THE FUTURE OF UK PENSIONS
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.
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.
It is reported that the
Government has two main aims:
- To reduce the percentage
of retirement income provided by the State.
- 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.
- No matter how pensions are
provided, they are always a charge upon society’s production.
- 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.
- 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
- 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.
- 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
- This characteristic of the
NI scheme was anticipated and explained by William Beveridge in his 1942
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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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
Attempts to Reform Pensions.
- 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.
- These changes have been
somewhat contradictory, and betray a lack of a consistent philosophical
- 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.
- 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.
- 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.
- The resulting confusion
has greatly increased the cost of administration of the pension system.
- 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.
- 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.
- 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
- The basic pension should
then be incremented each year so that it is always the nominated percentage of
- The State should then
vacate the field of graduated and other supplementary pensions, and
concentrate on encouraging private savings and effective management of private
The Variable Pension Option.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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 have
not been a runaway success.
- 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.
- In August 2002 the following report was made on an
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
- 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.
- 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.
- Unless participation in
the scheme is voluntary it seems pointless to talk about "encouraging"
Private versus Public Provision.
- 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.
- This should, of course be
seen against the background of a "state pension system in decline".
- 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
- 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.
- 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
- 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.
- 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
- 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
- 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.
- 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.
helpful comment was made recently by
in Hooper and ors v Secretary of State for Work and Pensions 
EWHC 191 (Admin)
paragraph 32 of his judgement he said:
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.
- And in paragraph 33 he
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
- 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
- Although his remarks were
made n the course of a case regarding widows’ benefits, they could equally
apply to retirement pensions.
- 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.
- 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.
- 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