Public Servant Lifestyle

The Pensions Commission’s inaugural report calls for a comprehensive approach to UK pension provision – and one which can be sustained over the long-term.

The inaugural report of the independent Pensions Commission has presented it’s conclusions on the adequacy – or otherwise - of pension provision in the UK. It sets out the major challenges society faces and the unavoidable choices which need to be made.

The report, entitled: Pensions: Challenges and Choices is deliberately detailed and wide-ranging, examining all the different elements of the pensions system and looks ahead at areas of concern, outlining what steps can be taken to improve the current situation. Pension policy – the Commission’s report agues - has too often in the past been designed piecemeal: the report suggests that the UK needs a comprehensive approach which can be sustained over the long-term.

Huge Challenge

Adair Turner, Chairman of the Commission, said: “Society and individuals face a huge challenge, but one that can be overcome. Longer lives and low birth rates will change dramatically the ratio of older to younger people. Major adjustments to average retirement ages and to pension provision are required. Over nine million working people will face pensions they may consider inadequate, unless they save more or retire much later than their parents.

“The underlying problems have been getting worse for 20 years at least, but were masked by the temporary impact of the baby boom generation, by a failure to anticipate the scale of life expectancy increases and by the irrational equity market exuberance of the 1980s and 1990s.

“We must now make adjustments which we should ideally have begun 20 to 30 years ago. And to get policy right we need to look comprehensively at all aspects of the problem. Too often in the past, under successive governments, pension policy has addressed specific problems without a clear overall context. This has had unintended and adverse consequences.”

The report explains that faced with the increasing proportion of the population aged over 65, society and individuals must choose some mix of four options. Either:

Pensioners becoming poorer relative to the rest of society; or

Taxes/National Insurance contributions devoted to pensions rising; or

Savings rising; or

Average retirement ages rising

The report argues that the option of poorer pensioners is the least attractive and that some combination of higher taxes and/or National Insurance contributions, higher savings and/or later average retirement age will be required.

It also argues that no single solution makes sense, and therefore does not present a figure for a ‘savings gap’ but illustrates the trade-offs involved between different combinations of response.

The report’s main focus on looking at long term trends has identified a number of areas where the adequacy of pension’s data has been lacking in previous years. The Commission has made a number of recommendations about how the Government collects and analyses statistical information. The Government welcomes and accept these.

Key points in the report make crucial points, including:

Public expenditure constraints and an increasing number of pensioners mean that state pension provision per pensioner will decline relative to average earnings. But rather than increasing to fill the gaps, private pension saving, and in particular employer provision, is in significant long-term decline as provision shifts from final salary (‘Defined Benefit’) schemes to less generous money purchase (‘Defined Contribution’) schemes. (This is commonly called the ‘DB/DC’ shift).

As a result, if current trends continued over the long-term, future pension income would be deficient in total and increasingly unequally distributed. Home ownership could provide important retirement resources for many people, but it is not a sufficient solution to the problems and entails significant risks.

The problems will be more severe in 15 to 25 years time than in the next 10 years. A ‘muddle-through’ option does exist but it would be less socially equitable and less economically efficient than we could achieve if we now thought through a planned and comprehensive policy for the long-term.

Average male life expectancy at age 65 has increased from 12.0 years in 1950 to an estimated 19.0 today. The Government Actuary’s Department’s 2002-based principal projection suggests that it will rise to 21.7 by 2050. If average male life expectancy at age 65 continued to rise at the 1980-2000 trend rate it would reach 27.7 by 2050.

There are four barriers to the success of a voluntary pensions saving system; most people do not make ‘rational’ decisions about pension saving; the cost of advice significantly reduces the return on saving; the UK pensions system is extremely complex – leading to confusion and mistrust; and means-testing increases this complexity and for some people reduces the incentives to save which the tax system provides.

Unless new initiatives can make a major difference to behaviour it is unlikely that the present voluntary private system combined with the present state system will solve the problem of inadequate pension saving.

Save Now, or Pay Later?

Responding to the Commission’s interim report, Kay Carberry, Trades Union Congress (TUC) Assistant General Secretary, commented: “The voluntary approach to pensions saving has had its day. The country faces a stark choice. We either save more now or pay a high price later. For a decent retirement for all either all employees and employers start paying enough into pensions, or everybody will end up paying more tax and working for longer. There is a compelling case for phasing in compulsory employer and employee pensions contributions to increase the numbers of people saving.”

