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PENSIONER POVERTY |
When the UK Social Security Committee last held an inquiry into
pensioner poverty the following submission was sent to the Committee for its
consideration.
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. However, the submission was made
individually and not on behalf of any body.
The submission makes some philosophical observations on poverty, particularly
among pensioners, and offers some lessons from the Australian experience.
Micawber's view of the world suggests that poverty is the result of failing to
live within one's means, as a result of extravagance, or ineptitude. But thrift
and care may not ward off poverty if it is caused by simple lack of means. Much
can be done to alleviate poverty among elderly people by provision of an
adequate income in retirement.
It is the author's contention that an adequate income can best be provided
through an integrated state-run scheme, and that the basic state pension should
be set at a level which confers dignity on elderly people without the need for a
means test.
But he also proposes a radical new approach to the provision of pensions by the
state.
The rate of old age pension remained unchanged at 10/- (50p) per week from 1925
till 1945, being raised to 26/- (£1.30p) only in 1946 in anticipation of the
introduction of the National Insurance Scheme.
Inflation had been low - as witness the slow pace of increase in such a
fundamental thing as the cost of a standard inland letter. But by 1955 the
weekly pension was increased to £2, implying an inflation rate of 7.5%. For the
last thirty years pension increases have been granted annually. The rate of
inflation has averaged 8% or more, sometimes being even higher.
The National Insurance Scheme was started in high hopes that poverty would be
eliminated. The brave new post war world was supposed to achieve what Lloyd
George never managed - a land fit for heroes to live in.
Part of the problem with providing a living income to those who can no longer
earn a living wage is that the pace of wages tends to outstrip inflation. In
times when the national belt must be tightened the annual increases in pension
are geared to the cost of living index, which is lower than the increase in
average weekly earnings. As a consequence, pensioners slowly experience a
reduction in their purchasing power vis-à-vis their employed compatriots.
One answer to this dilemma has been to introduce income supplements such as the
minimum income guarantee. By this means, the available resources are targeted to
those whose total income is at, or not much greater than, or even less than, the
basic pension rate. Such income is necessarily means tested.
In the House of Commons on 20th October 1999, Mr Rooker said that the proportion
of pensioners dependent on means-tested benefits fell from 57 per cent. in 1979
to 40 per cent. in 1996-97. This seems to have happened despite the fact that
pensions were being incremented only by the cost of living index.
Nevertheless, it is disappointing that the proportion dependant on means tested
benefits should be so high. There seems to be here evidence of imprudence or
improvidence. People have not been providing for their prospective retirement.
They have not been saving, or not been earning additional state pension, or not
been members of occupational schemes. Surely it can not all be due to periodic
absence from the work force resulting in a reduction of earned basic state
pension.
When the Government proposed in 1998 to increase the minimum income guarantee to
£75 this was received enthusiastically by some members of Parliament, who
proposed in Early Day Motion number 1 that the basic pension be raised to that
amount.
Would it not be better to go down that road rather than continue with futile
efforts to encourage or compel people to make additional provision for
themselves?
The Australian experience may shed some light on this.
As the Committee will be aware, Australian age pensions are heavily means
tested. There are two separate means tests - a test on income and a test on
assets.
At one time the income test was applied in such a way as to reduce the pension
by £1 for each £1 of other income. Currently the reduction is by only half of
the income over the threshold, and it will be eased to only 40cents in the $1.
The assets test imposes a reduction of pension income by $3 per fortnight for
each $1,000 of assets over a threshold.
The assets test has a dual effect because of the "deeming provisions". Under
these provisions, all financial assets are deemed to be invested to return
prescribed rates of interest, and it is this deemed income which is used in the
income test, rather than the actual income derived from the assets. If the
income earned from the assets exceeds the deeming rate (which happens with share
dividends) then the pension is larger than if the actual income were earned from
some other source, such as an occupational pension.
The operation of the means test gives rise to regular, and intrusive,
requirements that changes in circumstances be reported to the authorities. It
also gives rise to the design of complicated schemes to circumvent the tests,
and the introduction of new provisions designed to foil such schemes. Another
effect is to introduce definitions and provisions and exclusions which make
income for tax purposes different from income for means testing purposes.
Some of this effort is also directed at protecting fringe benefits, such as
health care cards and pensioner concessions.
