Responses to Turner reveal consensus for state pension reform

The remit of the Pensions Commission, led by Adair Turner, was to review the regime for UK private pensions and long-term savings, and to investigate whether there is a case for moving beyond the current voluntarist approach. In 2004 the Commission produced its initial findings. Below, we analyse the responses from key stakeholder organisations to this report.

Broadly speaking, responses to the first report¹ of the Pensions Commission reveal a high degree of consensus. First - not surprisingly - no organisation recommended the unpalatable option of leaving things as they are and allowing pensioners to become poorer than the rest of the population. Second, virtually all the organisations' submissions that we scrutinised (see Our Research box) assert that the current state pension system is in urgent need of an overhaul, and many argue that the success of the entire national pension strategy depends largely on such reform. The main differences in opinion tend to hinge on how the state pension can be improved (see table 1a and table 1b for an outline of responses).

Just two of the organisations (the TUC and the consumer organisation Which?) argue that compulsory contributions into private pensions is a desirable solution. The other respondents are agreed that this is not a favoured option and that the voluntary system can work if certain changes are put in place. Raising the state pension age (SPA) to 70 is also a popular recommendation - opposed, famously, by the TUC - although it is acknowledged by many that for any political party this route would be a difficult one.

Compulsion versus voluntarism

A core focus of the Pensions Commission's investigation is the question of whether a voluntary system of private saving can work. Its initial report does not attempt to come up with a final answer to this, but it does conclude that "unless new government initiatives can make a major difference to behaviours, it is unlikely that the present voluntary private system, combined with the present state system, will solve the problem of inadequate pension savings".

Many stakeholders in the pensions industry that argue against compulsion draw on the experiences in Australia, where it has already been introduced. The CBI argues that a contribution rate set by compulsion would "become the norm for contributions rather than the floor, leading to an overall reduction in saving". The Association of Consulting Actuaries (ACA) echoes this view - warning that it would have a "levelling-down" effect on private pension contributions, particularly from employers. The Society of Pension Consultants (SPC), which has launched an outright attack on compulsion, also holds this view, as does the National Association of Pension Funds (NAPF).

Other arguments against compulsion are that it could: "displace other forms of asset accumulation" by individuals (according to the NAPF); threaten the further erosion of tax incentives (the NAPF and the CBI); and affect the stability of many smaller businesses due to increased costs (the ACA, the NAPF, the CBI and the SPC). The NAPF also asserts that people on low incomes should not divert their scarce resources into compulsory pension saving.

A further concern is that compulsion will affect the behaviour of employers, who will see it as an extra tax on employment. The CBI warns: "[Compulsion could] lead to the distortion of economic activity - making some firms reluctant to grow and hire new employees beyond the minimum threshold for compulsion and forcing other firms to move into the informal economy." The ACA argues that to make compulsion work the minimum rate for employer contributions needs to be set high enough to avoid the levelling-down effect. This in turn would lead many employers to reduce costs elsewhere, endangering employment. The SPC also fears that the extra cost on employers could cause some employers to downsize their workforce.

Yes to compulsion

So what are the arguments in favour of compulsory private pension saving? The TUC says: "The voluntary private pensions system has failed: we can see no plausible combination of fiscal incentive or exhortation that will sufficiently lift the rate of private savings or provide universal coverage for the whole workforce. We can see no alternative to introducing a system of compulsion."

Which? argues that compulsory contributions by employers and individuals is "the most effective method of ensuring that sufficient pre-funding is made to avoid burdening future generations with unnecessary liabilities". Qualitative in-depth research² on individuals by this consumer organisation revealed that compulsion, while an "anathema to some", was broadly accepted as the only realistic way to ensure that people save for later life. In particular, it was envisaged that compulsion could remove the anxiety of choice from pension decisions. "Respondents wanted employers to be made to at least match employee contributions," the organisation says.

A quantitative survey by Which?, carried out in September 2004, also found a majority in favour of compulsion. Almost three-quarters (73%) of respondents agreed that it should be compulsory for all employers to contribute to a pension scheme, and 71% agreed that all employees should contribute.

If compulsion is introduced, the level of contributions and the nature of the private pension provision become of paramount importance. The TUC advises that an adequate second-tier pension (over and above the basic state pension) would cost 15% of pensionable earnings over £6,000. This, it says, would apply to all employees with no upper limit on earnings. The 15% should be split on a 2:1 basis between employer and employee and phased in over time. A revitalised state second pension (S2P) would also play a part in the envisaged arrangement in that it would fund pensions for workers with jobs that are too low paid and irregular to benefit from a private sector solution.

