Pensions Policies what are the future liabilities?

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1 Pensions Policies what are the future liabilities? Foundation for Science and Technology July 11 th,

2 Total Personal Sector Balance Sheet End 2003: Estimated Figures to the Nearest 50 Billion Assets Liabilities Cash and Deposits (1) Short term consumer debt Securities (equity and bonds including via 350 mutual funds) Insurance Company Policies (excluding pensions) 300 Unquoted Equity 100 Non-Pension Financial Wealth 1,150 Residential Housing 3, Mortgage Debt Net Housing Wealth 2,250 Pension Funds and Policies (2) 1,300 Unfunded Public Sector Pension Rights (3) 500 Accrued State Pension Rights 1,100 Non-state Pension Rights 1,800 State Pension Rights 1,100 Total 7, Net Personal Sector Wealth 6,400 Of Which Market assets and liabilities 5, Net Market Assets 4,800 PAYG claims on future tax resources 1,600 (1) The Cash and Deposits figure is as per M4 for individuals in ONS Financial Statistics. This figure is below the figures recorded in the Blue Book Household sector balance sheet, since the household sector includes non-incorporated businesses and charities. Small judgmental adjustments to exclude theses latter two groups have been made to derive personal sector estimates for other asset categories e.g. for securities, for which the total household sector figure is 400 billion (2) The personal sector claim against pension funds can be higher than the value of assets, o the extent of pension fund deflects (and was by about 70 billion at end 2003). Personal sector funded scheme rights might therefore alternative be expressed as 1,400 billion, but only if there is no risk of pension fund insolvency (3) The GAD estimate for March 2003 is 425 billion, but this will increase significantly once it is recalculated using the latest life expectancy estimates, and using an equivalent discount rate to that used in the private sector Old-age Dependency Ratio: All 65+ : 20-64, UK based 2004-based Source: GAD 2004-based principal population projection, UK GAD 2002-based principal population projection, UK ONS Population estimates unit, UK 2

3 Impact of the 1940s-1960s Baby Boom on the Old-age Dependency Ratio With baby boom No baby boom Source: Pensions Commission analysis based on a synthetic model fo the England and Wales population Public Expenditure on Pensioners as a Percentage of GDP : Pensions Commission Base Case Projections 8% 7% 6% 5% 4% 3% 2% 1% BSP SERPS/S2P Pension Credit Housing Benefit/Council Tax Benefit Other Disability Living Allowance/Attendance Allowance Source: Pensions Commission analysis Note: Other includes Winter Fuel payments and free TV licences. The public expenditure projections quoted here and at other places in this Report and the estimates of the percentage of pensioners covered by means-testing, reflect the complex interaction of numerous trends. Published official estimates have varied from year to year. Figures should therefore be considered as indicating broad trends and particularly differences between options. Appendix F explains the modelling tool Pensim2 which has been used to generate these projections. Note in particular that the projections use fixed assumptions for flows of private pension income. In reality one might expect options entailing weaker incentives through wider means-testing to imply smaller flows of this kind, which could increase public spending on means-tested benefits further 3

4 State Pension at Point of Retirement Assuming a full Contribution Record for a Person Who Has Been on Average Full-time Earnings throughout their working life: Percentage of Average Earnings 4 35% 3 25% 2 15% 1 5% BSP SERPS Increase due to S2P Source: Government Actuary's Quinquennial Review of the National Insurance Fund as at April 2000, GAD Active Members of Private Sector Defined Benefit Pension Schemes by Scheme Status, Millions Millions Open DB Closed DB Source: Occupational pension schemes 2004, GAD 4

