Briefing note for MPs on real costs of compensation

by Dr. Ros Altmann

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1. The Government’s refusal to compensate the 125,000 victims of pension scheme wind-ups was based on a major error in the DWPs initial cost estimates.  

Fear of a £15 billion commitment seems to have persuaded the Government to reject the case for compensation even though the High Court, the Parliamentary Ombudsman and the Public Administration Select Committee have called for compensation to be paid.

Now, drawing on the latest figures from the DWP, there can be no doubt that the costs of full compensation have been grossly exaggerated.  Between now and 2011, the net cost of full compensation should be about £42.5million a year

Over the next 50 years the average cost of full compensation should be well below £100million a year – and replacing less than the full pensions would cost correspondingly less.

2. Errors made by officials when calculating entitlements to state benefits cost taxpayers far more than the cost of full compensation every year – £725million was overpaid in official errors last year alone.

3. The Financial Assistance Scheme (FAS) is not delivering even the limited help it is designed to pay out.

4. There are sources of funding other than taxpayers which Government could use in the longer term, but an initial emergency aid package is urgently needed now.

1. FULL COMPENSATION UP TO 2011 SHOULD COST £42.5m A YEAR
(and under £100million a year for whole 50 years)
The costs of compensation for the victims of pension scheme wind-ups have been grossly exaggerated.  Using the latest figures released by the DWP, there will be 25,000 people reaching their pension age by 2011 and the average pension lost is £3,300 a year.

Using prudent assumptions about the amount raised from taxing pensions and amounts saved by not having to pay means-tested benefits, the cost of fully compensating all 25,000 people up to 2011 should be about £42.5m a year.  Replacing less than full pensions would cost even less.  This is in today’s money and excludes arrears.  (See Appendix One for details of calculation and assumptions).

£42.5million is a tiny amount in the DWP budget.   Just last year alone, officials made mistakes costing taxpayers £725million, by overpaying benefits to people not entitled to them.   That is 17 times the cost of full compensation!

After 2011, the costs of compensation will rise as more members retire, but even then the net cost of full compensation should be well below £100m a year.  The £15 billion figure used by the Government is statistical nonsense.  It was supposed to be a ‘cash cost’ but the Treasury has refused to endorse the figures and neither the DWP nor the Treasury have been able to provide a single example of having previously used these ‘cash costs’ to measure long term spending for 30 years or more.

DWP’s own figures show that the real cost (net present value) of full compensation is actually around £3 billion (not the originally suggested £15 billion).  Even this £3 billion does not take account of tax paid on restored pensions and savings in means-tested benefits not paid to those who get their pensions back. 

So the net cost, over the next 50 years or so, should be more like £2 billion (or even less if pensions were not restored in full.)  In fact, as pensions are paid each year, not all at once, the average cost over 50 years should be well under £100m a year in today’s money.   So compensation is not unaffordable at all.  Let’s put the costs in context:

2. OFFICIAL ERRORS COST MORE THAN COMPENSATION EACH YEAR

• The total DWP budget is £124.7 billion (i.e. £124,700million!)
• Official errors in benefit calculations cost taxpayers  £725million last year alone (see Appendix Two for details)  Official errors are not recoverable
• Every year, we spend over £20,000 million on tax relief for pensions
• Every year, higher rate tax relief on pensions costs over £10,000 million
• Every year, national insurance contracting-out rebates cost over £10,000 million
• Official errors in pension credit cost taxpayers £130 million last year

3. FINANCIAL ASSISTANCE SCHEME (FAS) IS FAILING
The Government claims the Financial Assistance Scheme (FAS) is helping those in most urgent need and that taxpayers can’t afford to do more.  That is simply not true.

So far, the FAS has paid out just £3million, while administration of the scheme has cost taxpayers £7million!  Unless this changes rapidly, the FAS in practice will turn out to be little more than political spin, seemingly designed to placate MPs, rather than helping those who have lost out.  Only a few hundred of the 10,000 wind-up victims  already past pension age have received anything at all from the FAS. 

MPs and their constituents have been badly misled.  The Government has not put £2.3 billion into the FAS at all.  The Treasury has not put a penny into it and has no plans to do so!  The £2.3 billion is another ‘cash cost’.  The real amount (net present value) is around £750m over 50 years, which will be reduced by tax paid and benefits not received. 

The Treasury has refused to make any money available and the DWP has deliberately inflated the estimates of likely cost of complying with the Parliamentary Ombudsman’s recommendations.  The truth is that the £15 billion figure – which the Prime Minister was misinformed into announcing as the cost of full compensation – is not valid, but has frightened MPs unnecessarily.  Now that more accurate figures are available, no MP need turn a deaf ear to pensioner constituents for fear of creating an unsupportable tax burden.