The TUC recommends that the level of adequacy for the second-tier pension should be determined from time to time by an independent body. This would operate in a way similar to the Low Pay Commission's role in setting the national minimum wage. Occupational schemes would include defined-benefit (DB), defined-contribution (DC) and risk-sharing models. All funded schemes would be run on a joint-trustee basis with an enhanced role for trade union trustees.

Which? envisages a radical shift in the provision of private pensions. It advocates that the second-tier pension (coupled with a universal basic state pension) would be based on a "collective approach". In its Blueprint for a national pensions policy³, it sets out proposals for a collective scheme model, operated by regulated collective scheme providers, such as trade unions, mutual societies, not-for-profit organisations, charities, special public interest groups and/or schemes set up on an industry-wide basis. The latter would be an "attractive alternative to employers' final-salary schemes". Research carried out by Which? found that the collective scheme concept was well received by individuals, particularly as it had the advantage of providing "strength and safety in numbers".

State pension reform

At the more extreme end of the suggestions for reform of the state system is the widely discussed idea of a "universal" or "citizen's" pension, which is based on a residency test rather than national insurance (NI) contributions. Organisations in favour of this are the NAPF (see details of its investigation into this proposal), the Pensions Management Institute (PMI), Which? and the Equal Opportunities Commission (EOC). The Association of British Insurers (ABI) has also expressed a tentative interest in this as a possible model for the basic pension. The Liberal Democrats, incidentally, also favour a citizen's pension.

One advantage of this type of structure would be that the system could be simplified, contracting-out could be abolished, and means-testing scrapped or reduced, removing disincentives to save. This is considered to be fairer for people on low incomes, especially part-timers and carers - an issue that affects women in particular.

On the subject of a citizen's pension, Sir Digby Jones, CBI director general, is characteristically forthright: "Although well-meaning, supporters of a universal citizen's pension are missing the point. A much larger state pension is unnecessary for everyone and frankly the country can't afford it." The CBI's view is that the answer lies in gradually increasing the basic state pension to the level at which the pension credit is paid. Entitlement would continue to take account of the member's NI record and an earnings-related second-tier state pension should be retained for those without an occupational pension.

Incentives and education

Among the organisations that advocate the continuation of a voluntary private savings system, it is recognised that change is needed in the private savings regime to ensure that more people save adequately for their retirement. While most recommend that more should be invested in financial education, others, such as the NAPF, believe that initiatives such as the government's informed choice agenda (OP, March 2004) will find it hard to succeed while the pension system remains so complex.

Which? argues that the government's financial education programme is inappropriate, "given the degree and nature of risk inherent in pension planning". The Independent Pensions Research Group (IPRG) and the Northern Pensions Resource Group (NPRG) made a joint response to the commissioners. They say improved financial education could help increase pension saving but add, "if products are unsuitable or unaffordable, all it will mean is that people understand that more quickly".

The submissions include the usual cry from many members of the pensions industry for genuinely simplified regulations and for more incentives for employer contributions - so no surprises there. The NAPF, for instance, says: "The incentives system could be streamlined, and there could be significant deregulation of private retirement savings, which would bring down costs and promote innovation." More specifically, its submission calls for a regulatory regime that encourages more risk-sharing models among occupational schemes, such as hybrid, cash-balance and career-average arrangements.

The NAPF points out that any workplace pension with an element of risk-sharing falls within the regulatory regime for DB occupational pensions, as enshrined in the 2004 Pensions Act. "We do not believe that this regime is conducive to further development of such models of retirement provision, despite the fact that they could provide an important part of an incentivised solution to the UK's pension savings problems."

Later retirement

One of the options put forward by the Pensions Commission interim report was that the average retirement age should rise. In recognition of this, the majority of major stakeholders suggest that the government should announce the raising of the SPA to 70 at a future date. The ABI and the TUC oppose this option, saying it would disadvantage the poorest people.

¹ "Pensions: challenges and choices," ISBN 0 11702780 4, available from The Stationery Office, tel. enquiries: 0870 600 5522 or from its website (www.tso.co.uk/bookshop), price £49.50 (main report and appendices), £30 (main report only) or free (executive summary), and free for download from the Pensions Commission's website (www.pensionscommission.org.uk ).

² "Which? pensions: choice and responsibility - report of qualitative research", November 2004, for more information go to the Which? website (www.which.co.uk ). ^{3 "}Blueprint for a national pensions policy," available from the Which? website (www.which.co.uk ) via "Campaigns", "Personal finance" and "Savings and pensions".