New clause 5 - Report to Parliament (No.1)

Armed Forces (Pensions and Compensation) Bill – in a Public Bill Committee at 3:30 pm on 24th February 2004.

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'The Secretary of State shall report to Parliament on the feasibility of establishing a funded pension scheme for members of the Armed Forces within two years of this Act coming into force.'.—[Mr. Swayne.]

Brought up, and read the First time.

Photo of Desmond Swayne Desmond Swayne Conservative, New Forest West

I beg to move, That the clause be read a Second time.

You may recall, Mr. Griffiths, that when I spoke on the sittings motion I said that we should have this debate. During the debate on proposed new clause 1, I asked the Minister why the review body had presented the case that the armed forces pension scheme should remain an unfunded pay-as-you-go scheme. The matter was presented as a fait accompli—there had been no discussion, nor any consideration of the possible alternatives, such as a part-funded or fully-funded scheme. I asked the Minister during that debate whether he could share with us some of the logic that went into reaching that decision, but he did not respond.

I therefore tabled this proposed new clause, entirely with the intention of being helpful to the Government. Labour Members may be surprised to discover that the Government have a target for funded pensions. The target is that 60 per cent. of all pension liabilities should be fully funded by 2050, as opposed to 40 per cent. at present. There is not the slightest chance of the Government achieving that target unless they start taking radical initiatives now. I am providing them with an opportunity to do so, by tabling the proposed new clause.

It may be that it is inappropriate to move the armed forces pension scheme on to a funded basis; there may be perfectly logical and acceptable arguments to be made on the matter. However, we must have that debate. The proposed new clause calls for a report, and provides the Minister with two years to do the research work for that report. Such a report would enable us to have the debate properly, and to reach decisions.

Under a pay-as-you-go system—the existing system—this year's taxes are used to pay for this year's liabilities. Nothing is saved; nothing is invested. Imagine the considerable impetus to economic activity of investment on the scale that we are discussing, if we were to move to a funded scheme. The potential benefits would not just be for members of the armed forces who are the beneficiaries of the scheme, but to the entire economy. Arguably, a funded scheme would also encourage additional voluntary contributions, and that could have a significant impact on the benefits that would be payable.

Historically, it was always thought sensible to handle public service pensions on a pay-as-you-go basis, be they pensions for the military, the police, teachers, the fire service or civil servants. It was thought to be more sensible to pay for them out of current revenue, rather than to hand over money to the private sector, incurring fees and charges, to

generate and manage the funded schemes. However, times have changed, not least because the population has aged significantly. An existing pay-as-you-go scheme is in effect a sophisticated pyramid selling operation, because payouts depend entirely on the expectation of a future continued level of paying in.

In the past, it was always thought entirely sensible to consider that expectation legitimate, but with a much smaller working population in the future having to pay the tax revenues to pay for the liabilities being incurred now, I would suggest that that is no longer a certain equation. Therefore, the pyramid selling aspect is not one that we can look to with as much equanimity.

Pension payments now account for an increasing proportion of the services budget. Fully one quarter of our annual expenditure on the police force is taken up by pensions. It would be interesting if a Minister were able to provide similar figures for the proportion of defence expenditure that is now accounted for by pension payments. Given the amount spent on procurement, perhaps it would be more interesting to examine the total cost of manpower, with the pension cost as a proportion of that. That would be more realistic.

The total liabilities that we have built up with the pay-as-you-go pension schemes that the state now sponsors are truly enormous—probably equivalent to the entire gross domestic product, or about £600 million. It is undeniable that public sector pensions have been denied the stock market growth available to private pensions, which have enabled them to keep up with the market. We have discussed in Committee ways in which we might want to improve the scheme, but the cost of those has to fall entirely on the taxpayer because we have a system that prevents that cost falling on the stock market and on economic growth and other benefits. The asset growth of the funded system would have far outstripped any cost of management fees or any other such fees and made the same benefits much more easily affordable.

There is a counsel of despair that our obligations are so large that they cannot realistically be funded at all. If we struggle to pay the unfunded pensions now, how can we afford in addition to put money aside to fund new entrants at the same time? That is undoubtedly a counsel of despair. There are funding strategies that can be devised to deal with that. That is why the report gives the Minister two years in which to look into this question and to examine funding strategies.

Photo of John Cryer John Cryer Labour, Hornchurch

I can recognise one particular funding strategy, which is increasingly taxing the wealthy—a burgeoning proportion of the population—and redistributing that towards pensioners from the armed forces, the police, the fire brigade and the other public services with unfunded pension schemes.

