Speech to the Annual Conference of the National Association of Pension Funds
To be speaking to you this morning in the slot reserved for the Secretary of State is a great pleasure for me and I suspect a great surprise for you. Last week there was a media flurry when my friend Oliver Letwin said at a speech to the Police Federation that it would be a miracle if he were the Home Secretary after the General Election. A week later the National Association of Pension Funds has almost achieved this miracle for me.
And I will seize with both hands this opportunity to set out the approach my Party would take if I were, shall we say by some great good fortune, to serve as the Secretary of State for Work and Pensions.
But I would just like to take a moment to say how much I appreciate the advice and expertise of the National Association of Pension Funds. Peter Thompson has been a marvellous Chairman. He richly deserved to win the title of Pensions Personality of the Year - how much competition there was is not for me to say! And I very much look forward to working with his successor Terry Faulkner. He has already spoken up with great passion and conviction on, for example, the absence of any pension shortfall insurance in this country.
Then you have of course your formidable new Director General Christine Farnish. A couple of months ago I ran into Christine on the Eurostar to Brussels when we were both going to a conference on European Pensions. As well as that, in the gaps between the conference sessions, she was going off to the Commission to set them right on some of the worst mistakes in their draft Pensions Directive and Christine achieved just about everything she set out to do - as I knew she would.
We are all here at this conference because we care about the future of our nation's pensions and the prosperity of our pensioners. Everybody that I talk to in the world of pensions tells me the same thing. It is vitally important to have long-term stability. We need an environment in which people can plan and save with confidence. I can assure you that message is received and understood. There's quite enough uncertainty in the world already without politicians adding to it. Everything which my Party proposes on pensions is part of a long term vision for better funded pensions. But that sense of responsibility does not mean we will not hold the Government to account for their mistakes or press for the action that is so obviously needed and is so obviously lacking.
We have had a lot of consultation about pensions policy. In fact I recently put down a Parliamentary Question asking the Minister how many consultation exercises on pensions they have carried since 1997. The reply was there have been so many that the answer could only be obtained at disproportionate cost. If it would have been a disproportionate cost for officials to count them all up, think what a disproportionate cost it has been for you to respond to all of them. In fact I think the reason we don't have a Minister for Pensions yet is that they must be carrying out another one of those consultation exercises. And then the decision will go to an expert committee. I think it should comprise Ron Sandler, Paul Myners, Alan Pickering and Adair Turner. We'll end up with an appointment that is catmarked, unbundled, with no bells and whistles, and compulsory.
We face a crisis of funding pensions in our country. How we got here is a long and complicated story. As you may know, I have compared it to the film The Perfect Storm. You only get something as big as the crisis affecting our occupational pension schemes today if a host of different factors all come together. Many of them are not under government control - improvements in longevity or a shift to a much less paternalist model of employment. But that makes it all the more important that the things which are under the government's control it gets right. And sadly the removal of the Dividend Tax Credit has made a bad situation worse. It has taken £5 billion out of our pension schemes every year. That makes £30 billion already. When it's capitalized that's around £100 billion.
In addition the contracted out rebate is no longer set at an actuarially adequate level. That is another £1.5 billion a year taken from our pension funds. It adds up to an enormous extra burden for them at a time when they are particularly vulnerable anyway.
I have been trying to get accurate figures about the amount that we save in our pension funds and the value of the assets in them. Last year I was shocked to discover the Office of National Statistics and Ministers putting out figures that frankly could not possibly be credible. They were saying we saved £86 billion a year in our pensions in 2001. Ian McCartney said "These figures suggest that the stable economy has created the right conditions to save and that our policies to encourage higher levels of private saving are having a positive effect." On reflection, perhaps it is better that he is Chairman of the Labour Party rather than Minister for Pensions.
