Ros’s initial comments on Pensions Commission reform proposals

by Dr. Ros Altmann

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So where are we now after the Pensions Commission report?

At last the report is out.  Now the next round of consultation will begin.  If the Chancellor gets his way, this issue will be endlessly debated for the next few years.  If the Prime Minister prevails, we will get some kind of reform in the next year or two.  Will the proposals laid out in the report provide the answer to our pensions crisis?

What did we need?
There were three major areas which the Pensions Commission report needed to address.  These were firstly, reforming state pensions, secondly encouraging more private saving and thirdly explaining the implications of trying to extend retirement periods in the face of demographic change.

1. Reforming state pensions:  Reform state pensions, to end the spread of means-testing, simplify the system and ensure fair treatment of women.  A state pension that provides a decent floor for income at older ages and ensures poverty prevention.
2. Incentivising private contributions:  Encourage private savings, by both individuals and employers, so that people can have more than the basic state minimum.  Recognise that confidence in pensions has collapsed, employers are pulling out of pension provision and both individuals and employers are reluctant to contribute, so either effective incentives or compulsion are required.
3. Encouraging part-time work at older ages:  Explain the implications of present retirement trends and begin the debate on re-thinking the whole concept of retirement, so that it becomes a process, rather than an event, with no particular one age that should be considered ‘normal’ for stopping work altogether.

What did we get?
Many of the proposals contained in the report are welcome and can form the basis of new model for UK pensions in future.  The commission has recommended the following:

1. State pensions for poverty prevention:  State pensions should be universal, flat rate, indexed to earnings and more generous than now.  The state would gradually pull out of earnings related pension provision, in favour of poverty prevention.  This change would be phased in over a long period of time.
2. Automatic enrolment in Government-organised pension saving scheme:  A new National Pensions Savings Scheme should be set up and administered by the government, to provide people with better pension products.  There would be compulsion on employers to contribute, but only if their employees are also contributing.  A 4% contribution from an employee would be matched by an extra 3% from the employer and 1% from tax relief, which could be portrayed as £ for £ matching of employees’ contributions.  Workers would be automatically enrolled in this scheme, to make it harder for them not to have a pension, but they could opt out if they wanted to.
3. Increase state pension age:  The state pension age would be raised over time, to 67 and then beyond, but there would be 15 years to plan for such a change.

What we did not get:

1. Urgent action on state pensions:  State pensions will not be simplified in the short term at all. The Commission does not recommend radical, urgent action, but takes an evolutionary approach to reform.  The pension credit, state second pension and contracting out would remain in place, but there would be two flat rate state pensions, one universal and the other contributory.  Thus, the proposals do not deal with the problem of imperfect take-up of means tested benefits, so that pensioner poverty will remain and do not solve the problem of women being treated as second class citizens, due to their roles as carers, rather than full-time workers.
2. Proper incentives for employers and individuals:  There are no new incentives for pension contributions by employers, they are simply going to be compelled to contribute if the employee wants them to.  The system of tax relief is also remaining, even though the Commission recognises that it is both unfair and inefficient as an incentive mechanism.
3. Re-thinking retirement – whole new phase of life:  Flexible retirement and part-time working at older ages would be a better solution than just raising the state pension age, because it would cater better for individual differences.  Moving the state pension age up from 65 would be unfair to many on low incomes, or in poor health, but encouraging employers and individuals to consider part-time work in later life and delaying taking the state pension would be an important part of solving the pension affordability problems.

What we still need:

1. Re-assess state spending:  State spending on pensions could be re-deployed, to fund a much higher state pension, without raising taxes.  The £11billion a year spent on contracting out, the huge sums spent on administering means tested pension credit and the complexities of state pensions, plus the Chancellors pension ‘gimmicks’ of fuel allowances, travel and TV licences, could all be used to fund a higher state pension for everyone instead.  We are currently wasting enormous sums of public money which could be better directed elsewhere.
2. Introduce fairer and better incentives:  The Commission does not really propose properly incentivising pension contributions and retaining tax relief is not a fair method for most people.
3. Public sector pensions:  The enormous costs of future public sector pensions are spiralling out of control and need to be addressed.
4. Annuities:  As more and more private pensions will be defined contribution, it is essential that people are encouraged to get the best annuity for their circumstances.  At the moment, people are automatically charged over 1% of their entire pension, as commission on their annuity, even though most people receive no advice at all. 
5. Problems of final salary schemes:  One of the biggest problems facing corporate UK is the financing of legacy pension liabilities.  This is going to need some creative dialogue between members and employers, with members likely to have to pay more, or accept less, from their schemes in future.  A rise in scheme pension ages is inevitable for most people, which is another reason why the public sector pension agreement is so problematic for the future.
6. Restore confidence:  One of the biggest scandals of all relates to the tens of thousands of people who have saved all their lives in a pension scheme and ended up with no pension, even though Government said their money was safe and protected by law.  If we truly want people to trust the Government on pensions in future, then we must ensure that people are compensated when things go wrong. 