Photo of Desmond Swayne Desmond Swayne Conservative, New Forest West

Of course, one way of providing a more generous armed forces pension scheme would undoubtedly be higher taxes, but it is a myth that there are people out there who are sufficiently rich to pay higher taxes. The lesson of history is that whenever we

have sought to soak the rich we have ended up taxing people on ordinary incomes much more heavily. Before the war, one had to earn twice the average income to pay any income tax at all. Now one starts paying income tax at somewhat less than half average income, and that when we have increasingly embraced that notion of progressive taxation, to which the hon. Gentleman referred. I do not detect any enthusiasm for the prescription that he offers. No one writes to me to offer to pay higher taxes.

Photo of Mr Win Griffiths Mr Win Griffiths Labour, Bridgend

Order. We are wandering from the issue. The hon. Gentleman should return to it.

Photo of Desmond Swayne Desmond Swayne Conservative, New Forest West

You are right, Mr. Griffiths. I was tempted down that path.

One way of devising a strategy to generate the resources for a funded scheme would be to move to a proper contributory scheme and abandon the current fiction in which an abatement of pay is used to take account of the benefits of the scheme. To give members of the armed forces ownership of their scheme through a proper contributory system would not only potentially generate the funding for a fully or partially funded scheme but have significant additional benefits for the scheme's management.

The argument for moving to a fully or partially funded scheme rests principally on the superior growth rate that equities have experienced during recorded history. It would also arguably take advantage of the Government's superior covenant for borrowing. The one thing that the Government can do better than anything else is borrow. They can do it more efficiently, more effectively and at lower cost, which is why I have always been somewhat suspicious of the private finance initiative and thought that it had more to do with the Maastricht convergence criteria than principles of sound public finance. However, I shall not go any further down that road.

A significant benefit can be drawn by separating out pension obligations from the balance sheet rather than confusing them with the current expenditure on the armed forces. It would also provide us with an opportunity to create a funded scheme for new service entrants, which, like our own scheme, might be significantly more generous at an affordable rate in the future. There are significant arguments against that, and with the greater potential growth in equities comes a significantly greater risk attached to the scheme. The Minister will have to examine those consequences in his report.

Equally, however, there are ways of offsetting that risk. I was interested to hear about a recent meeting sponsored by the Centre for Economic Policy Research and the Royal Economic Society on 3 February, entitled ''Defusing the Pensions Timebomb: What are the Policy Options?'' Professor David Miles of Imperial college fell somewhere in the middle of the arguments. On one side are those people whom I would describe as the counsellors of despair. They say that the system is far too expensive and that we cannot pay for it. Certainly, one problem is that people are trying to pay in one generation for two schemes, as they have to meet their existing obligations while starting to fund for the future. The argument

runs that given that the existing generation are voters, none of them will stand for it.

One the other side are the evangelists of the Adam Smith Institute, who say that the growth in equities is so great that it will more than pay the costs of the entire transition in one generation. Professor David Miles is sceptical about some projections of the benefits of swiftly moving to a fully funded scheme, although he accepts the long-term benefits of funded schemes.

When the Minister is compiling his report during the next two years, he should read the report of the recent meeting. In it, Professor David Miles considers the possibility of an insurance scheme that would run alongside the funded scheme, and its affordability, which would take much of the risk out of the equation.

The Minister will have to consider a number of possibilities when compiling his report. One is that the Government could reduce the burden of liability that they have built up by issuing Government stock and investing the proceeds in equities. The difference between the interest payable on Government stock and the equity returns would reduce the scale of the problem. Equally, they could borrow to purchase annuities or corporate debt and use the interest rate difference to reduce the cost of current pension benefits. A number of questions arise as a consequence of any thinking along those lines. Could the Government realistically borrow so much, and how much are we talking about? Would that have an impact on the markets—perhaps driving up interest rates and making the whole scheme unaffordable? What would be the impact on the financial markets? Could we devise ways of making such a change more manageable, perhaps taking it in stages? Would the markets simply take it as a one-off and absorb it accordingly, as a restructuring exercise?

All those big issues must be dealt with, but they are part of a current debate. The Adam Smith Institute is working on it now. Policy institutes and think-tanks are working on it, so it is part of a current and important debate. I return to where I began: if the Government are serious about their targets for 2050, they must go through the process of evaluating the measure. It is important to have answers to my questions. For that reason, we have given a reasonable amount of time in the new clause—two years—for the Government to go away, reconsider and report. This important issue must be fully examined if we are to come anywhere near the very desirable target that the Government have set themselves.