I wasn't very confident in the figures for our pension fund assets either. They were all over the place. In fact without any comment at all they retrospectively reduced their figure for the value of the assets in our pension schemes in 1999 by £104 billion. They managed to lose an amount more than the entire GDP of Portugal - knocked off our pension funds overnight by the stroke of a statistician's pen. So I have been working hard trying to get more accurate figures. Andrew Smith, to his credit, accepted my criticisms, apologized for the mistakes that were made publicly, withdrew his figures and allowed the ONS to engage in a dialogue with me about their calculations. My own estimate, drawn from ONS figures, is that we weren't actually saving £86 billion in 2001. I can tell you today the true figure is around £32 billion of contributions into pension schemes - and that includes contracted out rebates.
These figures are devastating. What they show is that we are saving perhaps a third of what Ministers were claiming only a year ago. The figure is going up a bit because contribution holidays are coming to an end and companies are having to put more money into their pension schemes. But the extra amount that is going in barely compensates for the amount going out with the loss of the Dividend Tax Credit. Businesses are having to run very hard just to stand still.
These figures have enormous implications. We just aren't saving enough to enjoy a decent pension when we retire. The combination of a low level of savings and a modest state pension is unsustainable. We have to rebuild our pensions savings. And if we don't, people will retire with such low funded pensions that they will claim higher state benefits instead.
There is something here which has puzzled me and perhaps you for a long time. Just about every official forecast you ever see of British public spending on pensions shows it running at about 5% of GDP from now until Kingdom come or at least 2050, which for a politician, if not an actuary, amounts to the same thing. And that's despite the number of pensioners rising by 50%. How do they manage it? The answer is that every possible assumption, is being tweaked to get to that magic 5%. For example, they assume that the income that pensioners get from funded savings grow in line with earnings. But the levels of pension contributions I have just described couldn't possibly sustain that. If you use a more pessimistic, dare I say more credible assumption that income from funded saving grows in line with prices not earnings then that adds 1% of our entire national income or £20 billion in today's prices - to expenditure on the Pension Credit in 2050. That shows that means-testing benefits doesn't reduce public spending if funded savings aren't there. Many of the forecasts also leave out disability benefits, Housing Benefit or Council Tax Benefit. The welfare payments are a much more important part of benefit expenditure for pensioners in the UK than on the Continent. In fact, in a speech at the Institute of Economic Affairs this week, I estimated that the total benefit spending on pensioners in 2050 could well be more like 10% of GDP than 5%.
We are heading for a society with low levels of funded pensions and high levels of dependence on means tested benefits. That's not the direction in which I want us to go. And to be fair to them, it's not the Government's stated objective either. In their Pensions Green Paper, that's the first one in December 1998, they said the aim was to reverse the balance of pension income so that instead of 40% from private savings and 60% from the state, it shifted to 60% from private savings and 40% from the state. Indeed this is one of the DWP published targets from 1998. The DWP annual report, published last week, includes a 'summary of progress'. It says 'the measures that are being introduced to encourage people to save for their retirement will take time to alter the balance between State and private sector provision.' You can say that again! We were happy to support the Government when they announced that as their goal. But it is five years since they set their target and I don't think they have made any progress at all. And in the rest of this speech I want to explain how I think we could get back on track.
First, we have to recognize the State's responsibility to provide benefits that offer pensioners dignity and independence and provide a solid base so that people know their saving is worthwhile. I am a realist and I know that there is always going to be some means testing in the British social security system. But we are heading in the wrong direction. In 1997, 37% of pensioner units were on means tested benefits. By this autumn when the pension credit comes in that could rise to 59%. The IFS have projected that the proportion of pensioners on means-tested benefits will grow to 73% by 2025 and 82% by 2050.
Means testing has increased, is increasing, and ought to be diminished. Means testing undermines the dignity of our pensioners. It also undermines your ability to advise people confidently that they will be better off if they saved. It seems to me that one of the flaws in Ron Sandler's Report for example, was to assume that if he introduced a basic stakeholder savings product, kite marked and low cost, then he didn't need to worry about suitability. But however simple this product, be it a stakeholder savings scheme or a stakeholder pension, it is not suitable for people who are going to find themselves losing benefit as a result of having saved. The $64,000 question is: How big a capital sum do you need to yield an income that will float you off means tested benefits. Ministers will never give a straight answer to this question, and that's because the answer is a lot more than $64,000.