The politics:

The Chancellor is wedded to the spread of means testing and has already declared linking state pensions to earnings as unaffordable.  This is a direct challenge to the Pensions Commission proposals and it will be interesting to see how the debate plays out.  The Chancellor is probably in a minority of one when he sees means testing as a sustainable pensions policy for the future.  Relying on continued mass means testing of pensioners will ensure that private pension coverage continues to fall, so that in the end more and more people will end up with only the state pension to live on and the costs to the state will soar.  The Chancellor also seems to have suggested that linking the state pension to earnings is ‘unaffordable’.  This is a dangerous statement, because, if the state pension is not linked to earnings in future, over time pensions will again fall way behind the standards of living of the rest of society and we will be back to the situation before 1997, which this government has had to address by spending enormous extra sums on pensioners.  Number 10 is keen on the idea of a citizens pension, particularly if it is only at the basic state pension level, and the commission acknowledges that this is one option and would at least help improve the situation of women somewhat.

My verdict:
Excellent analysis, some really great proposals, but not bold enough.  An evolutionary approach may sound attractive, but the longer the pension issue is left, the worse the problem will become.  We really need radical action now.

We all know there is a pensions crisis.  This crisis is the result of the failure of the UK pensions model.  Essentially, pensions have two functions, firstly as social insurance to prevent poverty in old age.  This was the original aim of pensions and is a natural role for a state ‘national insurance’ pension.  Secondly, pensions have also become a savings vehicle, which would normally be considered a private sector function.  The problem is that the state pension is undermining private pensions and neither part of our system is working properly.

We have a unique pension environment in this country, which has relied on successive Governments cutting state pensions and relying on private pensions to offset these cuts.  Our state pension is also probably the most complex system in the world, most people do not understand it.  We have three parts to the state pension – the basic state pension, the earnings related state pension and means tested benefits.  We also have the policy of allowing people to ‘contract out’ of the state earnings related pension piece and put their national insurance contributions into a private pension plan.  No other country does this, and it was once thought to be a brilliant idea, but recent studies have shown that contracting out has not been a good deal for most people and they would have been better off staying in the state pension.  The removal of the link between state pensions and earnings many years ago, eventually resulted in too many pensioners in poverty and a political need to spend more public money on pensioners.  State pensions were cut too far and the rise in means testing – which now reaches nearly half of all pensioners and will extend to three quarters in future – is undermining private pensions.  Private pension provision is crumbling, as employers pull out of traditional defined benefit schemes and cut contributions into new defined contribution arrangements.  A succession of scandals and poor performance has destroyed confidence in private pensions and there are not enough incentives to make employers or individuals believe it is worthwhile to contribute.  The trends have been dramatic, with pension coverage falling rapidly in the private sector and means-testing spreading to nearly half of pensioners now.  When claiming pension credit, any private pension is penalised by at least 40% and often by 100%, so pensions are no longer a ‘suitable’ investment for many people.  This means that one part of our pension system is undermining the other and such a situation is unstable and unsustainable.  The Pensions Commission has recognised that any system of private pension saving needs to be considered against the background of the state pension system and has rightly concluded that means testing must be reduced, state pensions should be flat-rate, universal and rise in line with earnings and that private savings need to be encouraged.  Such conclusions may be out of line with what the Treasury believes in, but they are sensible policies and my big disappointment is that the proposals are not sufficiently radical.  We need reform urgently, it is no use waiting for 2020 to address this problem, people need to be making their plans now and, at the moment, the complexities and means tested penalties of state pensions are providing confusion, which makes private saving almost impossible for many people.  The sooner this situation is sorted out, the better.