond the endpoint of Pension Credit "will
face combined Housing Benefit/Council Tax Benefit tapers of 85%."[65]
49. In his oral evidence to us Professor David Blake
of the Pensions Institute referred to a newspaper article that
he had seen suggesting that the value of the Minimum Income Guarantee,
indexed to earnings, was £92,000.[66]
He added that if this were true then:
"You would have to build up a fund of £92,000
to buy an annuity equivalent to the Minimum Income Guarantee.
That provides a huge disincentive to a whole range of lower income
people ever getting anywhere near to building up the savings and
not even lower income people but people with reasonable incomes
to build up a fund of £92,000. The average amount going to
annuitisation today in insurance companies when people retire
is £30,000, that is the average amount annuitised, and yet
we have this £92,000 alternative to saving out there with
the Minimum Income Guarantee. To me that provides the biggest
disincentive. For people below a certain level of income
I cannot figure out what it would be at the moment it would
not be sensible for them to save at all for their pension simply
because they can get this alternative benefit."[67]
50. The figure of £92,000 referred to by Professor
Blake, which has been widely reported in the press, is clearly
dependent on the underlying assumptions and in these bald terms
is misleading as it takes no account of the Basic State Pension.
So in order to explore this further we approached Deborah Cooper,
a fellow of the Institute of Actuaries who works for Mercer Human
Resource Consulting Ltd, to work out the value of the Minimum
Income Guarantee under some reasonable assumptions. She estimated
that to purchase an annuity that paid £98.15 a week indexed
to earnings growth would cost £97,000, which is how much
a man aged 65 with absolutely no other income would need to pay
for an annuity equal in value to the MIG. However, in practice
many individuals have a full entitlement to the Basic State Pension.
Deborah Cooper estimated that to purchase an annuity that paid
£75.50 a week indexed to prices would cost £60,000,
which is how much a man aged 65 with absolutely no other income
would need to buy an annuity equal in value to the Basic State
Pension. These figures highlight the extent to which the state
is focussing resources on lower income pensioners. They also highlight
the extent to which lower income individuals of working age face
a diminished incentive to save for retirement due to meanstested
benefits. The calculations above suggest that a single man with
a full entitlement to the Basic State Pension would need life
time savings of only £37,000 (£97,000 minus £60,000)
in order to top up their income to that provided by the Minimum
Income Guarantee, not the £92,000 mentioned by Professor
Blake. A single woman, on the other hand, would need a larger
amount owing to her higher average life expectancy. Potential
income from Housing Benefit and Council Tax benefit would lead
to increased estimates of the size of the fund that would lift
an individual out of eligibility for meanstested benefits.
51. Similar numbers were also calculated for 2050,
assuming that the MIG (or Pension Credit guarantee, as it is set
to be renamed) is indexed in line with earnings while the Basic
State Pension is increased in line with prices. These calculations
also allow for an increased average life expectancy. An annuity
that provided a level of income equal to the MIG/Pension Credit
guarantee is calculated to cost £282,000 at today's prices.
An annuity that provided a combined income from the Basic State
Pension and the State Second Pension is calculated as costing
£187,000. This gives a difference of £95,000. The fact
that this is increasing over time is also not surprising
since it highlights the growing generosity of the MIG/Pension
Credit Guarantee relative to the Basic State Pension arising from
the former being indexed in line with earnings while the latter
is increased in line with prices. The various calculations demonstrate
that, regardless of the precise underlying assumptions, individuals
will be required to accumulate a relatively large fund (possibly
as high as £282,000) in order to be above the level of meanstested
benefits.[68]
The distribution of tax relief
52. On tax incentives, a relatively large proportion
of tax relief benefits the higher income groups. In evidence the
Minister stated that of the estimated £6.4 billion relief
on contributions by employees and the selfemployed in 200102
around £3.7 billion was in respect of higher rate taxpayers.
On employer contributions, in broad terms, of the total of £9.5
billion around £5.4 billion was in respect of higher rate
employees.[69] This means
that some 57 per cent, or £9.1 billion of £15.9 billion,
of tax expenditure is being absorbed by higher rate taxpayers,
who account for 10.4 per cent of all taxpayers.[70]
The effectiveness of this tax expenditure is open to doubt especially
since it is of disproportionate benefit to those who least require
incentives to save. The Government acknowledges that while academic
research suggests that the allocation of savings may be affected
by tax relief, "there is little evidence that tax incentives
can significantly increase the overall level of saving".[71]
Some witnesses made the point that tax relief was tax deferral.