Meanwhile the Confederation of British Industry (CBI) has urged the government to show leadership on pensions, at the same time as revealing figures showing employer contributions doubling to £37bn a year since 1997.

Digby Jones, Director-General, says the massive rise in employer contributions is hitting profits, damaging investment and jobs. The CBI also says employer contributions rose from £18bn in 1997 to £37bn in 2003. This demonstrates the strength of employer commitment to pensions, even though "a Molotov cocktail of circumstances" has combined to undermine final salary provision.

Digby Jones said: "It is time to pull heads out of the sand and start talking about credible solutions, rather than only beating up on employers. The rise in employer contributions demonstrates the scale of the problem that firms have been responding to. There have been some poor examples but generally speaking companies have been miscast as the villains of the pension’s piece...It may be politically difficult but it's a government responsibility to show leadership and so far this has been insufficiently forthcoming. I have high hopes the new Secretary of State will move the situation to new ground."

Pension Compulsion

The CBI has also restated its opposition to pension compulsion, saying the move could cost business up to £22 billion a year. It says firms would see it as 'a tax on jobs', while employees might resent being forced to invest in the stock market. "Compulsion would present the government with a hostage to fortune," said Digby Jones. "If an individual's fund failed to deliver after compulsion, they might seek compensation from the government who had made them enter a scheme in the first place."

But - the CBI leader made clear - business is not ‘running scared’ of radical solutions. The CBI wants the state pension increased by 32% to the level of the pension’s credit - a rise from about £80 to £105 a week in today's money. This would serve eliminate pensions means testing and encourage more people on low incomes to save.

The employers' body says the government could partly pay for this by gradually raising the state pension age to 70 between 2020 and 2030 – but also stressed that employers must do more to ensure the survival of the UK's voluntary pension system. The CBI has also made it clear that firms should contribute to pension schemes with employees, where they can afford to. It welcomes the government's recent acceptance that firms should automatically opt-in new employees to company schemes.

Public Sector Pensions

Digby Jones takes the view that current public sector pensions are unsustainably expensive, adding that they are distorting the labour market. He predicts growing resentment among private sector workers and employers and council tax payers, unless there is a plan to deal with the issue. He is also unhappy that the government is over-optimistically presenting the Pensions Bill as a benefit to employers, when it is more likely to add to costs. Mr. Jones said: "Ministers must do nothing to add to employer costs if we are going to reinvigorate the UK's voluntary system. I am confident we can get things back on track but only if employers, the government and individuals all accept their responsibilities. It is easy constantly to blame business but there are more firms working hard to resolve the problem than the government or unions give credit for."

Alan Johnson, Secretary of State for Work and Pensions, said: “The Commission has had a hard look at the pension system in the UK, and has set out the stark challenges we all face in providing for increasingly long retirements. This report brings home the message the Government first highlighted in the 2002 Green Paper; that people must either save more or work longer.

In particular the analysis shows that occupational pension contributions and membership has been steadily slipping over at least two decades. These pressures have been largely unnoticed due to stock market exuberance.

“This is why we must continue our programme of rebuilding confidence in pensions, for example through the creation of the new Pension Protection Fund, as well as giving people the information they need to make choices about pensions and rewarding people who choose to work longer.”

The Commission report states that the way forward – and these options will be the focus of the Pensions Commission between now and the publication of the Second Report in Autumn 2005 - must involve:

A major revitalisation of the voluntary system

Changes to the state system

Increased compulsion beyond that already implied by the State Second Pension and contracting-out arrangements

The publication of these first findings now kick starts the consultation process. The Commission is seeking views on the appropriate role of the Government in ensuring pension adequacy, on whether there is agreement on the facts set out, and on the best mix of the three ways forward identified.

Professor John Hills added: “The report is deliberately detailed and fact-based. The present pensions system is poorly understood – and its likely evolution even more so - perhaps unsurprising given the bewildering complexity of the UK system. We hope that our report will contribute to improving understanding, and we will welcome reactions to the analysis we have put forward".

The Government set up independent Pensions Commission was appointed by the in December 2002 with the remit “to keep under review the regime for UK private pensions and long-term savings, and to make recommendations to the Secretary of State for Work and Pensions on whether there is a case for moving beyond the current voluntary approach.”

The complete First Report: Pensions: Challenges and Choices, is available to download here.

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