Frank Field knows as much about the benefits system as anyone and he has this week published his own estimate of the cost of an annuity to keep someone clear of means-testing throughout retirement - £85,000. Even that may be too low an estimate, because I don't belive he has allowed for the growth of means-testing with the MIG growing with earnings when the basic state pension only grows with prices. My own estimate is £142,000 as the sum a newly retired pensioner couple would need to keep clear of means-testing throughout retirement. Only after that do you receive a full return on your savings. It is a staggering sum.
So let me make it clear to you today. I recognise that any serious agenda for reviving our savings culture has to include reversing the spread of means-testing. And I can tell you today that my Party is therefore committed to reform of the system so pensioners are less dependent on means-tested benefits. There are a variety of ways for achieving this. We can't promise that it will all be achieved in one simple step. But we are committed to tackling this problem.
In fact we have already shown how serious we are about this. When the legislation for the Pension Credit came before the House of Commons, I was happy to work with Steve Webb of the Liberal Democrats and with Frank Field to put forward an alternative to more means testing. We said that money should instead have gone into a higher pension for older pensioners. We were serious then when we proposed and voted for that alternative approach and we are serious now as we look at how best to reform benefits for pensioners.
The state has a second responsibility too. It is not just a matter of the interaction of savings and means tested benefits. There is another very important interaction between the State and private funded pensions - rebates for schemes that are contracted out of the State Second Pension. Contracting out has been one of the great British success stories. The decision by John Boyd-Carpenter to allow people to contract out from the modest Graduated Retirement Pension was a crucial moment in the history of occupational pensions in this country. We could have gone down the route of the Germans who at that very time abandoned funded occupational pensions in favour of more generous State provision. Instead contracting out created a distinctive British mixture of funded pensions and State benefits. It has served us well for 40 years. But I detect increasing evidence that people are unhappy with how the contracting out regime is working. It is partly because, as I said earlier, the rebates simply aren't set at an adequate level anymore. We can't indefinitely impose this hidden tax on companies whose occupational pensions are contracted out. Then there are the administrative costs as well because of the sheer complexity of the contracting out regime now. And then with the arrival of S2P and the prospect that it could go flat rate, the relationship between rebate and the State Second Pension gets even more obscure. It is no surprise that the Association of Consulting Actuaries have said that contracting out "on its current terms survives by inertia only. It should be abolished. At present it simply adds to bureaucracy and confusion without offering - what it was supposed to do - a meaningful incentive to save privately to reduce forward State commitments."
Mentioning actuaries gives me the chance to applaud the work that they do. Everyone has their own favourite actuary joke, and we all know how well paid they are, but I am sure I speak for many in the room when I say that I know they do a difficult job which is getting no easier. With the benefit of hindsight I am sure there are few professionals who would not change some advice they have given at some stage in their career - I certainly would. But neither I nor my Party attribute the woes of the pension industry to the activities of the actuarial profession.
Already companies are voting with their feet. When firms close their final salary schemes to new members what they also do is contract these new employees back in to the State Second Pension. What we are seeing is the first wave of an incoming tide of people contracting back into the State system. A survey by Mercers has shown that only 6 per cent of newly-established employer defined contribution schemes are contracted out. And, in addition, we know that only a small minority of stakeholder schemes are contracted out. In the short run this is a good deal for the Government because more revenues come in. But the shift comes at a very high price - much higher state pension liabilities in the future.
So the second policy pledge I can give to you today is that we recognise that the system of contracted out rebates cannot continue in its current form. We are looking at a range of options for reforming it or replacing it. My Party is no longer committed to keeping contracted out rebates if we can find a better way of rewarding companies that are offering funded pensions for their employees.