For example, Alan Pickering told us:
"You ultimately pay tax on your pension if you
draw enough to lift you above the personal retired person's allowance.
It is more tax deferral than a tax incentive. But I think that
tax deferral is a very important incentive to persuade people
to save long term. The fact that you do not pay tax on the money
until you actually have the money at your disposal to spend is
perhaps the only reason why people would save through a long term
pension savings vehicle rather than through a bank account or
an ISA because the net effect of the ISA tax regime is not much
more attractive to a basic rate taxpayer than the tax regime applicable
to a pension scheme."[72]
53. Ms O'Connell (PPI) said:
"¼
tax incentives are tax deferrals and not tax avoidance. There
is about [£]6 billion of tax that people as pensioners pay
on the income they receive as occupational private pensions."[73]
We believe that the current distribution of tax
relief should be reviewed especially in the light of the current
debate on the abolition of higher rate tax relief and that consideration
be given to a system of matching contributions.
Lack of clear vision
54. Some witnesses identified the absence of any
clear vision or overall objectives as a major weakness.[74]
Professor Disney told us:
"there has never been the big picture out there,
in other words, where is this reform going? A failure is perhaps
to say, what is it we really want to end up with in terms of the
British system? Do we really want all this complexity or do we
want to end up somewhere simpler? Quite often in the reform process
you cannot discern what that end point is."[75]
55. We were also told that the UK system was not
accommodating future trends. According to Professor Blake, "any
pensions system must think 70 years ahead or more if it is looking
at its viability."[76]
He said that the factors of ageing and falling fertility were
making pay as you go systems increasingly difficult to sustain
over a long term basis and the traditional defined benefit, employer
based schemes were less suitable to the long term future when
the emphasis would be on increased labour mobility. A number of
witnesses took a contrary position and saw the move away from
DB schemes itself as a major weakness in UK pension provision.
For example, according to Mr Jenkins (UNISON):
"the closing of good final salary schemes and
defined benefit schemes and their replacement with inferior products
and, in particular, inadequately contributed money purchase schemes"
was a major problem because it shifted the "investment risk
and the whole cost of the pension to those least able to afford
it."[77]
He added:
"We obviously share the view that some employers
are backing away from the pension promise and we see the main
problem as employers taking the opportunity to cut costs at this
juncture, using the various excuses of increasing costs in the
current economic climate."[78]
56. The decline of the mixed economy approach was
also identified as a major weakness. Under the mixed economy approach,
or shared responsibility, the State agreed to provide the basic
pension with workers and employers supplementing those arrangements
through the occupational system. The TUC told us:
"That notion of shared responsibility has now
been eroded. There has been a huge shift of the risk and provision
of pension to the employee. It is not feasible for the individual
employee to carry that burden. It simply is not possible. This
erosion of this concept of shared responsibility is now one of
the greatest weaknesses in the British pension system."[79]
57. The TUC cited the declining value of the Basic
State Pension when expressed as a proportion of earnings as evidence
of the erosion of this shared responsibility. The TUC said: "the
break between the Basic State Pension and earnings is now, we
feel, a fundamental weakness."[80]
58. The UK pensions system has a number of general
strengths and weaknesses which are widely recognised. We were
struck by the extent to which the private sector and state provision
were treated separately as if in separate silos or watertight
compartments, whereas in reality people were subject to the complex
interaction of the two systems. A clear vision of future pension
provision must encompass both systems. We do not feel the Green
Paper sufficiently considered the effect of the interaction between
state and private systems.
State Pensions
59. A particular strength of state provision is that
the Government has tried to stabilise the growth in pensioner
poverty by targetting additional resources towards the poorest
pensioners.[81] In evidence
the Minister stated:
"The Government's immediate priority has been
to focus resources on those pensioners who need them the most.
