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Hammond: Rebalancing Britain's pension provision

Speech to Pensions Age Conference 2006

"It's a pleasure to be here today and to have the opportunity at this critical point in the post-Turner debate to summarise, from the point of view of Her Majesty's Opposition, where we have got to and to review the nature of the current political landscape surrounding this issue.

There is no doubt in my mind that the Pensions Commission report and Adair Turner's robust promotion of its conclusions has stimulated some real debate around this important issue and raised awareness of a subject which is all too often pigeonholed in people's "put off until tomorrow" tray.

We believe that the Pensions Commission correctly identified the key issues that have to be addressed and has set out, sometimes provocatively, a series of potential solutions to those problems in a way which has stimulated debate and provoked reaction. And looking at the comments in the specialist press following the publication of the Commission's final report, they have certainly succeeded in provoking reaction. Many of the comments have been hostile towards individual aspects of the package, but I think it is interesting that almost nobody rejects the key underlying finding of the report: namely that, if we want to stimulate pensions saving (with whatever degree of compulsion or encouragement) amongst people on median and lower incomes, then we must first address the expansion in means-tested pension benefits which undermines the incentive for such saving. It is easy to forget that Turner was not originally asked to look at the operation of the state pension system: it is an irony indeed that arguably the most politically far-reaching part of his recommendations are strictly outside the remit he was set!

So where are we now in this great debate? You may be better positioned than me to answer that question, having just heard the Pensions Minister speak. I, like most of the rest of the world, am still struggling to reconcile the Chancellor's apparent endorsement of "90-95%" of the Turner Commission's proposals on April 4th with his known concerns - primarily about short to medium term affordability. The Chancellor is an astute political operator if he is anything and clearly recognised the damage being done to his positiom by being painted as the opponent of pension reform and the road-block to a Blair-brokered solution to the "pension crisis". But to announce that he supports 90-95% of the Commission's proposals and that he recognises that there is "a limit" to the use of means-testing, while expressing continuing reservations about affordability, really leaves us not much the wiser. My analysis is that, by asserting his support for 90-95% of the Turner proposals, but then entering caveats to that support, the Chancellor is seeking to reassert his control over the pensions agenda, while reserving the right to reinterpret the Report's conclusions in a way that suits his own agenda.

Of course, any reform of the state pension system is going to have significant public spending implications over a long period of time and it is not surprising that the Treasury would want any such changes to be dealt with in the context of the next year's Comprehensive Spending Review. We can be fairly confident that the Treasury's starting point for the CSR will be that, against a backdrop of a tight overall spending situation for the period 2008-2012, there will be an expectation of overall savings in the DWP budget fuelling above-inflation increases in health and education in particular. A significant part of those savings already identified by the Treasury is the windfall gain from the equalisation of women's pension age between 2010 and 2020.

Gordon Brown is faced with a political problem: he is clearly planning to use this money for other purposes but will be uncomfortable to have had the spotlight thrown on this diversion of resources away from the state funding of pensioner benefits at a time when the Government's own agenda is focussing attention on the changing demographic profile and the need for increased support to ensure a decent standard of living for pensioners. It seems to me that the 2050 position, as mapped out by Turner, presents the Chancellor - any Chancellor - with little problem - minor tweaking of Turner's proposals with regard to the increase in the pension age could ensure a cost to the Exchequer no higher that the pre-budget report projections and Turner has demonstrated that the restoration of the earnings link would then be "affordable" in 2050 (although a prudent Chancellor would probably want to leave himself some wriggle room - perhaps by having an annual uprating in line with earnings unless Parliament resolved to the contrary). So 2050 is do-able: the Chancellor's problem is the period between now and then, during which Turner brazenly presumes to hypothecate the savings from the equalisation of women's pension age - money which the Chancellor has clearly ear-marked for spending elsewhere.

So when Gordon Brown talks about concerns regarding the affordability of the Turner proposals on state pension arrangements, this is a concern about the cost of getting from where we are now (and where we will be over the next decade and a half with the benefit to the Treasury of the saving from the women's pension age equalisation) to where Turner wants us to be (or somewhere thereabouts) in 2050, rather than a concern about the cost from 2050 onwards. Gordon Brown aspires to be the Prime Minister of this country during the period when the biggest part of the short-term funding gap occurs. He has not sought to take control of the agenda merely to see his Comprehensive Spending Review filleted by the removal of a large chunk of his war chest at the behest of Adair Turner. We can, therefore, anticipate that the current debate going on within Government relates to modifications to the Turner package to delay the implementation and reduce the short-term impact of the changes to State support that Turner is proposing. I could speculate on the various devices that the Chancellor might propose to achieve that objective, and I could propose some suggestions of my own but that is probably not the best use of our time this morning. Only when we see the White Paper will we understand the outcome of that internal and ongoing debate within Government.

