New Clause 5
Nigel Waterson (Shadow Minister, Work & Pensions; Eastbourne, Conservative)
Thank you, Sir Nicholas. Whenever you summon someone to speak, I always expect a roll of drums as well. I welcome you to the Chair for what you rightly sense might well be our last day in Committee, after which all the guns will fall silent—at least for a short time. We are now skiing off piste and exploring those things that should have been in the Bill, and our proceedings are all the more interesting for that.
I take no credit for the draftsmanship involved in new clause 5 and new schedule 1, which is the work of the Association of Consulting Actuaries, particularly Mr. Ian Farr and his colleagues, and the Association of Pension Lawyers. I wish to make a small point on the drafting to spike the Minister’s guns if, as I suspect, he raises technical issues in that respect. If the principle of our proposals is accepted, it is always up to him to take them away and perfect them. That is not up to us. Opposition Members are not in the business of winning draftsmanship contests—we do not have the facilities. However, if the general principle of our proposal is accepted, as it should and must be, we can make progress.
Why have we tabled the new clause and the new schedule? We agree with the actuaries, who obviously have their fingers on the pulse of remaining defined benefit schemes, that there has not only been a massive shift away from DB schemes in this country, but that there will be a further acceleration of that process for two reasons. The Minister is fond of saying—and accurately so—that the move away from DB schemes started as a gentle downward course in the late 1960s. However, what we have seen, particularly since 1997, is a massive acceleration in that process. One thing on which we can all agree is that, in the world of pensions, if people are in a DB scheme, they are receiving the Rolls-Royce treatment and will end up with a relatively comfortable retirement, not least because, on average, contributions to defined contribution schemes are about half those to DB schemes.
It should be a policy aim of whoever is in government to maintain and protect DB schemes. That was the stated aim of the Pensions Act 2004, but that seemed to have the opposite effect by piling more cost and bureaucracy on to those who still run DB schemes. I have mentioned two risks, and we have discussed one exhaustively in Committee: the risk to existing provision of bringing in personal accounts. We have tried all ways in which to safeguard existing provision because, on the whole, that is significantly more generous in respect of the employer contribution than the 3 per cent. envisaged in personal accounts. The year 2012—if it be that year, although I do not want to re-open that one—will be the moment when employers will focus their minds on whether to stay in the DB game.
We have also touched on the consultation document produced by the Pensions Regulator, which is a more recent development that has taken place in the past few days. I made a brave attempt to read it last night, but one has to be a certain sort of person to catch all its nuances. It is very much actuary speak. It talks principally about the assumptions of those who run schemes—the trustees, essentially—about their members’ longevity. It contains much about what is rather depressingly called the “continuous mortality investigation”, which I think—but I am open to correction—is a process run by the actuarial profession that constantly reviews the levels of longevity in the country. It is, of course, good news that we are all living longer and, hopefully, healthier lives. I would never agree with those who go on about the demographic time bomb as though it were some horrible development not to be welcomed. Of course that is to be welcomed, but it has massive implications for pension funds.
There are all sorts of fascinating tables in the document, which you might wish to browse at your leisure Sir Nicholas, but although I searched high and low, it does not seem to come up with a figure as the new benchmark for male life expectancy, whether that be 87, 87-point-something or 89 years. However, some people estimate that if that sort of level were applied across the board to all pension funds, it could add an extra £75 billion or so in liabilities to pensioners. If that is the figure, that is the figure. If it is the necessary consequence of those life expectancy figures being accepted, there is no point arguing.
I think that it is fair to say that at almost every juncture in recent decades when the Government Actuary, or actuaries generally, have focused on projecting longevity, they have almost always understated it. That process might, of course, change with things like obesity and diabetes coming to the fore, but that is a matter for the future. That is another major risk in terms of the attitude of sponsoring employers to stay in DB schemes when they start to do their sums based on what is, of course, a consultation document. However, it is clear from some of the press briefing of the past few days that that is where the regulator wants to end up in terms of across the board longevity projections.