One approach, and it is in the NAPF's own report Pensions Plain and Simple, is to abolish contracted out rebates to finance a big increase in the value of the Basic State Pension. There is a major prize here as you float a lot of people off means-tested benefits. But we can't go down this route unless we are absolutely clear that we are putting in place new incentives for companies that are operating funded pensions. The NAPF report recognizes this. But you can't spend the same money twice. You can't put all the money into higher benefits for pensioners and then also say there need to be new incentives for companies to save. If we are to replace contracted out rebates in a way that is fair to British business, we need your views on what is the best regime to put in its place. Of the £11 billion currently estimated to be paid in National Insurance Rebates, £3.5 million goes to personal pensions and other DC arrangements. About £3 billion of the remaining £7.5 billion is paid to private sector employers. If contracting out is to end, we must ensure that incentives of a similar magnitude are provided in some other way. The challenge is for you to put forward ideas on the best ways of providing those alternative incentives for companies and individuals to put money into pensions. We might conclude that all that is needed is some reform of the existing system for contracted out rebates. But we will also want to consider far more radical options. My Party is keen to take a leading role in this debate.
So far I have set out our commitment to reforming benefits and to better incentives for funded savings. There may well be people in this conference hall who think we need a third step as well - compulsion. I appreciate that people who propose compulsion do so from the highest motives - they, like me, want to tackle the problem of our inadequate saving. But I have to say that I am far from persuaded of the case for it.
My first objection is one of principle. I am just uncomfortable with trying to solve yet another public policy problem by forcing other people to do what we want. At this rate our country is going to end up like Switzerland of which it was said that: in Switzerland everything which isn't forbidden, is compulsory.
That's not the sort of country I want to live in.
There's a second problem too. What if we end up forcing people to do something which no IFA would recommend as being in their best interest? Can we really take a someone earning, say, £12,000 a year and with a credit card debt, and tell him that he is obliged to put more money into his pension, when it might not be the best thing for him to do in the circumstances.
Even if compulsion does increase gross saving, it doesn't necessarily increase net saving. People might borrow more, or save less in other ways. In Australia compulsion hasn't increased the net amount that is being saved at all.
There's another problem as well. In the past, any list of approved pension savings schemes in which people were compelled to save would be bound to have included Equitable Life. What if people who had been forced to save had put their pensions there? Wouldn't they have come back to the Government and said that it had a liability for having forced them to put their money into Equitable Life? Wouldn't their demands for compensation be just about irresistible?
These objections to compulsion are, well, compelling. It is most unlikely that any Government of any political persuasion would end up with some of the more ambitious versions of compulsion. I am afraid I'm rather cynical about the compulsion debate. There are quite a few businesses, maybe represented in this hall today, who are sticking with loss making products like stakeholder pensions because they think that they might be compulsory in the future. You take a loss now in the hope that compulsion might be round the corner. It is very convenient for Ministers for you to believe that, but I think it's a tease. I don't think anyone should stick with a product just because they believe that it might become compulsory in the future.
There are however, practical things which we might be able to do to shift the balance towards saving without going to full blown compulsion. We particularly need to help employers who wish to make contributions into an individual's pension scheme. It was the previous Conservative Government which removed the power for employers to require their employees to join a company pension scheme. The world has moved on since then - it is much less paternalist. I doubt if many companies would wish to make membership of their scheme compulsory even if they could. But when we recognised in 1986 that compulsory membership was no longer appropriate, we made two mistakes. Firstly, if we had permitted concurrent membership of a personal pension and a DB plan, it would have avoided most of the horrors of misselling. It was Conservative Peers in the Lords who showed we had learnt from that mistake when they forced the Government to allow concurrency with stakeholder pensions. Secondly, we should have allowed companies to presume someone is a member of a pension scheme unless they opt out. And that is what I propose today.
We have created too many regulatory obstacles for companies who wish to put money into an employee's pension scheme. The presumption is that they should be members unless they specify to the contrary.
As the Work and Pensions Committee of the House of Commons said in their recent report that presumption "would have the advantage of ensuring that those who, perhaps through inertia, did nothing, would build up a private fund. But unlike compulsion, it would also allow those who did not want to make these savings to choose not to do so."
They go on, "Evidence from the United States suggests that changing the default option in this way does indeed increase the number of individuals who are saving, particularly lower earners, women and ethnic minorities, but it also reduces the savings of some of those who would have saved more than the default amount."