What is clear is that the objective will be to put in place now a regime which will be credible and durable over the long-term; one which sends a clear signal to young potential savers about the extent and effect of means-tested benefits that they are likely to enjoy in retirement and the effective total "tax and withdrawal" rates that they will face so that they can make rational decisions about long-term saving, while minimising the short-term costs to the Exchequer. [That will create a tension: a tension between the requirement to provide the necessary incentive on the one hand and the political demand for "equity" on the other: The easiest way for the Chancellor to reduce the short and medium term burden as the Exchequer is to delay improvements in state pension benefits so that they impact only on the age cohort whose behaviour he is seeking to influence - certainly those below the age of 50 and perhaps even younger. But that analysis ignores the electoral power of the over-50s (who will soon be a majority of the electorate) and would lead to howls of anguish from pensioner support groups who have been lobbying for the return of the earnings link. There is, however, no clear logic to the Turner proposal for a 2010 start date for the earnings link with a ten year gap before the first increase in the state retirement age.

The Government has been saying from the time of the publication of the second Pensions Commission Report last November that it wants a cross-party consensus on this matter. Despite the obvious scope for political point-scoring in an environment where long-term, and sometimes difficult, decisions have to be taken, the Opposition is ready to engage in a consensus building exercise - if only one were on offer. Since the Turner Report was published, there has been no attempt by Government Ministers to meet with opposition parties, to gauge our thinking or to explore the extent to which a consensus around the tough decisions could be reached. The truth, of course, is that the Government has not been able to reach an agreement between the Treasury, No. 10 and DWP and, therefore, has been quite unable to reach beyond the confines of government to seek to build a wider consensus. Once again, the interests of the nation, which surely would be served by a broad political consensus on this issue, are being sacrificed to the rivalry within Downing Street.

My working assumption now is that the so-called "attempt to build a cross-party consensus" will consist of a call to hear a potted version of the White Paper, days before it is published, over tea with the Secretary of State. But let us fantasise for a moment. Let us imagine that my phone rings, even as I step down from this platform, with an urgent request from the Secretary of State for a private meeting to thrash out the basis on which a cross-party consensus might be formed. Beyond the question of an appropriate structuring of the phasing of state pension arrangements to make them affordable (an objective which we share completely with the Government), what else would we want to see in the package in order to feel that there was a chance of reaching an agreed settlement that could endure, perhaps for half a century - long enough for even the youngest of today's workers to begin to plan for their future?

Our first principal is that reform of the pensions system must be based on equity and fairness. That means equity between age cohorts, between the genders and between different sectors of the workforce. There can be no "different set of rules" for those in the public sector and part of the package has to be a long-term, fair and equitable solution to support the retirement incomes of public sector workers. The first step on this road is to achieve transparency over the implied employer contributions to public sector pension rights accruing. Once we can measure the cost effectively, and therefore can take it into account as part of the overall remuneration package of public sector workers, it will be easier to benchmark the public sector package against its private sector counterpart. All of you will know that there is a real sense of anger and grievance across the private sector about the Government's sell-out to the public sector unions on the question of retirement age at the very moment when increases in retirement age are on the agenda in many occupational schemes. The retirement age, in itself, is not the crucial issue - the crucial issue is the total cost to the public sector employer. The structure of the package - in terms of pension age, employee contribution level and benefits is something for negotiation in the workplace, but the overall cost of that provision is a legitimate concern of the taxpayer - and in particular a legitimate concern of private sector businesses and private sector employees who are being asked to face up to painful and costly change themselves.

And the system must be made fairer to women. In practice, higher female participation rates in the workforce will, over time, reduce the problem of inadequate contribution-based pension provision for women, but we can do better building on the proposals we put forward at the last General Election for flexible contribution credits for people with caring responsibilities. This is an area which I would expect the Government to address in its White Paper and where we will insist on a robust and equitable solution.