Photo of Gerald Howarth Gerald Howarth Shadow Minister (Defence) 3:45 pm, 24th February 2004

I was not going to speak in this short debate, but my hon. Friend raises some interesting issues, especially those to do with the contributory scheme. There are more difficulties for funded schemes and he referred to a large amount of money that would be necessary to fund such a scheme, pointing to the advantages that would accrue to those anxious to access pension funds for investment purposes. We

know that investment funds are the source of a lot of new businesses: they certainly lubricate the wheels of enterprise in this country. I shall not go down the road of why they have lately got into some difficulty. However, there are more difficulties with a funded scheme. It would have to have a board of trustees. That would not necessarily be representative, but it would have to be in place by law. If that board, which would be responsible for administering the fund, got it wrong—as pension fund managers and trustees do occasionally—and there was insufficient money to pay pensioners, the burden of funding those affected by a shortfall resulting from such mismanagement would undoubtedly fall back on the Government of the day. They would effectively underwrite the scheme because the public would not countenance our armed forces or veterans being treated in any other way.

The point about a contributory scheme has real resonance. Again, the Government ought to consider carefully how to deal with that issue before the Bill goes to the other place. There is widespread resentment among members of the armed forces about the notion that they get a good pension scheme but that they do not pay for it. We can argue about whether the scheme is good, but we cannot argue that people in the armed forces do not pay for it. Of course they pay for it, even though that is not obvious, through the abatement arrangement. In other words, the income of members of the armed forces is currently reduced by 7 per cent. per annum, which is the Armed Forces Pay Review Body's recommendation. Members of the armed forces pay for their pensions, but they do not have the appearance of ownership. That ought to be considered.

I am not going to be unreasonable and I accept that there is a downside, which is that the pay of servicemen would probably have to be reduced to take into account the extra payments that they would make. At present, the pension is based on the abated salary. A serviceman such as the hon. Member for Falkirk, West (Mr. Joyce) receives a pension on the basis of 93 per cent. of the salary that had been due to him. However, if the system was made transparent and ownership of it was given to servicemen and women, one would have to pay them more and deduct a sum from the pension, which would be seen on their payslips. The pension bill that would accrue as a result would be greater because the Government's pension bill would be based on 100 per cent. rather than 93 per cent. The only way to pay for that in a cost-neutral straitjacket is through reduced pay.

I accept that there is a downside, but there is a debate worth having and the Government should encourage it. The Minister has responsibility for the armed forces, so when he goes around the country, in the consultative mood on which he is so keen, he ought to take the opportunity to ask people what they think. Pensions are probably not an immediate concern to most of them, although with the new changes the issue will be more apparent on their radar screens. It would be interesting to know whether people would be prepared to accept a small reduction in their salaries, with a transparent deduction on their payslips for their

pensions. I do not know what the outcome of such a debate would be, but it would certainly be interesting to determine whether there was sufficient resentment, as I have suggested, to encourage them to favour a scheme that would result in a slightly reduced salary.

Photo of Mr Syd Rapson Mr Syd Rapson Labour, Portsmouth North

I do not necessarily accept that there is widespread resentment about paying for the scheme, but I recognise that there is widespread resentment about the perception that those concerned do not pay towards their pensions. I was an industrial civil servant for 39 years and was lucky to be in a non-contributory scheme similar to the scheme that covers servicemen and women, inasmuch as I did not contribute but my wages were deducted in the same way. Throughout those years, the members were pleased with the system. They were annoyed at the perception that they were not paying towards the pension scheme, but the nub of the members' pleasure was that the scheme was not funded as such. The money was not in a fund but in the Government's coffers, which gave them security when they became pensioners.

I am worried that if the fund is managed and controlled in the way you propose, many servicemen and women will consider themselves at risk because the pension fund could be at the vagaries of the market instead of them being afforded the protection, which we always accepted in the civil service, that the Government will pay the pensions. I accept that there is widespread resentment at the wrong perception that members do not pay towards a pension when they do so by abatement, but not that they are resentful of the type of scheme that they are in.

Mr. Howarth rose—

Photo of Mr Win Griffiths Mr Win Griffiths Labour, Bridgend

Order. I remind hon. Members to keep interventions brief and that I am not responsible for proposing anything in the Committee.

Photo of Gerald Howarth Gerald Howarth Shadow Minister (Defence)

More is the pity, Mr. Griffiths, sucking up to you as I am.

I agree with the hon. Gentleman's basic thesis, but he is slightly mixing up two ideas. He implies that a contributory scheme would necessarily be a funded scheme, but I am not suggesting that. In fact, I am making the opposite assertion that the scheme should be contributory and that contributions go into the Government coffers rather than a specific fund. He is right that I was referring to the wrong perception that exists and causes resentment.

I am not minded to take the view that a fully fledged funded scheme, as set out by my hon. Friend the Member for New Forest, West, is the best way to proceed. However, as the whole pensions issue for the armed forces is under review, it is worth considering.