4. SOURCES OF FUNDING OTHER THAN TAXPAYERS
The Government says taxpayers should not have to fund the whole cost of compensation.  This does not mean that no compensation should be paid at all! 

Firstly, the taxpayer actually benefited disproportionately among creditors of companies that failed before 2003, since the Inland Revenue had a preferential right to the assets prior the pension scheme receiving any money. 

Secondly, there are other options open to Government.  They include:- 

a.  Unclaimed assets in banks and building societies

b.  Orphan estates in life and pensions companies

c.  Contributions from the venture capital industry

d.  Contributions from the many firms who earned substantial fees from   advising final salary pension schemes

e.  National Lottery funding

f.  Using existing scheme assets to pay pensions instead of buying annuities and paying profit and risk margins to insurers, and possibly unwinding annuity options that are already in place.

APPENDIX ONE:  CALCULATION OF COSTS OF COMPENSATION

25,000 people will reach scheme pension age (not just age 65) by 2011
Average pension entitlement for those who have lost pensions on wind-up is £3,300 pa.

The DWP claims it is ‘too difficult’ to estimate how much tax would be payable on the restored pensions and how much it would save by not having to pay means-tested benefits to people who get their pensions back.  However, the following prudent assumptions can be used to estimate the net costs of replacing the lost pensions.
–               assume average scheme is paying 20% of pension entitlements
–              assume average tax rate on pensions received is 12.5%
–              assume 20% of cost will be offset by means-tested benefits not being received
–              assume all members over pension age are still alive in 2011

Likely scenario:
25,000 people x £3,300 average pension = total pension lost £82.5 million
Extra amount needed (assuming 20% paid by scheme) = 0.8 x 82.5m = £66m

Assume tax paid on pensions averages 12.5% x £82.5m = £10.3m
Assume 20% reduction of cost for benefits not received: 20% of £66m = £13.2m
Total net cost to replace lost pensions = 66 – 10.3 – 13.2 = £42.5m a year

Pessimistic scenario:  If we assume average pension entitlement 50% higher i.e. £4,950 a year, the total net cost to replace lost pensions in full would still be just £63.7m a year by 2011. 

APPENDIX TWO: COSTS OF BENEFIT OVERPAYMENTS – OFFICIAL ERRORS

The Table below shows the amounts of taxpayers’ money wasted by officials who have overpaid benefits to people by mistake.  These amounts of taxpayers’ money paying benefits to people who were not entitled to them  make the cost of compensation pale into insignificance. 

Cost to taxpayers of official mistakes overpaying benefits in 2005-6*
Source:  Written answers Hansard 10 July 2006, Column 1570W

Income support	£200m
Housing benefit	£150m
Pension credit	£130m
Disability living allowance	£60m
Incapacity benefit	£ 50m
Jobseeker’s allowance	£ 50m
Council tax benefit	£ 40m
State pension	£ 30m
Other	£ 15m
TOTAL OVERPAID BY OFFICIAL ERROR	£725m

*NB These figures are rounded to the nearest £10m (which suggests that £42.5m is almost a rounding error!)
APPENDIX THREE:  Details of non-taxpayer sources of funding:

a.  Unclaimed assets in banks and building societies – the Chancellor has already earmarked these for ‘good causes’ but they could be spent first on compensation to the innocent victims of pension wind-ups.  Isn’t this a “good cause”?

b.  Orphan estates in life and pensions companies.  Government could charge an exit levy on any insurance company assets that are distributed to shareholders.  These shareholders have an interest in restoring confidence in pensions and have also benefited in the past from fees earned on pension assets, so there is logic in using some of the orphan estates for pension restoration

c.  Contributions from the venture capital industry.  Venture capital companies bought and then ‘restructured’ traditional manufacturing businesses, getting rid of debts, allowing unattractive parts of a company to fail and then running the remaining business without the burden of legacy debts, such as pension fund liabilities.  Jettisoning pension liabilities was often very profitable, but such action ignored the problems this caused for scheme members who lost their whole life savings, with no warning.  Morally, there is a strong case for venture capitalists to contribute to a trust fund to rescue workers whose pensions were taken away from them in corporate restructurings before any official protection was in place.  

d.  Contributions from the many firms who earned substantial fees from advising final salary pension schemes in the past, such as actuarial firms, lawyers, accountants, banks.

e.  National Lottery funding.   After a Parliamentary Ombudsman into Court Line, the Government issued an interest-free loan to start a protection fund for holidaymakers.  Lottery money could be used to start a scheme to fund pension restoration.

f.  Using assets available in the schemes themselves  and possibly unwinding annuity options already in place.  There is currently £1billion in hundreds of schemes that could be used to pay compensation immediately to all those who need their pensions restored now and are struggling to survive without their company pension – and even without some of their state pension.  We should put annuity purchases on hold and permit trustees to pay pensions to those already past pension age or terminally ill.