The Work and Pensions Select Committee held an inquiry to examine the future of
pensions in the UK.  The following submission was sent to the Committee for its consideration, and has been published.

James Nelson F.F.A., the author of this submission, is an actuary born and educated in Scotland, a long term Australian resident, and a Vice President of the British Australian Pensioner Association.

Preliminary

It is reported that the Government has two main aims:

1. To reduce the percentage of retirement income provided by the State.

    

2. To increase the percentage of retirement income coming from private provisions.

These aims are possibly based on the belief that reducing the percentage of retirement income provided by the State will reduce the overall cost of pensions; this may not be so.

Summary
 

1. No matter how pensions are provided, they are always a charge upon society’s production.

    

2. Over many years, governments have lost sight of the need to provide for relief of poverty in old age in a manner which preserves the dignity of elderly citizens. In doing so, they have vacillated between encouraging workers to rely on the public sector and encouraging them to rely on the private sector.

    

3. What is needed is an all-party, non-political philosophy of pension provision that will underlie government policy and practice through many changes of government and governing party.

    

Pension Provision
 

1. A recent letter from an employee of the Department for Work and Pensions says:
   
    

   The NI scheme is different from a commercial insurance scheme where premiums are linked to expected benefit. Instead, it operates on a "pay-as-you-go" basis. The NI contributions paid into the NI Fund in any year finance contributory benefit expenditure in the same year.

    

2. This is just another way of saying that the NI Scheme is unfunded. In this, the NI scheme is not unique, the Civil Service pension scheme being another example of an unfunded scheme.

    

3. This characteristic of the NI scheme was anticipated and explained by William Beveridge in his 1942 report.
   
    

   24. . . . in providing for actuarial risks such as those of death, old age or sickness, it is necessary in voluntary insurance to fund contributions paid in early life in order to provide for the increasing risks of later life and to accumulate reserves against individual liabilities. The State with its power of compelling successive generations of citizens to become insured and its power of taxation is not under the necessity of accumulating reserves for actuarial risks and has not, in fact, adopted this method in the past.

    

4. It should not be thought that a funded scheme, such as occupational pension schemes or private pension provision, is inherently different from an unfunded state scheme. In both cases there is a basis of "right" to the benefits enjoyed by the pensioner, and in both cases the pensioner is supported out of the current production of people in their productive years.

    

5. In the unfunded state schemes, the "right" is financed by taxpayers (not by the government as is sometimes suggested) and by current contributions of those who have not yet retired. In the funded private or public schemes, the "right" is financed by the earnings of the accumulated assets. Part of present production and profit is used to pay interest and dividends and rents to funded schemes, so that present pensioners can be paid and the liability for future pension benefits can be met in due course.

    

6. In both cases, part of society’s present production is set aside for the maintenance of those who are no longer in the productive work force.

    

7. This will always be so, unless we engage in an active euthanasia program, stamping all new born babies with a "use by" date.

    

The Pension Conundrum.
 

1. The problem faced by government, by society itself, is how to apportion the cost of pensions between the public sector (the taxpayer) and the private sector.

    

2. The solutions attempted to this conundrum do not necessarily have a neutral effect on the cost of pension provision. It is possible, indeed it is likely, that one or other of the practical solutions will result in an increase in the overall cost of providing for old age.

    

3. For example, if the state provided pension is inadequate to prevent poverty, then a higher outlay will be needed in compensatory measures such as the Minimum Income Guarantee and Pensioner Tax Credits. This could well overwhelm any savings made by diverting pensions expenditure from the public to the private purse.

    

4. Relief of poverty in old age needs to be viewed as part of the social infrastructure of a civilised society. This approach enables us to compare the relative advantages and disadvantages of public and private provision in much the same way as the cost of provision of physical infrastructure is considered.

    

5. The primary cause of the failure of the pension system can then be seen as the failure of governments to provide an adequate pension foundation on which the private individual and the individual’s employer can build. The fashion for small government, infrastructure provided by the private sector, reduction of taxation, can result in a chaotic system of pension provision, just as it has done in the fields of railways and postal services.

    

6. Relief of poverty in old age must be seen as the responsibility of society, which must lay aside adequate resources to meet these needs. If the national scheme is unfunded, not based on invested funds, then the cost will have to be met in the future. Although the pensioner would, in this case, have no invested assets supporting his claim for an adequate pension, nevertheless society (and government) must accept the obligation to repay years of productive life with a dignified retirement.