As a result, for those on the lowest incomes, the foundation of
support provided by the State will take them close to or beyond
[the two benchmarks: twothirds of earnings (close to the
replacement rates of current pensioners); and half of earnings].[82]
60. The Minister pointed out that for those with
low lifetime incomes, replacement rates provided by the State
on retirement are more than 100 per cent. In the case of somebody
on £100 per week, their replacement rates will be 137 per
cent. The Minister told us:
"The minimum income guarantee, rough and ready
as it is, was designed to tackle immediately that floor of poverty.
I do not think there is a Member in here who does not get from
their surgery constituents who say, "I have got a very small
pension", or, "I have got a very small set of savings".
The cliff edge effect between the state and private provision
means that they get no real benefit from additions to their pension
or income. What we then have to grapple with in the context of
resources available is, how do we first of all guarantee a system
that helps those in poverty who are excluded from the Basic State
Pension and those who are in the system, who have little or no
additional resources but who are penalised for those additional
resources? How can we ensure that we have a Pension Credit which
recognises savings now but in the future encourages people to
save?"
He went on to say:
"That is why the three interlocking measures
are there. There are intellectual arguments about whether it should
be done that way or this way, but in the end a judgement has been
made by ourselves, and we hope it is the right judgement, but
it is certainly true that from October this year significant numbers
of pensioners will have substantial increases in their income
that would not have been there if it had not been for the major
changes through Pension Credit."[83]
61. In terms of weaknesses of state pensions, many
who submitted evidence to the Committee had concerns with the
importance of income related benefits in delivering support to
pensioners. The Equal Opportunities Commission stated that "the
UK relies more heavily than many other countries on meanstesting
as a means of raising the income of the poorest pensioners".[84]
Age Concern stated that the Pension Credit:
"remains a benefit based on an assessment of
income, savings and other factors and as such is likely to still
have some of the main problems of incomerelated benefits
namely: incomplete takeup; complicated and expensive administration;
and an impact on incentives".[85]
62. Table 2 gives the percentage of families who
are eligible for any meanstested benefit, both before and
after the Pension Credit reform by age. This shows that it is
already the case that over half of families aged 60 and over,
are entitled to some meanstested benefit and that this is
set to rise to 58 per cent as a result of the Pension Credit reform.
Projections from both the Department for Work and Pensions (DWP)
and the Institute for Fiscal Studies (IFS) suggest that current
policies imply the proportion of pensioners eligible for the Pension
Credit will increase over time.[86]
Table 2. Percentage of families entitled to means-tested
benefits, without and with Pension Credit reform.
Note: In
couples, age refers to the age of the oldest person in the couple.
Source:
Banks, J.,
Blundell, R., Disney, R. and Emmerson (2002), Retirement, Pensions
and the Adequacy of Saving: A Guide to the Debate, IFS Briefing
Note No. 29 (
www.ifs.org.uk/pensions/bn29.pdf).
63. Several providers of Stakeholder Pensions
pointed to the difficulties of selling pensions to individuals
who might be in receipt of meanstested benefits. For example
Lloyds TSB/Scottish Widows stated:
"targeting support also creates difficulties,
particularly with those who are just above the level where they
qualify for support. The Pension Credit aims to mitigate that,
but has not been set at a level which generally makes saving attractive.
Because the extra Minimum Income Guarantee (MIG) benefit from
personal income is reduced by 40 pence for every pound, people
who may qualify are actually better off spending than saving.
The loss of Housing Benefit and Council Tax benefit can make the
position even worse for some."[87]
We conclude there is nothing inherently
wrong with a means-tested approach which focusses available resources
on the poorest pensioners, if the issue of "take-up"
is adequately addressed.
Private pensions
64. As noted above, one distinctive feature
of UK pension provision compared with similar European countries
is the relatively high reliance on private pensions. During the
course of our inquiry a number of strengths and weaknesses of
private pension provision were raised. Mr Jory (B&CE) told
us that the comprehensive range of different types of pension
arrangements meant "that most people have access to some
kind of pension arrangement." Mrs Harriet Maunsell, Chairman
of the Occupational Pensions Regulatory Authority (Opra) told
us:
"The strengths of the current private
pension system are that it is very wideranging; it covers
almost every way in which an employer and employee might wish
to save, insured schemes, selfadministered, small, large.