Before I get into the detail of the new clause and new schedule, I want to talk about the general issue of simplification or deregulation, which the Government, to their credit, have partly embraced as a necessary aspect of promoting and retaining a large number of DB schemes. There are measures in the Bill that we enthusiastically support that are on the same agenda, following the deregulation working group’s report. More can be done, and one of the main things is conditional indexation. At the end of the day, the Government can have no reasonable objection to the principle behind it. It happens in other countries—I can explain in detail what happens in Holland—and seems to be a useful tool for maintaining DB scheme membership at a relatively high level.
What harm can conditional indexation do? If not a single sponsoring company embraces the idea, and if, instead of moving straight from DB to DC—shifting all the risk from the employer to the employee, which we do not want to encourage—there is a third way, if I can use that expression, of conditional indexation, why not use it? Pensioners will be better off. What do the Government have to fear? The choice is between having a Rolls-Royce DB scheme and perhaps a Volvo or a Jaguar one. If people stick their heads in the sand—I am not suggesting that the Minister will do that—they could end up with no such pension scheme at all and fall back on to the personal accounts scheme. That scheme, although it has merits, does not have many for those who have no personal pension savings, but can be in a scheme where the employer contribution might be 10, 12 or 14 per cent.
So, what harm can it do? I make this offer to the Minister: if not a single sponsoring company takes advantage of this possibility, I will buy him a slap-up dinner in the restaurant of his choice. I cannot see any downside to these proposals—[Interruption.] I note that the Minister is pondering my offer.
The essence of new clause 5 is to end the ban on employers being able to offer new conditionally indexed pension schemes. It seems to me, the ACA and others that in around 2012, many employers will feel that they have no credible alternative but to move to DC pension provision and, if their existing scheme is still open to new members, or even existing members, to close it altogether and switch to DC, or simply move to personal accounts.
The actuaries have carried out work on the decline in membership of DB schemes. They say:
“Since 1995, the number of employee members of open, private sector defined benefit schemes has declined from 5 million to just 900,000 now.”
That is a massive decline. They also refer to the latest National Association of Pension Funds survey, which was published at the end of 2007, that said that only 40 per cent. of employers with open defined benefit schemes were prepared to say they expected no changes in the next five years. Fifteen per cent. are already expected to switch to pure DC, and 22 per cent. are expected to modify their scheme while retaining some DB provision. The ACA’s 2007 pensions trend survey found that 68 per cent. of employers expected further levelling down of provision in the period ahead and that 76 per cent. thought that more “good” schemes would close.
It is a bit like the issue of compulsory annuitisation. Nobody else around the world seems to do this. The mandatory indexation of both deferred pensions and pensions in payment in defined benefit schemes is unique to the United Kingdom. No other legislature in the world has placed such an onerous obligation on private sector firms to take on such an open-ended commitment on costs and liabilities. While I cannot claim to have made an exhaustive survey of European practices, I see the country that comes nearest is the Republic of Ireland, which requires indexation of deferred pensions only, and Germany, which requires it for pensions in payment only.
It is also clear that since the CBI gave oral evidence to the Committee, it has reviewed its position and now supports the new clause and new schedule. It set that out in its e-mail to the Committee of 6 February. That endorses the backing already given to the measures by the NAPF, the Society of Pension Consultants, and the Association of British Insurers. All the big players in the pensions field support this proposition, which makes it more difficult for Ministers to resist it, although I am sure that they will have a shot at that.
We, as legislators, will be held responsible when a process speeds up again whereby 100 per cent. of all risks fall on not employers, but ordinary employees. What is the point of conditional indexation? New conditionally indexed schemes offer to many mid-sized and larger employers that are prepared to share risks with their employees a pension arrangement that will not only attract and retain employees, but cap employers’ future costs. I do not think the ACA suggests that that would be particularly appropriate for smaller employers. The sobering thing that many major employers talk about is what is stretching into the distance: this ever-increasing escalator of liabilities based on year-on-year indexation. The ACA gave both written and oral evidence to the Committee. Of course, the Association of Pension Lawyers has looked at the legal issues in great detail, so I will not go too deeply into that. I am sure that it has made, or will make available, whatever thoughts it has on the technical side of things to officials.