    

Attempts to Reform Pensions.
 

1. Over the past 40 years or more, many attempts have been made to reform the pension system. Among the changes to the state system have been the introduction of Graduated Retirement Benefit, later replaced by the State Earnings Related Pension Scheme. And most prominently the reduction in the index used to compensate for inflation.

    

2. These changes have been somewhat contradictory, and betray a lack of a consistent philosophical approach.

    

3. For example, the reduction in the rate of annual increment of the basic state pension was no doubt an attempt to relieve the taxpayer of a burden, which was to be shifted to personal and occupational pensions, mostly in the private sector, and of course mostly funded in the present for liabilities to be met in the future. The ultimate in absurdity was reached with the risible, even insulting, increase of 75 pence per week.

    

4. The two graduated schemes (GRB and SERPS) on the other hand seem to have been attempts to transfer responsibility from the private sector to the state scheme, in that the pension ultimately payable was supposed to be related to the lifestyle needs of the pensioner.

    

5. In both of these, provision was made for contracting out. Although the contracted out pension was to be provided by the private sector, the state found itself accepting all or part of the responsibility for loss of real value due to inflation.

    

6. The resulting confusion has greatly increased the cost of administration of the pension system.

    

7. What is needed is a pure and simple approach to pensions. Either provide a flat pension benefit, free of means test, and designed to prevent poverty in old age, or else take over the provision of supplemental (graduated) pensions for all, with no provision for contracting out.

    

The Flat Pension Option.
 

1. This would be a return to roots. The state should select a level of pension designed to relieve, and indeed to prevent, poverty in old age. In the context of the recent investigation into the Pensioner Credit proposals, an appropriate level for illustrative purposes might be £100 per week.

    

2. This pension should then be represented as a percentage of Average Weekly Earnings. As an illustration, in Australia the base rate of pension is set at 25% of AWE, except that it was set at 26% during the transition phase after the introduction of the Goods and Services tax.

    

3. The basic pension should then be incremented each year so that it is always the nominated percentage of AWE.

    

4. The State should then vacate the field of graduated and other supplementary pensions, and concentrate on encouraging private savings and effective management of private sector funds.

    

The Variable Pension Option.
 

1. An alternative to vacating the field of supplementary pensions would be to terminate the provision for contracting out. Occupational schemes would then be substantially modified, and would probably apply only to the upper echelons of the salary scales.

    

2. At the time the Graduated Retirement Benefit was introduced, occupational and private pensions were mainly provided for higher earners. The pensions industry was beginning to enter the field of pensions for lower paid workers. Contracting out was seen as necessary so as to avoid extensive changes to pension scales.

    

3. These concerns were probably misplaced. Perhaps no one anticipated that inflation would reach such high levels as have been experienced. Certainly nobody expected the fiddling and changes that have been made over the years.

    

4. In this scenario, the basic flat pension would be determined as set out above, and the additional pensions determined as at present, but indexed by the same index, i.e. AWE.

    

5. Higher paid employees and self-employed people could still be eligible for privately funded additional pensions. No doubt the rules of occupational schemes could be amended to cope with the enhanced and compulsory state pension.

    

6. Pension schemes for government employees and members of parliament need not be contracted out from the state system. Indeed it would be simpler if the members of such schemes were included in the graduated variable pension scheme, and the rules of the current schemes were amended to ensure that the total pension from the state scheme and the occupational scheme was not excessive.

    

Stakeholder Pensions.
 

1. Stakeholder Pensions have not been a runaway success.

    

2. It may appear at first sight that a Stakeholder Pension should be very attractive, with its low fee structure. The trouble is that personal pensions are sold rather than bought. Unless a pension plan yields a satisfactory commission or other form of income to the seller, it will not be sold.

    

3. In August 2002 the following report was made on an internet site
   
   
   Abbey National has withdrawn their business stakeholder pension product. They will still administer the 2000+ existing customers, but they will still provide stakeholder pensions for individuals (at present, I add). The 'low' fee (1%) charged by providers, for each pension sold, is too low for many of the providers who would usually operate in this market.
   
   The market place now has three large providers: Scottish Widows, Norwich Union and Standard Life. However, the current issue is not one of who will provide the service, but about getting business owners (with 5 or more employees) to actively introduce a stakeholder pension into their company as law requires.