As a result that has been very successful: large amounts of money
are saved, in certain segments of the general population. The
average figure overall is very high, but that is skewed."[88]
65. Private pension provision can take
a number of different forms such as occupational, personal and
stakeholder schemes. Some schemes are employer-sponsored. Occupational
pension schemes are generally one of two types:
Defined benefit schemes provide
an individual with a pension that depends on their salary and
their job tenure. The salary that is taken into account is often
an individual's final salary and hence these schemes are typically
known as final salary schemes. For example a scheme might offer
an individual 1/60th of their final salary for each year of service.
This would lead to an individual with 40 years of service receiving
a pension worth 2/3rds of their final salary.
Defined contribution, or money
purchase schemes, provide individuals with an annual contribution
to their pension. The amount of income that the individual will
receive in retirement will then depend on the investment performance
of the fund and the annuity rate at the time that the pension
is purchased.
66. A number of witnesses commented on
two developments within private pension provision: the switch
from DB to DC employer sponsored schemes and the degree to which
Stakeholder Pensions had been successful.
Switch from Defined
Benefit to Defined Contribution schemes
67. The Committee received evidence from
a number of witnesses that increasing numbers of employers were
closing DB schemes to new members and replacing them with DC schemes.
According to the Norwich Union, "23 per cent of private sector
employers with defined benefit schemes say it is likely that they
will close them to new employees in the next two years, whilst
a further 23 per cent say that this action has been taken within
the last two years".[89]
68. According to the CBI Employment Trends
Survey 2002 (ETS), "24 per cent of firms had closed their
final salary scheme to new entrants in the past five years and
12 per cent are considering doing so. However, the majority of
companies offering a defined benefit retirement scheme have no
plans to alter that provision."[90]
According to NAPF, the number of companies closing their final
salary pension schemes to new members has nearly doubled in the
last year.[91] The TUC
cited evidence by the NAPF that employers that had not closed
their DB schemes were considering altering other terms, such as
reducing their accrual rate.[92]
69. Although some witnesses may have been
unsure of the precise extent of the switch from DB to DC schemes,
most were clear that a transition was occurring. For example,
the PPI stated:
"The wholesale shift to DC is not
100 per cent, although it is happening."[93]
70. A number of reasons were put forward
to explain the move from DB to DC schemes. The CBI said that benefits
had "been ratcheted up" for so many years that costs
were going "out of control" and employers needed to
contain them.[94] The
CBI added that some employers "have switched because defined
contribution schemes are better and more suitable for their employees
but for others, affordability clearly has been an important issue.
Recent changes in government policy, the demographics of an ageing
population and poor stock market returns have greatly increased
financial and administration pressures on employers sponsoring
occupational schemes."[95]
71. The SPC agreed and said:
"There are a number of employers
who have changed their defined benefit scheme and made it worse,
as well as there are employers who have replaced defined benefit
with defined contribution and not made it worse. The other point
is, from the point of view of the benefits people are accruing,
the changes generally are for the worse, and therefore the pensions
people are earning this year are probably less than they were
earning last year. From the point of view of the burden on employers,
the CBI are right, it is going up, because employers with defined
benefit schemes are having to finance the falls in investments.
And so what we have is an unfortunate position that the pension
rights that people are accruing are smaller but the burden on
business is still growing, and that is all driven by investment
markets."[96]
72. The TUC stated that "the principal
reason for the closure of final salary schemes is that employers
are looking to reduce costs."[97]
Mr Robinson (IPPR) said that some employers had decided that their
current pension system was unaffordable and had switched to the
DC scheme as the means of achieving such cost savings.[98]
Mr Jenkins (Unison) said that the closing of good final salary
schemes and their replacement with inferior products and, in particular,
inadequately contributed moneypurchase schemes, was "a
major problem" because it was shifting the investment risk
and the whole cost of the pension to those least able to afford
it. He added that:
" We obviously share the view that
some employers are backing away from the pension promise and we
see the main problem as employers taking the opportunity to cut
costs at this juncture, using the various excuses of increasing
costs in the current economic climate."[99]
73. Some of the evidence to the Committee
stated that final salary schemes were preferable to DC schemes.
For example the Alliance of Occupational Pensioners was "firmly
of the view that the final salary schemes are the best route to
ensuring a decent income in retirement."[100]
74. However, many witnesses pointed out
that the switch from DB to DC was not, in itself, a bad thing.
