The pensions reform White Paper Are we on the right track? Speech by Alison O Connell Scottish Widows 30 June 2006

Transcription

1 The pensions reform White Paper Are we on the right track? Speech by Alison O Connell Scottish Widows 30 June 2006 Page 1 of 5 All of us, especially if we have worked in the financial services industry as I have, believe that saving is a good thing. Over the years, we have learned from savings schemes in Singapore, or Chile, or Australia, or Sweden. Many of us have worked on blueprints for a national savings scheme the other day I rediscovered work I did on one at McKinsey over ten years ago. The biggest lesson I have learned in my decade (so far) in pension policy is that any national savings scheme can only work with a good enough state pension. The recent White Paper fluffs this. In my 5 minutes, I ll explain why and suggest what lessons we can take from other countries. Difficulties and risks with a national savings scheme As a result of auto-enrolment, people will face new decisions: whether to stay in, what investment to make, how much, and which provider to go with. These decisions will be more complicated than need be because of the uncertainty around what level of pension people will get from the state in future, for two reasons: First, an individual will not know how much state pension he or she will be eligible for. The Basic State Pension will become near-universal by 2020 but it will only provide 14% of National Average Earnings, or 76 a week. To get clear of means-testing and to the White Paper target of 135 a week, 27% of NAE, an individual will need some S2P. The reforms bring around 1 million carers into S2P, but still one-quarter of people will not qualify for S2P each year. The White Paper is rather coy about the implications of this. By presenting outcomes only for people with a full National Insurance record, the White Paper glosses over the significant number of people will do worse than that.

2 The second type of uncertainty for many people will be whether they will be eligible for Pension Credit in future and if so, how much will they receive and what that means about the value of saving now. Here the White Paper gives no certainty. Although an intention to index the Guarantee Credit to earnings was announced, no mechanism by which this would be achieved was described, nor the level at which Savings Credit might be given in future. But these parameters make a huge difference to the outcomes for Pension Credit. The extent of means-testing by Pension Credit will remain uncertain and high Proportion of pensioner benefit units eligible for Pension Credit 44% -51% 70% 60% 45% 31% 29% 45% Current system (DWP) After White Paper reforms (DWP) After White Paper reforms ( initial estimates) The White Paper shows that Government expects around 40% of people to be eligible for Pension Credit for the next 15 years or so, then a reduction to around 30%. The Government indicates there is uncertainty in these numbers, but does not show what the range of uncertainty might be. modelling suggests that up to 45% of older people could still be eligible for Pension Credit by 2050 and we are doing more work to identify the likely range of outcomes. So the White Paper sets an expectation that Personal Accounts will make up for an inadequate state pension; get over the means-testing trap; and then get people to a target 45% replacement rate for income in retirement. This is a lot for one scheme to do. Page 2 of 5

3 The Personal Accounts scheme is pretty brave for Government. It is: setting expectations very high without providing a stable underpin using an untried technique (auto-enrolment has never been tried on a national scale, only in employer based schemes) and facing risks of things like system build going wrong and unintended consequences which are always a risk when Government intervenes in savings, capital and labour markets All this risk, when Personal Accounts are only expected to be less than 1/10th of total retirement savings assets. Role of Government in pension provision How can we reduce the risks and make auto-enrolment a success? We suggest Government needs to reconsider the balance between state and private provision. Let me explain what I mean with reference to pension policies in other countries. Personal Accounts are planned as a package with low state pensions Target income for an average earner as % NAE ~60% ~60% ~40% ~41-50% Max. 42% ~8% 15% Min. 33% Max. 27% Australia Chile Sweden KiwiSaver in NZ Compulsory UK Personal Accounts Auto-enrolment In theory at least, in the countries which have introduced compulsory private savings, everyone should be taken above and beyond adequacy: to around 40% of National Average Earnings (NAE) in Australia or around 60% of NAE in Sweden or Chile. Governments here have decided that choices about saving rather than spending should be restricted for quite a large slice of an individual s money. Page 3 of 5

4 An alternative policy is to guarantee adequacy through the state pension. New Zealand is a fairly generous example of this approach. Its state pension, which has wide political consensus, is set at a minimum of 33% of NAE. Nearly everyone gets this or more. Only 5% or so are eligible for means-tested benefits. The NZ Government allows individual choice about savings vs. spending at lower levels than the previous countries, but not so low as to threaten adequacy. The only other national auto-enrolment scheme to be proposed - the KiwiSaver will allow opt-out, but those choosing to opt out know they can still get by on the state pension. No target for retirement incomes above adequacy is set. In fact, although I have shown the KiwiSaver amount as an income, it can be taken as a lump sum, with no fear of falling back onto a means-test if spent. What underlies the UK s White Paper proposals is a curiously different policy. Compulsion does not extend very far, and does not guarantee adequacy. There is a low, and uncertain level of state pension that may reach 27% of NAE for some people, but for at least a third of people (and perhaps as many as a half) will be inadequate - below 25% NAE unless they claim means-tested benefits, which we know not everybody does. But the private pension saving on top is voluntary (through autoenrolment) so that cannot ensure adequacy either. Why we have chosen such a different policy? It is perfectly possible and affordable to have a guaranteed adequate state pension not perhaps as generous as New Zealand s and it doesn t have to be a Citizen s Pension if for some reason you don t like that idea. The has set out very detailed analysis to show different ways to have a simpler, single-tier flat benefit that would reduce the numbers eligible for Pension Credit down to 10% or so. We can transition to that as quickly or as slowly as you like depending on your views of administrative convenience. Page 4 of 5

5 A suggestion We can do so without spending any more money, or we can spend money differently. What if we increased NI contribution rates by 1% each on employer and employee? That would be enough to secure easily a good basic state pension that would make Pension Credit a residual benefit for 10% or fewer. Then the Personal Accounts scheme could be introduced with a total contribution rate of 6% rather than 8%. The total amount going into pensions state and private - should be about the same. We would have the same overall result with only slightly extending the Government s role in compulsion. Crucially, adequacy would not be risked for anyone. The people we are most worried about the lowish earners - would be more likely to be covered in the most efficient pension system there is. Those decisions about opting in or out and investment choices would be less critical if people do opt out or their investments go bad, adequacy is not threatened. The Financial Services Authority is more likely to be able to say people should stay opted in. There would be no imperative to have a pension scheme - it could be a more flexible savings scheme that helps people with other financial needs like buying a house for example. All the risks I spoke of earlier become less severe. We are not saying we should rush into this solution or any other. But we do think analysis of alternative balances between state and private like this should be carried out. We found the White Paper justification for the chosen state pension reform highly selective. The state pension reforms in the White Paper are incremental: they tidy up the system to some extent, but leave it complex and uncertain, and do not make a big difference to the income distribution. The White Paper got it right in saying that the state pension system has to change to be a good foundation for Personal Accounts. But something more than incremental change is called for. Having a third of people means-tested through Pension Credit - and that looks like an underestimate - is not a sound basis for an auto-enrolment savings scheme. A continuing mistake in UK pension policy since the 1980s has been to have too high expectations of what the private sector can provide when the state pension is mean. I really hope we do not continue making the same mistake. Page 5 of 5