It also seems that conditional indexation schemes would offer employees a far less volatile pension benefit than pure DC. Pensions would perhaps be based on career average earnings linked to service, save on occasions when scheme funding falls into deficit, with the condition that pension benefits will be indexed in line with a scheme-specific index—typically, inflation up to a 2.5 per cent. a year cap. Restoring indexation would be the first priority when a scheme returns to service. I will speak in a moment about the experience of Holland regarding the extent to which employers actually make use of the availability of conditional indexation.
Conditional indexation would not apply to the benefits offered by existing types of DB schemes. For the sake of simplicity, these amendments would apply only to new conditionally indexed arrangements that were set up after the Bill had become law. The provisions in no way interfere with existing types of risk-sharing arrangements or, indeed, with types that might be identified in the future. The Minister’s approach might be to say that we have to look at this in the round, that there are various sorts of risk-sharing and that we should look at all of them together and have a review—in tune with the current Prime Minister’s attitude to issues—but I do not think a review will do anything except put off the evil day. Why not do this, and then, if other ideas seem good, put them in as well?
I suspect that the Minister will argue that more time is needed to study the issue, but it has not suddenly popped up. This proposal has been floating around for a long time, and the ACA and the APL have made themselves available for detailed discussions with Ministers and officials. It is certainly an issue that the industry has been talking about for quite a long time. The ACA’s pensions trend survey over the last two years, to which I referred, has found that more than 70 per cent. of employers support the promotion of new risk-sharing schemes. I gather that next month a new survey conducted by HSBC and the Pensions Management Institute is to be published, and this survey—I have had a sneak preview—will show that more than 60 per cent. of employers favour arrangements whereby they can carry some or all of investment longevity and pensions inflation risk. I think we need to listen to that kind of evidence when it comes up.
I mentioned the ACA’s evidence to the Committee. Mr. Farr said openly:
“Conditional indexation—what we have proposed—is not a panacea. We and all the national pensions bodies that support this believe that it could stop the dramatic shift from defined benefit to defined contribution schemes that we have seen over the past 10 to 12 years.”
He describes conditional indexation as
“a genuine middle way between defined benefit and defined contribution; it has been well tried and tested in the Netherlands; it requires only small changes to the law; and it could be implemented quickly.”——[Official Report, Pensions Public Bill Committee, 17 January 2008; c. 82, Q106.]
I agree with all of that, and the NAPF supports this. In its memorandum, it said:
“The NAPF believe the Government should have considered more closely the option to introduce conditional indexation...The NAPF believes the Government should go further so that, for future accruals only, conditional indexation is granted depending on the current funding position of the scheme.”
It was made clear in November that the members of the occupational pension schemes joint working group, which involves the ABI, the ACA, the APL, the IMA, the NAPF and the Society of Pension Consultants, all took the view, talking specifically about conditional indexation, that risk-sharing
“would be a welcome step in the right direction to extending possible designs for risk sharing schemes.”
The CBI has now changed its position. In its most recent briefing, Neil Carberry, its head of pensions and employment policy, said:
“At our oral evidence session, the CBI indicated that while our members were in no way against the proposal for conditional indexation set out in new clause 5, they were more concerned by other issues...These issues should be a key part of the reform programme, and conditional indexation is certainly not a panacea. However, the introduction of such schemes will enable a minority of firms to choose to retain defined benefit style pensions where they might not otherwise have done so. This would be a valuable development. Following further consultation, therefore, CBI members feel that the inclusion of new clause 5 in this Bill would be beneficial as a way of presenting firms with another option for offering a high quality pension scheme.”
Finally, I quote the latest briefing from the TUC:
“We regard a government-led review of risk-sharing approaches to be an urgent priority.”
It also says that it believes
“that opportunities should be explored for occupational pension arrangements which genuinely share the risk between employer and members, where the only alternative is closure of DB.”
I find that very encouraging.
Without showing my slides, as it were, I will take the Committee through my recent trip to Holland.