I suspect like most people with my political background, my knee-jerk instinct is invariably against any form of compulsion or quasi-compulsion. In a classically-constructed world, Government would provide people with as near-perfect information as possible, perhaps exhort them to do "the right thing" and then leave them to get on with it - facing the consequences of their own recklessness if they chose not to. But we do not live in such a world and in an environment where society, in the form of the state, extends an effective support to those who do not do what they are best advised to do, it is right and proper for us to consider whether some stronger incentive to act responsibly is appropriate.

The general thrust of this Government's approach to work and welfare - and I endorse it - has been that those who can work, should work, while those who can't work will be supported. Extending that analogy to the provision of long-term retirement income, it is reasonable for us to work from the assumption that those who can save should save, while using a means-tested benefits system to support those who cannot. In short, most of those in work should, by and large, be saving throughout most of their working life for their retirement. The auto-enrolment proposals of the Turner Commission seem to us to be a sensible balance between the extreme approach of full compulsion and the laissez-faire approach of allowing inertia to work against saving. But if we are to support auto-enrolment, we will need a system which is both effective and simple. Employers - particularly small employers - are already reeling under the burden of performing statutory functions on behalf of the state. We must not create a significant additional burden out of the auto-enrolment process.

And coupled with auto-enrolment, is the question of compulsion for employers in contributing to their employees' pension funds. Looking at the combined effect of tax and benefit withdrawal rates that average or lower income earners will face on the income from any pension fund they build up in an NPSS-type scheme, it is clear that without a substantial matching contribution - and there is no magic to Turner's specific proposal of an overall pound for pound matching - there will be insufficient incentive for saving to occur. Research demonstrates that the employer contribution, plus the harnessing of the power of inertia, are likely to be the most effective measures in stimulating long-term saving. The role of the employer is crucial: payments by the employer to the employer and deductions from the employee by the employer are already entrenched in that relationship. The employer is not the Government. Nor is he a financial services organisation. Odd as it may sound, he is likely to be the authority-figure most trusted by the average employee. So, whilst we would always prefer a voluntarist solution, we see the value of involving employers and we do not object in principal to the idea of a compulsory employer contribution, but subject to some important caveats:

First, the Government must make it quite clear that the employer is a facilitator in this process, not a net contributor: there is no pot of gold in the employers' bottom drawer with which to pay a pension contribution over and above what would otherwise be the total remuneration package, without rendering British business materially less competitive in the global marketplace. Therefore the role of compulsory employer contributions is not to add to the total remuneration package of the employee, but rather to redirect part of that total remuneration package from cash wages to pension contributions. There must be no prevarication about this point; no attempt by Government to curry favour with unions or workforce by pretending that it is otherwise; no risks taken with Britain's long-term economic competitiveness.

And secondly, because of this, both the employer and the employee contribution will need to be phased in over a relatively long period of time, allowing both to adjust smoothly to the changed mix of cash and non-cash remuneration, and to spread the impact on aggregate domestic demand of the switch from cash wage increases to pension contributions.

Thirdly, the 3% contribution must be fixed on the face of the legislation. Britain's competitiveness will potentially be damaged if the employer contribution figure becomes a plaything in the hands of government and unions - with constant lobbying for increases in the way we have seen with the national minimum wage. Employers will need a great deal of reassurance about the operation of this system and any suggestion that the employer contribution rate could be abruptly increased will undermine employer confidence in the reasonableness of the scheme.

Fourthly, there will need to be, as Turner has acknowledged in his final report, a system of support for smaller companies - not only to ease the financial burden, but also to ease the administrative burden of operating the deduction and payments system.

Then there is the question of the mechanics of the NPSS itself. There has been recent press speculation that the Government is seeking a hybrid of Turner's proposals and those put forward by different industry groups. I would be surprised in that were not the case - who would expect the Government to do anything other that try to cherry-pick the best aspects of each scheme. What will be the drivers from Government's point of view? Minimisation of implementation risk; simplicity of collection mechanism; avoidance of Government mis-selling risk; minimisation of cost and, finally, minimisation of employer engagement with the process.

