Pensions crisis is going to lead to a care crisis – we have to plan ahead now

by Dr. Ros Altmann

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We are in the middle of a pensions crisis, which has been building up for many years. This crisis is the result of policymakers’ failure to adequately grasp the challenges of our ageing population. We seem to be at risk of making similar mistakes with the funding of long-term care in decades to come.

In the past few years, policymakers have kept insisting that there is no pensions crisis, despite the demise of our final salary schemes and falling savings ratio. In 2005, the Pensions Commission also concluded that we do not have a pensions crisis yet, but rather that we will have one in the future if we do not make changes.

That view is mistaken.

We do have a pensions crisis – it started several years ago. What we will have in the future is a pensioners crisis, when millions of baby boomers try to retire and find that their pensions deliver far too little money to live on. We need to encourage more long-term saving now, rather than waiting another few years.

Just as policymakers have been pretending the pensions crisis will not be a problem, they seem to be making similar mistakes with long-term care. As the proportion of older people in the population increases in coming years, there will inevitably also be an increasing proportion of the population needing long-term care. Studies show that at least one fifth of the elderly need long-term care for about the last two years of their lives. That could be over 4 million people. Who is going to fund this?

So far, policymakers have adopted the ostrich approach to planning for this eventuality. Basically just hope for the best and pretend it may not happen or leave it for someone else to find a solution nearer the time.

That is what we have done with pensions and it has not served us well. Let us learn from these mistakes.

People need to plan for the expense of care requirements at the end of their lives, but at the moment there is no help, advice or guidance for the mass market from Government or the financial industry on how to do this. Those with higher incomes will manage, but should we not ensure the rest of the population makes provision too?

Of course, there is no one policy change that will provide all the answers. A range of policy options is available, however, I do think that pensions can provide part of the solution. We could think about pensions and care costs together.

The Government plans to introduce a national pension saving scheme, with automatic enrolment for all workers and a minimum level of contributions from both workers and employers. Why should this only be used for a pension income? Perhaps a part of any pension fund building up for each worker could be earmarked to use for long-term care, if needed.

At the moment, policy forces most people to annuitise their whole pension fund at the point of retirement. This is probably not optimal for many.

The better off and those with higher value pension funds do have more options, but it would be good if more people had that flexibility. I am in favour of scrapping mandatory lifetime annuitisation at the point of retirement. In fact, I expect annuitisation will have to end anyway at some point, due to capacity constraints and rising costs – especially as more defined benefit schemes try to de-risk by annuitisation or longevity insurance, as defined contribution pension provision becomes the norm, and as Solvency II hits the market.

Why not encourage people to leave some of their pension aside, to use for long-term care in later life if they need it? They could either leave it invested in a specially designed care drawdown policy, or alternatively they could use the money to buy long-term care insurance.

There are numerous other possibilities. For example, we could require that 5% of everyone’s accumulated pension fund should be used to buy long-term care insurance which would cover, say, two years of care, with the State having to provide any more than this if required.

Another alternative would be to encourage provision of special annuities which offer accelerated payments if long-term care is needed in the future. Perhaps these accelerated payments could be tax-free, to reflect reduced costs to the public purse.

Or perhaps people could use part of their pension fund to buy a fixed-term annuity, for say, five years at a time and then if they need long-term care at some point in the future, they could use the balance of their pension assets, tax-free, to fund that. This makes more sense than the current system of leaving the balance of a drawdown policy to one’s estate and paying 35% tax.

Of course, another ideal source of funding for long-term care would be from ones home. If people do not have a pension but do own their own home, then using some of the equity value of their home for care home insurance, or to fund immediate care needs would make sense.

Finally, we may also need to consider using the national insurance system. At the moment, most of the money collected in national insurance relates to pension spending. For example, there is even the option of contracting out of the second state pension in exchange for paying reduced national insurance. I would suggest that the Government needs to reconsider this policy and recognise that a significant number of future pensioners will need far more than the state pension when they require long-term care. A nationally organised insurance system could provide part of the answer to the future burden of funding long-term care.

The bottom line is that we must plan for long-term care funding now, not wait until it is too late. Hoping for the best has not worked for pensions. We should learn from these mistakes to plan better now for long-term care, before the next crisis hits.