The same goes for stakeholder pensions. I was horrified when one of the largest stakeholder pension schemes described the hurdles that they had to clear in order for an employer to put money into an individual's stakeholder pension. Even if it was simply a employer contribution with no strings attached, they had to write to the employee to ask for permission to set up a stakeholder pension and put money into it. If the employee did not send back the signed consent form, then they couldn't pay in the money. 80% of the workers in their industry did not return the forms. The company did not have a legal basis for putting the money into the stakeholder pension. And if an employee did return the form, there was then a requirement for the company to send out a second letter within seven days advising that they could change their mind if they wished. Some of the people who signed the first letter would sign any letter and signed the second one as well. At the end of all this, fewer than 10% of the workers in the industry were going through the necessary legal hoops to enable the employer just to put money in their stakeholder pension. This was absurd. I am pleased to report that the first of these problems has been solved by a dispensation from the FSA. They are still waiting for the problem of the seven day rule to be solved. Moreover prospective members still have to receive 30 pages of key features and decision trees which help a few people, but put off many more.
We do not need to set such legal barriers in the way of companies that just want to pay money to their employees' pensions. In these circumstances the 'do nothing option' should be that the pension is set up. It should require a conscious decision to opt out. Although I object to harnessing compulsion to force people to save, I have no objection to using inertia instead.
This is all very relevant to Adair Turner's investigation of pensions. I admire Adair and am sure that his report will be worth the wait. When his committee was set up it was implied that if he judged that the current voluntary arrangements were not working, then the alternative would be compulsion. But, even if the current arrangements aren't working, it doesn't follow that the only alternative is compulsion. There are many other alternatives, including a wide range of reforms to our current system so that we improve the incentives for people to save rather than having to compel them. I hope and believe that Adair will feel able to range more widely over all these possible alternatives.
So far I have tried to outline some features of the Conservative agenda for pension reform. Reforming the structure of state benefits so that we reverse the trend to more means testing. Reforming contracting out so that the money that currently goes into rebates instead goes into the best possible form of incentives for companies and individuals to save. Harnessing people's inertia to encourage saving, rather than discourage it.
But there are other practical things which can be done urgently to try to halt or even reverse this trend for companies to close their final salary pension schemes. Accoring to the NAPF's latest survey 19% of final salary schemes are now open to new members - a devastating figure that nobody would have forecast even five years ago. The next step will be for more companies to close their schemes to existing members as well. Some have already started to do it. Unless we take significant policy measures, we are going to see nothing less than the disappearance of the occupational pension as we know it.
So today I can announce three specific measures to which I can commit my Party. All of them reflect the advice of many people in the industry, not least from our Pensions and Savings Advisory Group. Each proposal is aimed at strengthening Britain's occupational pension movement while there is still time. We do at least still have the infrastructure of occupational pension schemes in place. We must act before it is too late.
First, we should remember that the final salary scheme is just one form of defined benefit pension. There are others. Many businesses have concluded that they can't any longer afford to offer new employees the old final salary scheme on the 60ths formula.
Incidentally it's a great pity that we in the Commons have moved not just down to 50ths but to an accrual rate of 40ths, so much better than can be found in the rest of Britain. I could not in all conscience have been the pensions spokesman for my Party meeting so many people with real worries about their pensions if I had just voted an accrual rate of 40ths for myself. So I did not vote for this proposal and I am not taking the new higher accrual rate. The only trouble is I haven't yet explained to my wife what I have done, but I hope my secret's safe with you.
At the moment the regulations for companies that want to change the terms of their pension schemes are very onerous indeed. In fact it is easier for a company to close its pension scheme to new members than to change its terms. Although well-intentioned, this protection for the terms of schemes is now having the perverse effect of encouraging companies to close their schemes altogether because they just can't face the hassle of changing them. We need to tackle this problem. We support the relaxation of Section 67 which has caused so many difficulties over the last 5 years. And we would favour going further than the 5% the Green Paper proposes.
