A New Pension Settlement for the Twenty-First Century:Second Report of the Pensions Commission

Cass Business School

Adair Turner7 December 2005

• State has been planning a reduced role in pension provision for average earner

• Proposition: private pension provision should grow to fill gap

• Reality: private pension provision in underlying decline

Projected state spending per pensioner indexed in constant 2003/04 price terms: 2004 projections

Figure 1.5 p47

Participation in private pension schemes: 2003-04, millions

Figure 1.8 p50

• Is there a “crisis”?

• Is there a “savings gap”?

• If the problem is in the future, can we wait until then to deal with it?

State pension at point of retirement assuming full contribution record for a person who has been on average full-time earnings throughout their working life: percentage of average earnings

Figure 1.3 p45

Private pension income as a percentage of GDP by source 2005-2050

Figure 1.16 p57

Percentage of 50-65 year olds in danger of having replacement rates below benchmarks of adequacy

Figure 1.30 p79

Gross saving by sector as a percentage of gross national disposable income: 1980-2004

Figure 1.33 p83

Residential housing wealth as a percentage of GDP

Figure 1.31 p81

Wealth holdings in a closed economy in equilibrium

Figure 1.36 p85

Household non-pension financial assets and non-mortgage debt as a percentage of GDP

Figure 1.35 p85

Barriers to a purely free market solution

• Behavioural barriers to rationality e.g. inertia

• High selling costs

• Declining employer interest

• Complexity

• Expectations of spread of means-testing3

Sources of costs for the median earner aged 40 in the present Stakeholder Pension system

Figure 1.52 p111

Typical Annual Management Charge in alternative forms of pension provision

Figure 1.27 p71

Percentage of pensioner benefit units on Pension CreditIf current indexation approaches continue indefinitely: 2005-2050

Figure 1.22 p64

IFA assessments of attractiveness of different earnings segments: survey resultsThe design of the state system means that the returns to saving for people in this group are good.

Figure 1.23 p65

Two major elements of policy

• National Pension Savings Scheme (NPSS)

• More generous less means-tested state pension provision but at an age gradually rising with increased life expectancy

Female cohort life expectancy at 65

10

15

20

25

30

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Yea

rs

Historical Principal 2003-based

Principal 1983-based Principal 1992-based

Principal 2004-based

Impact of the 1940s-1960s baby boom: ratio of 65+ year olds to 20-64 year olds

Figure 1.45 p 99

State pension provision: the unavoidable trade-off

Figure Ex.6 p 17

Public expenditure and pension age increases: Pensions Commission proposed range for debate

Figure 3.1 p 1319

Percentage of adult male life spent after State Pension Age

2005State Pension Age 65 67 68 69

Life expectancy at SPA (years) 19.4 21.8 20.9 20.1

Percentage of adult life (18+) after SPA 29.2% 30.8% 29.5% 28.3%

2050

More generous state pension in the long-term at a later age:

• Unified Citizen’s Pension?

• Evolution of present system: BSP and S2P?

Figure Ex.8 p 21

Preferred way forward1. Build on current two-tier system and recent reforms, accelerating the evolution of

S2P to a flat-rate pension by freezing the Upper Earnings Limit for S2P accruals in nominal terms.

2. Index the BSP to average earnings growth over the long-term ideally starting in 2010 or 2011 as the public expenditure benefit of the rise in women’s SPA begins to flow through……making this indexation affordable long-term by raising the SPA gradually, broadly in proportion to the increase in life expectancy, for instance to 66 by 2030, 67 by 2040 and 68 by 2050.

3. Maintain the reductions in pensioner poverty achieved by Pension Credit, but limit the spread of means-testing by freezing the maximum level of Savings Credit payments in real terms (which implies that the lower Savings Credit threshold increases faster than in line with average earnings).

4. Base future accruals to the BSP on an individual and universal (i.e. residency) basis, and improve carer credits within S2P.

5. Accept the consequence that the public expenditure on state pensions and pensioner benefits must rise from 6.2% of GDP today to between 7.5% and 8% by 2045 (depending where SPA reaches in 2050).

6. Ideally introduce a universal BSP for pensioners aged over 75.

Percentage of pensioner benefit units on Pension CreditWith proposed state system reforms and introduction of the NPSS

Figure 6.42 p294

Key features of NPSS

• Automatic enrolment, but with right to opt-out

• Minimum default employee contributions of 5%, of which 1% paid by tax relief

• Modest compulsory matching employer contribution (3%) if employee stays enrolled

………impact on total labour cost 0.6%

• Payroll deduction, national account maintenance, bulk-buying: 0.3% annual cost target

• Individual accounts invested at individual’s instructions: default fund

The role of the state

• Ensures that all people are out of poverty in retirement, and creates a sound base on which private savings can build

• Encourages and enables low cost saving, but leaves ultimate decisions to individual choice

Pension income as a percentage of earnings for the median earner: retiring in 2053

Figure Ex.7 p19

Typical Annual Management Charge in alternative forms of pension provision

Figure 1.27 p71

Variability of real returns on equities over historical periods: 1899-2004

Figure 5.24 p197

Variability of real returns on equities over historical periods: 1899-2004

Figure 5.24 p197

Longevity risk in UK pension provision, £billion of total liabilities- broad estimates: end 2003

Figure 5.17 p181

Inflows and outflows from NPSS

Figure 6.36 p288

Aggregate NPSS funds at different rates of return

Figure 6.37 p288

Stock of annuities arising from the NPSS

Figure 6.38 p289

Long-run effect of NPSS on private pension savings as a percentage of GDP

Figure 6.39 p289

A New Pension Settlement for the Twenty-First Century:Second Report of the Pensions Commission

Cass Business School

Adair Turner7 December 2005