Much depended upon the level of employer contributions and the
ability of employees to manage the extra risk associated with
DC schemes. It was pointed out that there were advantages and
disadvantages in the two ways of an employer providing pensions
for its employees. For example, the PPI stated:
"It is very finely balanced as to
whether or not DB is better than DC. The answer will vary for
individuals and probably in certain types of industry as well
where there might be more shortterm working than longterm
working. I do not think one should be prescriptive about this.
What perhaps we could do is recognise that [moving from] DB to
DC puts more responsibility on the individual employee to understand
pension arrangements to make sure that the contributions are sufficient,
they have to choose their own investments, they have to manage
the pension much more actively than they did when they could rely
on getting twothirds of final salary. It is a different
type of behaviour that is necessary."[101]
75. It was put to us that in some cases,
DC schemes may be more appropriate, especially for people who
experience a lot of labour mobility during their working lives.
OPAS stated:
"I do not think the media has helped
by continually referring to final salary schemes as the RollsRoyce
of pension schemes being replaced by inferior money purchase schemes,
the phraseology which is used. The reality is that an adequate
final salary scheme is not as good as a properly funded and supported
money purchase scheme. A money purchase scheme for young people
has a long time to grow and develop in terms of what the pensioner
is going to get and has some advantages in that it is more transportable,
you can move them across. Those¼positive vibes have not been
made in support of money purchase schemes. The mantra is final
salary good, money purchase bad. It is by no means as simple as
that and probably more education is required on that to try to
get the message across. ¼one of the advantages of the final
salary scheme is that it is supposed to guarantee a particular
level of benefit regardless of how the Stock Market does, which
of course is not the case with a money purchase scheme. If it
works properly and the employer is still there and solvent, then
a final salary scheme would usually be better than a money purchase
scheme, but a good money purchase scheme would for some people
often be better than a final salary scheme, depending on the actual
accrual rates and various other factors."[102]
76. We heard that changes in rules and
tax incentives can trigger significant changes in an individual's
behaviour, such as affecting the amount that is saved and whether
retirement is delayed or encouraged.[103]
According to Professor Blake, defined contributions (DC) schemes
are associated with increased savings and delayed retirement,
whereas defined benefits (DB) schemes increase savings but encourage
early retirement.[104]
Professor Blake added that lowcost defined contribution
pension schemes were an effective vehicle for encouraging longterm
savings for retirement, but that a number of barriers needed to
be overcome, such as high marketing and setup costs, which
can especially affect lowincome groups. Alison O'Connell
drew attention to other factors that needed to be overcome such
as consumer apathy, uncertainty about the savings needed and savings
disincentives from a meanstested safety net.[105]
77. The CBI said that it was an "old
view" and a "false perception" to consider that
final salary pension schemes were the best for all employees":[106]
"Media and trade union claims that
these schemes represent an inferior form of pension provision
have helped to create the perception that defined contribution
schemes are a second class form of pension provision and that
therefore the closure of some final salary schemes represents
a 'crisis' in UK pensions. Such scare mongering runs the risk
of discouraging employees from joining highquality DC schemes
and exacerbates the problem of people not saving for retirement."[107]
78. Under some circumstances, DC pension
schemes have the potential to produce a pension in excess of somebody's
final salary.[108] Such
a relatively high return would be especially attractive to workers
on modest incomes, who are perhaps least attracted to final salary
schemes.[109]
Employer contributions
79. DB and DC schemes are examples of
how an employer might decide to design the benefits of its pension
scheme and hence part of its remuneration package to its employees.
But the key issue concerning the switch from DB to DC, which was
addressed by a number of witnesses, was the level of contributions
by an employer to a pension scheme. For example, Professor Disney
said:
"The issue is not DB to DC per
se, the issue is [whether] the transition [is] being used
to cut employer contributions."[110]
80. Official statistics showed average
employer contributions to DB pension schemes in 2000 were 16.1
per cent compared to 8.5 per cent in defined contribution pension
schemes.[111] Figures
reported in the press from actuaries Mercer Human Resource Consulting,
showed employers have cut contribution levels from 6.3 per cent
to 6 per cent of staff salaries since 2000.