Secondly, all the evidence is that employees look to their employer for information about the pension scheme. It's no good just giving them bald figures without any context or explanation around them. In order for the new initiatives for information about the value of people's pensions to have a real effect, they have to be put into some sort of context by someone who understands them. And the fact is that, sadly, many individuals can't afford or don't want to pay for an IFA. But a company ought to be able to explain the merits of its own pension scheme. Ever since we passed the Financial Services Act of 1986, companies and their advisers have felt anxious about this, as they knew that providing Investment Advice without authorisation is a Criminal offence, carrying the possibility of imprisonment. They have worried that if they go beyond the barest bones of factual information, they will be trespassing onto financial advisory work for which they will need to get separate registration with the FSA. But most employers don't necessarily want to become a financial adviser as well. So we will change the law to make it even easier for companies to offer information to individuals about their company pension scheme. I hope and believe that this will encourage people to value what they get from their company pension and to stick with it. One of the reasons why the crisis has got so bad as it has is the asymmetry between the costs for employers of providing the pension and the understanding by employees of how much it is worth. We can't ask employers to provide benefits which are expensive for them, but which are not valued highly by their employees. At the moment it is difficult for employers to show how much their pension might be worth.
I have one more proposal that I can announce today. Last December, the Chancellor proposed limiting an individual's pension fund to £1.4 million. This sounds like a lot of money, but the proposal is fundamentally flawed and it won't work.
There are three big problems with it. First, the proposed limit is in practice lower than the current earnings cap and would affect far more than the 5,000 people claimed by ministers. One independent estimate was as high as 600,000.
The Prime Minister and the Lord Chancellor are to be exempt from the £1.4 million limit. We can't have one rule for them and a different one for everyone else.
Secondly, the proposal to up-rate the limit only in line with prices will cause all sorts of problems. Ever greater numbers of people could be caught in the trap and planning ahead will be impossible as no-one can predict the future value of their fund.
Thirdly, the new rule imposes massive new administration costs. Every scheme would be obliged to report every year on the fund value of every member and the Revenue would have to collate all this information. That's a nightmare.
The Chancellor is tackling the wrong problem. The challenge is not to limit the amount of money people can have in their pension schemes. The challenge is the opposite - to encourage more people to put more money in to their pensions. Today I want to set out a different approach - a fair deal on pensions for everyone.
In the United States, tax relief for occupational pensions is based on one simple condition - that every member of a firm is allowed to join the pension scheme. That's a much better approach than in Britain.
I am therefore proposing that the lifetime savings cap should be abandoned, but subject to this very important condition. The limit goes if all the company's employees - from the highest paid to those on the minimum wage - are given access to the scheme on the same terms. We would also still need to keep some limit on the value of the tax-free lump sum.
We now have two nations in pensions. It's back to the bad old days of managers versus workers. That's not the sort of society we want. Our proposal will once more create one nation in pensions. Nobody held back. Nobody left behind.
I have set out for you this morning a six-point plan for pensions. First, we are committed to the reform of State benefits. Secondly, we will look at better ways of providing incentives to people to save, other than the traditional contracted out rebate. Third, although we don't believe in compulsion, we are willing to look at ways in which we can harness the power of inertia to make it far easier for employers to put money into schemes and for employees to stay within the company pension schemes. Fourth, we will make it easier for companies to change the terms of their pension schemes instead of closing them. Fifth, we will tackle once and for all the doubts in the employer's mind about whether they are able to give proper information to their employees about the merits of the company pension scheme. Sixth, and finally, we will move to a new inclusive approach to tax relief so that there are no upper limits on the tax relief provided that everyone can join the same scheme.
I believe that this is a positive and constructive way forward to tackle one of the biggest crises facing Britain today.
We are all at this conference today because we care about pensions. That's what the NAPF is all about. And I admire the work you do. You work in this industry because you want to see people enjoy a prosperous retirement based on a well-funded pension.
I get a lot of information about pensions over my desk every day. And do you know what's the most depressing? It's the increasing flow of invitations to conferences with titles like 'Closing Pension Schemes for Solvent and Insolvent Employers' or 'Effectively Winding Up Pension Schemes'. Does anyone join a great industry like this in order to close it down? It would betray millions of people who rely on a funded pension for a decent retirement if we saw one of Britain's great post-war successes disappear before our eyes. It's not too late to rescue our funded pensions. What it needs is a new approach, a fresh determination, a clear strategy. We've had enough of consultations and Green Papers. The time has come to act.