Much of this effort would be unnecessary if pensions were payable universally as
of right.
In recent years the Australian government has introduced a scheme of compulsory
superannuation. Employers are required to pay in a percentage of employee wages
to be invested and accumulated towards retirement pensions. The aim is that less
reliance will be placed on the state age pension or other means tested benefits.
But the scheme will, of course, be a long time in maturing.
One of the problems with the design of this scheme is that the employer (or more
lately the employee) can choose the institution which will be entrusted with the
accumulating superannuation funds.
Superannuation salesmen vie for this business, because the rewards for "writing"
new superannuation business are attractive. But of course, this results in high
charges made against the contributions, particularly in the early years; it may
take several years for the investment earnings to outweigh the charges.
In times when a lifetime career with one employer is becoming rare, many people
have several small residues of superannuation benefit languishing in different
funds. They have lost touch with the institution and the institution no longer
has a valid address for these members.
It is difficult to see how this system can provide adequately for old age in
face of these and other problems.
Without actual knowledge of how the contracted-out system works in Britain and
how the proposed stakeholder pensions will address such difficulties one just
has to wonder whether the solutions attempted in the past or proposed for the
future ever can reduce the percentage of pensioners who are dependant to some
extent on means tested benefits.
Over the last 50 years the British government has failed to acknowledge that
future pensions should be purchased by present contributions. There has been a
temptation to regard the National Insurance Fund as a source of ready cash, and
to transform the Fund from a soundly based investment fund run on actuarial
principles into a pay-as-you-go scheme. National Insurance contributions are
regarded as another form of taxation, and pension benefits are thought of as
being paid out of current year's taxation.
Pensioner poverty has been addressed by Band-Aid methods, but this has only
resulted in increasing the gap between poorer and richer pensioners. What is
needed is a fresh approach that will alleviate poverty and remove the
accumulating funds from temptation's way. This will ensure that when the present
generation promises itself future pension benefits it will also provide the
means whereby these promises can be fulfilled, instead of relying on future
generations to keep present promises.
The National Insurance Fund should be split into two separate components. The
first component would deal with benefits such as unemployment and sickness
benefit, lump sum bereavement benefits and the like; the second component would
be known as the "National Pension Fund" and would deal with age pensions. The
distinction is roughly between short term and long term benefits, between
uncertainty and certainty. Age pension is a contingency that certainly will
arise if one lives long enough, whereas the others are uncertain events.
Inevitably there would be some "fuzziness" at the edges. For example, what does
one do about disability benefits and widows' pensions? Perhaps the answer is to
make a transfer of funds from the NIF to the NPF when entitlement to the pension
benefit is established.
National Insurance Contributions would also be split, with the pension
contribution being paid into the National Pension Fund.
NPF contributions would consist of a basic flat contribution plus an additional
contribution similar to the contributions for state second pensions. The rules
would permit contracting out from the additional contribution but not from the
basic flat rate contribution.
At first sight this looks like the existing NIS except that the pension
contributions are paid into a separate fund. But this difference makes all the
difference.
There should be one single national authority responsible for collecting
contributions and recording contribution history. Its ambit would cover flat
rate contributions and also additional contributions other than those which are
contracted out. It would also accept and record contributions from general
revenue for people who are credited with contributions during periods of low
income, and contributions from the NIF during periods of sickness an
unemployment.
This is not the same as a "clearing house" for employer and employee
contributions. As is explained below, the contributions would not be passed on
to investment managers tagged with the names of individual members. Instead the
functions of investment of funds and recording of contribution and benefit
entitlements would be separated. Contributions would be paid into an
undifferentiated pool of funds, which would be invested by a range of investment
institutions.
The NPF would be run on the same actuarial principles as have underlain private
pension funds and life insurance benefits for many years. Whereas the NIF is
sustained at present with a fund balance of 1/6th of the annual benefit
liability, the NPF would be required to be maintained on what actuaries call a
"prospective valuation" method. This involves calculating the present discounted
value of all future benefits, and subtracting therefrom the present discounted
value of all future contributions.
Although this may sound complex to the lay mind, it is in fact based on simple
mathematical principles developed by the actuarial profession. It results in the
accumulation of a fund which at retirement could be say 10 or 15 times the
prospective pension benefit, depending on the assumptions made about interest
earnings, benefit inflation and longevity.