"The cuts are in addition to a stock
market decline of more than 20%. Average employee contributions
were 3.3%, giving a total contribution of 9.3% of members' annual
salary. Most final salary pension schemes need funding levels
nearer 18% of salary to provide a pension worth two thirds of
final salary after 40 years' service."[112]
81. The TUC gave an example of an employer
who had closed the final salary scheme to new members, which had
an employer contribution of about 14 per cent, and replaced it
with a money purchase scheme that had an employer contribution
of just 2 per cent.[113]
The TUC calculated that for an employee on average earnings, all
other things being equal, this change would result in the employer
providing £2,750 per year less in pension contributions.[114]
The TUC also gave an example of an employer switching from a noncontributory
final salary scheme, in to which it paid 16 per cent, to a DC
scheme with employer contributions of 5 per cent.[115]
According to the TUC, the employers' contribution represented
deferred remuneration and the reduced contribution amounted to
a pay cut.[116] A number
of witnesses referred to the contributions holidays that some
pension schemes had enjoyed in previous years. For example the
TUC told us:
"Contribution holidays have typically
favoured employers over employees. Overall 94% of surpluses were
used to either reduce employers' contributions or give them a
contribution holiday, less than 6% went on employee contribution
reductions, a ratio of about 16:1."[117]
82. The CBI told us that when employers'
contributions to DC and DB schemes are combined there is little
change in the amount of employers' contributions to pension schemes.[118]
83. Mr Tompkins (Partner, PricewaterhouseCoopers)
told us that data that is collected is difficult to interpret.
This was:
"because the amount paid into a defined
contribution next year is absolute, whatever it is, the amount
paid into defined benefit schemes this year depends upon the funding
level of the scheme and might artificially look high this year
because they are in a deficit, because they are funding a shortfall,
for example; so that that comparison is not a fair one. What is
fair is to compare actuarially the cost of providing the defined
benefit you would have been providing in the past to somebody
who had entered a scheme with that particular scale of benefits
with the contribution you are making towards their retirement
income in a defined contribution arrangement. And in general,
and the statistics... include some good information on the large
number of middlemarket companies where reductions have been
observed, I would say that it is not universal. There are some
notable examples. I know a lot of press comment came when Prudential
announced a change, but that was an example of a company with
a very substantial level of defined contribution funding being
put forward to the staff who were going to be replaced, in other
cases people have tended to cut down to the sort of level of contribution
that the weakest level of the defined benefit membership was getting
in the past. So I am talking of a likeforlike comparison
between what a particular employer or sets of employers we have
worked with have been inclined to put forward to start after a
change, and what the costs of the benefits were before."[119]
84. As Mr Duval (SPC) pointed out, the
changes in the contributions are "not intrinsic to the design
of schemes, there are a number of employers who have changed their
defined benefit scheme and made it worse, as well as...employers
who have replaced defined benefit with defined contribution and
not made it worse."[120]
He added that it was possible for the benefits people were accruing
to be generally worse, but the employer's contributions may be
increasing because employers with defined benefit schemes had
to finance the falls in investments. He said:
"[what] we have is an unfortunate
position that the pension rights that people are accruing are
smaller but the burden on business is still growing, and that
is all driven by investment markets."[121]
85. Mr Bowie, Fellow of the Faculty and
Institute of Actuaries (FIA), added that:
"We cannot argue with the CBI that
pension costs are going up, but they are going up mostly to fill
legacy holes in respect of promises that have already been made;
they are actually going down in respect of the benefits that people
are getting year on year going forward. And it is like everything
else to do with actuaries, it is all smoke and mirrors."[122]
86. Mr Bowie questioned the extent to
which employers had really thought through the changes to their
pension schemes. He said:
"Any employer, for example, who has
closed their final salary scheme to new entrants and put a defined
contribution scheme in for the new entrants but honoured the promise,
and will do so for all the people who were already there, and
thinks they are making any material difference to their financial
risk for the next 20 years has got their head in the sand. If
you are a company and you have got so many employees and you have
got hundreds of millions built up in your pension scheme and then
you start a defined contribution scheme for your new employees,
in ten years' time there will be £50 million or £60
million built up, because you are starting from scratch, and you
will still have hundreds of millions of pounds in your old defined
benefit scheme, and all your financial risk from pensions will