    

4. If the state opted to cover variable pensions, the need for stakeholder pensions would be much less even than it seems to be at present.

    

The State Second Pension.
 

1. The State Second Pension is a revamp of the SERPS pension, designed to extend the benefit of the salary related scheme to people who do not earn a salary, and to provide more generous benefits for people with low incomes.

    

2. Unless participation in the scheme is voluntary it seems pointless to talk about "encouraging" membership.

    

Private versus Public Provision.
 

1. The private pensions industry, including the actuarial profession, will always be in favour of private provision of pensions. A recent news item read, in summary:
   
    

   NEW REPORT BACKS COMPULSORY PENSIONS
   
   Private pensions should be made compulsory and the government must scrap its tax on dividend payments, according to a report out today.
   
   The quarterly Ernst and Young ITEM Club report said that with the state pension system in decline, people should be forced to save for their old age through a company scheme or private pension.

    

2. This should, of course be seen against the background of a "state pension system in decline".

    

3. No doubt there are advantages in the private sector system, one of them being, allegedly, competition. But in all competitions there are losers. Only one gold medal is awarded, and some competitors injure themselves or die in the attempt. Whether society is prepared to see pensioners in poverty because of the excesses of the competitive market is perhaps not a matter that society itself should decide.

    

4. Of recent times the private pension market has been plagued by unfortunate investment decisions. Companies have collapsed, bubbles have burst, dishonest accounting practices have led to sudden loss. The decline of the share market has hit hard at pension funds based on equity investment, and while shares are known to be a long term investment, pensioners and those near retirement do not have a long term to wait for the recovery.

    

5. In addition to these problems, there is the problem of an unwise investment decision, or an unwise choice of fund into which to place one’s pension savings. Even in a competitive economy it seems to be unfair that a pensioner’s comfort and dignity in retirement should depend on the choice of a pensions advisor or a particular fund.

    

6. There is therefore a perverse advantage in the public, unfunded, pension system. Unlike the private pension scheme, the state can afford to ride out the bad times, and protect the rights of the pensioners that have been promised in their working lifetime and earned, not by their contributions to a pension fund but by their contribution to the economy and society itself during their working lives.

    

7. The main disadvantage of the public sector is that the state can, at a whim, decide to reduce prospective benefits. This could be by changing the index on which pensions are based, or by denying some groups of pensioners the benefits enjoyed by the majority – such as the "frozen" pensioners residing in Commonwealth countries. Or it could be by changing the rules for widows’ pensions and failing to inform those who may be affected by the changes

    

8. If such changes were made by private sector employers or trustees, they could be taken to court and made to honour their obligations. Unfortunately this is not so in the case of a state pension fund, despite the passing, with all due fanfare, of the Human rights Act.

    

Conclusion

1. Shifting the burden of cost from the public sector to the private sector and back again is mere shifting of the wood pile from one side of the cellar to the other – and back.

    

2. Unless the government and opposition parties collaborate to develop a long term plan - a philosophy - of pension provision, crises will still occur with almost monotonous regularity.

    

Postscript

1. A helpful comment was made recently by Moses J in Hooper and ors v Secretary of State for Work and Pensions [2002] EWHC 191 (Admin)

    

2. In paragraph 32 of his judgement he said:
    

   Financial planning seems to me to be a significant aspect of family life and the benefits play some part in allaying fears for the future of a surviving spouse.

    

3. And in paragraph 33 he further observed:
    

   But the case [Marckx v Belgium] is of significance in demonstrating the importance of financial arrangements made as part of the enjoyment of the rights protected by Article 8.

    

4. Similar remarks were made in the course of the reasoning that led to his conclusion that Article 8 of the Convention for the Protection of Human Rights and Fundamental Freedoms had been breached.

    

5. Although his remarks were made n the course of a case regarding widows’ benefits, they could equally apply to retirement pensions.

    

6. One of the preparations made for old age is a pension designed to confer dignity and to relieve the family of the individual burden of supporting the aged members.

    

7. If the expectation of a pension is not fulfilled, partly because of the failure of the private system, but more significantly the failure of the state system to maintain the "social value" of the pension, then society has lost sight of the right to respect for private and family life.

    

8. More particularly is this so when a pensioner has planned to retire in the company of children and grandchildren in another country, and only finds out about the "freezing" regime when she has made an irrevocable commitment to emigrate.

James Nelson F.F.A.

Submissions to the DWP and DSS

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