In order to ensure that the administrators of the fund were not subject to
political control, the investment of the funds would be entrusted to the private
sector. This is possibly a revolutionary idea.
Unlike the Australian system, under which the private sector is responsible for
recording contributions history and maintaining fund balances, the proposed
system would separate the recording and investing responsibilities.
Financial institutions would be entrusted with the investment of portions of the
fund, with no one institution being responsible for more than (say) 5% of the
total, or 2.5%, or whatever low percentage did not result in undesirable
fragmentation. A system of competitive tender and rewards for performance would
encourage diligence, but the decisions on who should invest what would be taken
out of the political scene.
In years when the rate of inflation exceeded the earnings rate of the fund it
would be necessary for the government of the day to provide additional moneys
out of general revenue. This rule could also be applied n years when the
increase in average weekly earnings exceeded the rate of earnings of the fund.
Both of these measures would tend to provide for a pension which can be
increased each year at a level sufficient to ensure that aged people did not
slowly subside in the social and economic order.
It would also be a just impost on society, in that the burden of inflation would
fall on the fit and active, whom some thinkers would even blame for the very
incidence of inflation!
In designing the investment policy, it would be necessary to keep in mind the
need for diversity - a diversity of institutions, and diversity within the
institution being a desideratum. But the ultimate decision on selection of
institutions should be in the hands of an expert independent board.
In the 1980's we saw many examples of entrepreneurs getting their hands on the
funds of life insurance companies and/or pension funds, with mostly disastrous
results. There were also cases of banks organising consortia to provide funds
for people who were regarded at the time as financial geniuses. Some of these
geniuses ended up in jail, and some on Mediterranean islands! The lessons of the
past must not go unheeded.
It would not be required that investment institutions keep the investment of NPF
funds separate from their other investments. In many cases it could be an
advantage to have NPF funds invested in common with other funds. But the
supervisory board would take into account any proposal or intention of
institutions to merge or else quarantine NPF investments.
The national interest must also be taken into account in considering investment
policy, but it should not override prudence. The main objective of the NPF would
be to provide an adequate basic pension and a suitable vehicle for the
accumulation of second pensions.
The National Pension Fund would take many years to mature, but could only be
built up and made secure by a continuing resolve to save today for tomorrow's
benefits.
There are advantages in separating the record keeping role from the investment
role. One lies in the reduction of fragmentation - the emergence of little
pieces of benefit that either become absorbed by annual charges or, if protected
by legislation as they are in Australia, receive no or very little annual
increment by way of investment earnings.
Another notable advantage is the removal of the "roulette" effect on pension
accumulation. In Australia employers and employees can select the institution
which is to accept and invest their superannuation contributions. This is
supposed to encourage competition by giving the contributors the right to reward
successful investment managers with their business. In practice it introduces
uncertainty. Many employers and most employees have less than enough
understanding of the principles of investment. An institution can claim a high
investment return in times when all that is happening is that share prices
generally are going up; and returns can be apparently negative when the share
market is falling.
Then how does one know that the selected institution will still be in business
when retirement age comes? If you have made a good choice of investment manager,
but it falls into the hands of incompetent or even dishonest managers, your
pension accumulation can be severely affected.
One case which has received a lot of publicity in Australia is the takeover by
AMP of GIO. While not resulting in the bankruptcy of AMP, it has severely
affected its share price and could have an adverse effect on its policyholder
funds.
By pooling the funds of the National Pension Fund, and outsourcing the
investment management to a large range of investment managers one can ensure
that the amount of the pension, or even the existence of a pension, does not
depend on the luck, good or bad, of the choice that the individual has made. Any
loss arising from poor investment management will be shared equally by the
community rather than falling on the individual citizen.
Other matters which need to be taken into account include the protection of the
supervisory board and the advising actuary and possibly other people from
political interference or pressure. For example, it could be provided that if
there is any disagreement on professional matters between the actuary and the
government, the matter would be submitted for advice and resolution to the
Councils of the Institute and Faculty of Actuaries, both bodies being long
established by Royal Charter.
The submission was offered to the Committee for its consideration.
James Nelson F.F.A.