still be in that legacy thing. Closing it to new entrants and
starting something else makes not a whit of difference for the
next ten years to the company's financial risk ... I think it
is an absolute scandal that companies are using that and saying
that they are actually making any difference to their financial
risks, because it makes not a whit of difference."[123]
Transfer of risk
87. Under a defined benefit scheme, the
responsibility for ensuring that the fund meets its obligations
rests with the trustees and the employer. Although there is some
risk, all too readily realised if the company becomes insolvent,
any shortfall in the fund will need to be made good by the company
increasing its contribution to the fund. Under a DC scheme, the
whole risk is transferred to the individual as there are no fixed
or defined benefits. The return in the form of a pension entitlement
is determined by the performance of the investment up to the time
the fund matures. If the fund generates less of a pension than
was previously expected, perhaps as a consequence of a falling
equity market, then the whole of the investment risk is absorbed
by the individual. The problem is that some savers may only know
if the fund is insufficient when it is too late for them to do
anything about it. The Work Foundation, among others, expressed
concern about the "shift of risk from employers to employees
[and] declining levels of employer contributions".[124]
The TUC told us:
"The argument that defined benefit
schemes are inappropriate in the modern labour market is also
wide of the mark. Simply switching to DC does nothing to deal
with the other major factor in pension provision longevity
it only shifts responsibility for it to employees."[125]
88. Professor Blake asserted that most
people will have to rely on defined contribution schemes provided
by the company or provided by themselves through financial institutions
such as insurance companies. He added that these defined contribution
(DC) schemes needed to be well designed in order to help mitigate
the range of risks (contribution risk, investment risk, mortality
risk etc) that members of such schemes face. As regards possible
policy prescriptions, UNISON told us that:
"Tax treatment could also be used
as a cost effective way of encouraging and rewarding employers
who are prepared to share the investment risk with their staff
by providing a defined benefit scheme."[126]
89. However, this was a minority view.
Alan Pickering told us:
"I do not think that the Government
should do anything to encourage particular sorts of pension provision.
Government should create a level playing field where employers
and employees can jointly decide whether they want a defined benefit
scheme or a defined contribution scheme. The Government's real
concern is not with scheme design, but with the size of the contribution."[127]
90. The Committee heard from the Faculty
and Institute of Actuaries that they believed that 'the Pickering
report contained a number of important principles and proposals
to encourage private pension provision, and to increase understanding
of pensions issues and the value of benefits'.
91. We recommend that the Government
accept the Pickering recommendations on the legal framework for
private pensions. We will consider the draft Pensions Bill in
the light of his report's recommendations.
92. We consider that tax policy and Government
policy generally should be neutral on whether DB or DC schemes
are provided by employers. However, we agree with some of our
witnesses and are sceptical that many employers have fully considered
the implications of closing their final salary schemes.
93. The trend from defined benefit to
defined contribution brings with it an urgent need for a better
informed workforce. We recommend that the "new kind of
regulator" proposed by Mr Pickering be given specific responsibility
and adequate resources to mount a nationwide education programme
to explain to employers and employees the relative merits of DB
and DC schemes. In the event of an employer wishing to reduce
significantly the benefits of its pension scheme, we recommend
that there should be a statutory duty on the employer to consult
their employees and their representative body on the reasons for
the proposed reduction, with provision for conciliation in the
absence of an agreement being reached.
40 Q 276
[Mr McLean] same as Footnote 16 Back
41
Q 77 [Professor Disney] Back
42
Green Paper - Simplicity,
Security and Choice: Working and Savings for Retirement, DWP,
December 2002, page 27, para 48. Back
43
For description see
para 26. Back
44
GAD 2000 Survey, see
also para 26 and 27. Back
45
Q 165 Back
46
Q 221 Back
47
Q 221 Back
48
Q 569 Back
49
Q 77 [Professor Disney] Back
50
Q 77 Back
51
Q 77 Back
52
Q 164 Back
53
The figures for 200102
show the following: absolute pensioner poverty, as measured by 60
per cent of median incomes taken after housing costs, has fallen
from 27 per cent in 199697 to 11 per cent in 200102.
Absolute poverty, on the same measure but taken before housing costs,
has fallen from 21per cent in 199697 to 14 per cent in 200102.
Relative pensioner poverty, measured by 60 per cent of median incomes
after housing costs, has fallen from 27 per cent in 199697
to 22 per cent in 200102. Relative pensioner poverty, measured
by 60% of median incomes before housing costs, has increased slightly
from 21 per cent in 199697 to 22 per cent in 200102.