5 Participation in public and private sector nonstate pension schemes: percentage of workforce Contributes to nonstate pension Private sector Does not contribute to non-state pension Contributes to nonstate pension Public sector Does not contribute to non-state pension 1996/ / /05 Source: Government Actuary's Quinquennial Review of the National Insurance Fund as at April 2000, GAD Private Pension Income as a Percentage of GDP by Source % 7% 6% 5% 4% 3% 2% 1% Unfunded public sector Defined Benefit Funded Defined Benefit Money Purchase (occupational and personal) Source: HMT, ONS and Pensions Commission analysis Notes: Pension income based on Pension Commission estimates from the Family Resources Survey, the Blue Book and Pensim2. Includes income from annuities and lump sum payments. These figures include all pension income whether flowing to people below or above State Pension Age. Other figures (e.g.figure 1.21) focus solely on the income of those above SPA. About 4 of non-state pension income currently flows to early retirees 5

6 Residential Housing Wealth as a Percentage of GDP Gross residential housing Residential housing owned by the household sector Source: ONS Blue Book Home Ownership By Age Under and over Source: Living in Britain, GHS, GB Notes: Age refers to the age of the household reference person (HRP). The HRP is defined as follows: in households with a sole householder that person is the household reference person; in households with joint householders the person with the highest income is taken as the household reference person; if both householders have exactly the same income, the older is taken as the household reference person 6

7 Summary of Current Risk Bearing: Who Bears Which Categories of Risk? Risk Category Classic DB Classic DV UK State Pension Investment Pre-retirement Employer Individual (1)(2) State (4) Investment Post-retirement Employer Annuity Provider State (4) Specific Longevity Postretirement Average Cohort Longevity Post-retirement Long-term Average Cohort Longevity Pre-retirement Employer Annuity Provider State Employer Annuity Provider State (4) Employer (3) Individual State/Individual (5) Default/Political Individual (in future partly covered by PPF) Individual (6) Individual Earnings Progression Employer Individual Largely Individual (1) May be partially absorbed though with-profits funds (2) When investment returns is very poor however this risk is partially absorbed by the state if there is a means-tested element in the state pension system, e.g. a DC investor who does badly will in the UK receive more Pension Credit (3) Employer absorbs thins risk if (as in most DB schemes) the age of retirement is contractually committed far in advance (4) May be partially passed on to individuals by changing the value of pensions in payment (5) Depends upon whether the state is committed to a State Pension Age set far in advance and whether it delivers on this promise (6) Partly recovered by Financial Services Compensation Scheme Gross Mandatory Pension System Values 20 Gross pension as a percentage of average earnings Individual's earnings as multiple of average Netherlands Sweden Spain Australia USA UK New Zealand Strongly earnings related systems - Netherlands on quasi compulsory savings basis Intermediate systems - Australia on compulsory savings basis Become flat-rate over time Purely flat-rate system Source: Monitoring Pension Policies, Annex: Country Chapters Notes: Netherland's figures reflect the impact of the quasi-mandatory private savings systems as well as the PAYG pension. The Australian figures reflect the impact of the mandatory private pension savings system as awell as the PAYG pension 7

8 Public expenditure versus State Pension Age trade-off: state pension and pensioner benefit expenditure as a % of GDP 8.5% Commission option if SPA increases to 67 by % 7. Commission option if SPA increases to 69 by % % Pensions Commission preferred option modelled with SPA increases to 68 by 2050 Proposed range for debate DWP long-term public expenditure projections (Pre-Budget Report, 2005) Target Pension Income as a Percentage of Earnings for the Median Earner: at the Point of Retirement in 2053 Government Supports Enables Further provision by employer or employee on a voluntary basis 15-18% Enables and strongly encourages through auto-enrolment Provides through compulsory contributions: contributory basis 14% 15-18% 60-66% Provides through compulsory contribution: universal accrual basis 17% Full Basic State State Second NPSS pension with Impact of possible Pension Pension with 44 default contributions voluntary years of and reasonable contributions to contributions/credits return assumptions NPSS Total Source: Pensions Commission analysis Note: The range of 15-18% shown for the impact of default contributions reflects a range of assumptions about number of years of contribution between 25 and SPA 8

Assessing alternative policy options

6 Assessing alternative policy options Chapter 5 Section 9 sets out alternative policy reform options. This chapter evaluates them and presents the Pensions Commission s judgment on the best way forward.