Turner has set out a vision of an ultra-low cost system using a quasi-statal fund model. Others have proposed alternative routes. We know from the overseas experience that the great majority of people, having allowed inertia to keep them in the scheme in the first place, will continue to depend on it for any choice of fund. Perhaps the end result of the Government's deliberations will be a Turner-type "super fund" which will act as the default provider and will offer a low-cost option, while allowing individuals to select from a pallette of alternatives - perhaps offered by competing commercial providers - with higher costs attaching. If we are using the quasi-compulsion of auto-enrolment to persuade people to save, it seems right not only to offer them an effective low-cost default option but also to offer them the widest possible range of alternatives to that. As long as the low-cost default option is there, we should not concern ourselves unduly about the cost of alternatives that people might freely select. Over time, the default fund will either perform sufficiently well that no rational actor will opt out of it, or it will be put to shame by higher net returns being produced by alternative, higher-cost providers.

We have one simple prescription for the collection operation: it should not, under any circumstances, involve a new piece of Government or quasi-government IT infrastructure! Following John Hutton's early and bruising encounter with the CSA's problems, I suspect that he may be on that wave-length too. Minimisation of delivery risk and the political risk of another IT fiasco dictates a private sector, existing-structures based solution which has to be simple and user friendly for employers, as well as cheap to operate. The default fund needs to be completely independent of Government with a clear and transparent governance system - and under no circumstances should it be accountable to Parliament!

There will be many details around the operation of the collection, management and investment functions, but there should be no grand ideology in this part of the equation: if the necessary reforms to the state pension arrangements are set in place so that NPSS-type savings schemes can flourish, then the details of their form should follow the principals that I have set out above, and be structured on the basis of the best technical advice available.

One final point that we will want to see addressed in the White Paper is the restructuring of the Financial Assistance Scheme. The Scheme is clearly not working as originally intended, is under-resourced for its stated purpose and has now to be reviewed in order to encompass an effective Government response to the damning report of the Parliamentary Ombudsman. We have advocated that the Government should look again at the use of unclaimed financial assets as a means of financing a broader and deeper FAS. When we first suggested unclaimed assets as a potential option for supporting pension compensation at the time of the last election, the Chancellor claimed that there were no unclaimed assets: with the election safely out of the way, he has discovered them, and already ear-marked some of them for his own pet projects. What we need now is a quick, but effective, audit of the amount and availability of such assets so that we can have a mature debate about the extent of any further public funding that will be required in addition to ensure that the scheme is properly funded - not the hysterical gibberish that we heard from the Prime Minister and John Hutton immediately after the Ombudsman's report, aggregating undiscounted streams of cash payments over sixty years to come up with a ludicrous £15bn cost to the Exchequer.

My concluding thought is this: Turner has effectively focused the spotlight on his target audience - the roughly 50% of Briton's who are not saving for their retirement in any shape or form. But what about the rest? What about the beneficiaries (admittedly shrinking in number) of the "gold standard" - the traditional British occupational pension? Is Turner's NPSS, as many fear, a further threat to the survival of the mainstream British company pension? Is there anything that we can do to undo the flight by employers from occupation pension schemes? Are there any perverse outcomes from the legislation and regulatory regimes that have been put in place, from the application of FRS17, which need to be revisited in order to ensure that, alongside a Turner-type basic model that ensures broad-based long-term savings by those on average and below average incomes, there is also an effective system in place to provide for those on above average incomes who will also suffer significantly if the standard of living they have been used to falls dramatically in retirement.

This, of course, is a longer term issue and one which we are addressing within the remit of our Economic Competitiveness Policy Commission which will be reporting next summer. But we do need to consider, in the context of Turner's proposals, how we can also incentivise employers and employees to go beyond the minimum that an auto-enrolled NPSS would require; how we can ensure that there is no significant "trading-down" from current, more generous arrangements and how we can incentivise employers to maintain what is left of what was once Britain's gold standard of pensions saving.

There are big challenges ahead but also big opportunities to rebalance Britain's pension provision and put it back on course. But those challenges can only be met; those opportunities can only be seized, in ways which are effective and durable if a broad, cross-party political consensus is forged. It is going to be difficult enough to get real people to commit real money to a 50-year investment on the basis of a pledge by politicians about the future shape of state pension provision; but impossible if that pledge is made by one bunch of politicians, with another bunch threatening to tear the system up and start again in five years time.

We are disappointed at the introversion of government; at the gap between the rhetoric of consensus-building and the reality of deafening silence. But we remain ready and willing to engage with the Government if, even now, they seek a genuine meeting of minds and a sustainable way forward.

It is not too late, but with the White Paper expected in a few weeks time, it very soon will be.


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