Source tables 4.1 and 4.2 of Goodman, A., Myck, M. and Shephard,
A. (2003), Sharing the Nation's Prosperity? Pensioner Poverty in
Britain, Commentary No. 93, London: Institute for Fiscal Studies
Back
54
Q 77 Back
55
Q 77 Back
56
Q 164 [Ms Drake] Back
57
Q 165 Back
58
Q 78 Back
59
Q 78 Back
60
See for example, Q 165
[Mr Jenkins] Back
61
Q 165 Back
62
Pension Credit,
Second Report of the Work and Pensions Committee, HC 638-1 2001-02 Back
63
Ev 285 Back
64
Ev 286 Back
65
Ev 286 Back
66
Q 110 Back
67
Q 110 Back
68
Ev 405 Back
69
The Minister points
out that the employers' component is estimated on the basis that
under present arrangements, employer contributions are not taxable
as a benefit-in-kind of the employees. The estimates assume that
the proportion of total employers' contributions relating to higher
rate taxpayers is the same as that observed for employee contributions.
It is not possible to apportion the other element of the total cost
of tax relief between higher rate taxpayers and others. Estimates
are provisional and based on the Survey of Personal Incomes 1999-2000. Back
70
According to Inland
Revenue statistics for 2002-03, there will be 29.4m income taxpayers,
of which 3.07m will be higher rate taxpayers. Source: www.inlandrevenue.gov.uk/stats/income_tax/it_t01_1.htm. Back
71
Ev 289 [Minister's note] Back
72
Q 43 Back
73
Q 147 Back
74
See for example Q 276
[Mrs Maunsell] Back
75
Q 77 Back
76
Q 77 Back
77
Q 165 Back
78
Q 165 Back
79
Q 164 Back
80
Q 164 Back
81
Qq 77 and 78 Back
82
Ev 288 Back
83
Q 569 Back
84
Volume III, Ev 198,
para 26. Back
85
Volume III, Ev 166,
para 7.3. Back
86
Source: Chart 19, Page
30 of Pensions Policy Institute (2003), The Pensions Landscape,
(www.pensionspolicy institute.org.uk/news.asp?p=17&s=2&a=0). Back
87
Volume III, Ev 142,
para 3.5. Back
88
Q 276 Back
89
Volume III, Ev 162,
para 7.3 Back
90
Volume III, Ev 310,
para 2.6 Back
91
NAPF "Survey Reveals
Further Decline in Pension Saving", NAPF, 11 December 2002 Back
92
Volume III, Ev 287,
para 2.17 Back
93
Q 133 Back
94
Q 273 Back
95
Volume III, Ev 307 Back
96
Q 388 Back
97
Volume III, Ev 286 Back
98
Q 129 Back
99
Q 165 [Mr Jenkins] Back
100
Volume III, Ev 295 Back
101
Q 133 Back
102
Q 330 Back
103
Volume III, Ev 11 Back
104
Volume III, Ev 11 Back
105
Volume III, Ev 76 Back
106
Q 244 Back
107
Volume III, Ev 310,
para 33 Back
108
Pensions World,
November 2002, page 16. According to Donald Duval, somebody on an
annual income of £40,000 using the best 40 performance of the
US stock market could theoretically receive a pension in excess
of their final salary. Back
109
The CBI sets out some
arguments in favour of DC Schemes. See Ev 311, para 34 Back
110
Q 128 Back
111
Government Actuary's
Department, 2002 Back
112
"Employers put
less into pension schemes" The Guardian, 13 November
2002 Back
113
Volume III, Ev 286
para 2.15 Back
114
Volume III, Ev 286,
para 2.15 Back
115
Volume III, Ev 286,
para 2.16 Back
116
Volume III, Ev 286,
para 2.16 Back
117
Volume III, Ev 286
para 2.13 Back
118
Qq 240-41 Back
119
Q 385 Back
120
Q 387 Back
121
Q 387 Back
122
Q 387 Back
123
Q 391 Back
124
Volume III, Ev 219 Back
125
Volume III, Ev 289,
para 4.2 Back
126
Volume III, Ev 292,
para 19 Back
127
Q 52 Back
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