Photo of Mr Ivor Caplin Mr Ivor Caplin Parliamentary Under-Secretary, Ministry of Defence

I always appreciate the opportunity to have a short debate on such matters and I thank the hon. Member for New Forest, West for tabling the new clause so that we can do so. He asked how much of the defence budget is spent on pensions. The cost of accruing liability for pensions of those currently serving is between 3 and 4 per cent. of the defence budget. If we set up a funded scheme, which I think he

suggested—I shall come to the contribution of the hon. Member for Aldershot in a moment—one of the biggest issues would be the historic liabilities for which the Government would be responsible. I cannot put a figure on that, but I guess that it would run into billions of pounds.

The hon. Members for New Forest, West and for Aldershot raised several questions about the figure of 7 per cent. The last quinquennial report of the Armed Forces Pay Review Body, which was, if my memory serves me right, in 2001, contained an annexe outlining the thought processes on the armed forces pension scheme. A 7 per cent. abatement is not the cost of the pension but the extent to which it is regarded as better than comparable schemes. That is how the pay review body considers the matter. Indeed, if we examine the value of the abatement, which, as I said, does not relate to the value of the pension scheme, we come to the conclusion that the pension scheme is worth, as I said, something in the region of 22 per cent. of pensionable pay, not 7 per cent. So there are significant differences in the figures.

I want to comment on what would happen if we accepted the idea of the hon. Member for New Forest, West—apart from the fact that he has given me two years to produce a plan. I can understand why a pension fund that is partly funded by contributions from scheme members might be superficially attractive to hon. Members, but I can see no advantages in that to our service personnel. My first consideration is always, as many Committee members constantly remind me, to put the armed forces personnel first. Indeed the switch to contributions would be the corollary of moving to a funded scheme. In my view, it would lead to lower take-home pay and would therefore be unattractive to the armed forces.

What purpose would the fund serve? There is an argument about greater transparency, but our current arrangements are sufficiently transparency. We have internal Government accounting, which requires the Department's budget to include a pension contribution known, to use the jargon, as the annual superannuation liability charge. It is currently 22 per cent. of pensionable pay, and we publish a pension scheme statement along with the account. In the private sector, where I was fortunate to be a pension trustee of a scheme for three or four years, funds are seen as protecting members from the scheme's bankruptcy. It is hard—in fact, it is unthinkable—to imagine circumstances in which the Government would not meet their financial obligations to our armed forces and the veterans.

Funds also attract substantial management overheads, including the cost of running an investment portfolio, which would cost the scheme but bring no clear benefit to the members. Funds also carry substantial risks for scheme members if investments do not perform, as hon. Members said. The idea of a funded scheme would go hand in hand with the introduction of member contributions. The Defence Committee asked the Government to consider the matter carefully in its report on the Ministry of Defence's initial consultation proposals, at

paragraph 37 of the third report of Session 2001–2002. The Government replied to the Select Committee in two memorandums published in July 2002 in the fifth special report, and on 12 September 2002, ahead of the oral evidence given by the my hon. Friend the Member for Kirkcaldy (Dr. Moonie).

The Government actuary considered the case for a funded scheme and looked at the advantages and disadvantages of a contributory scheme compared with a non-contributory scheme. Specifically, the Government Actuary's Department considered an idea raised by the Forces Pension Society of turning the abatement of comparative pay made by the Armed Forces Pay Review Body, which is set at 7 per cent., into a 7 per cent. contribution by scheme members.

The pros and cons of an arrangement along those lines are not straightforward. When is any pension scheme straightforward? However, I assure the Committee that it would lead to lower take-home pay for members of the armed forces in the order of 1.5 per cent. The benefit of higher gross pay and the subsequent increased pension benefits is more than offset by additional income tax and national insurance contributions and an increased abatement from the Armed Forces Pay Review Body, which would be expected to take into account the improved pension scheme benefits.

I have no reason to believe that our armed forces would want to give up pay today for future pension benefits. It would be out of line with our assessment that take-home pay is a key driver for recruitment and retention. On that basis, I welcome the opportunity to have this debate with the hon. Member for New Forest, West, but I hope that he will withdraw the motion and new clause. If not, there will have to be a Division, and I hope my hon. Friends will resist the temptation that he places before them.

Photo of Desmond Swayne Desmond Swayne Conservative, New Forest West 4:00 pm, 24th February 2004

I am not sure that we have had the right debate. The Minister argues that we should not move to a funded scheme and gave plausible reasons to support that. My purpose in tabling the new clause was merely to ask him to consider the feasibility of providing such a scheme. He mentioned the work by the Government Actuary. That suggests that part of the work that the new clause would require of him has been done and, therefore, that it would not be the huge undertaking that it might otherwise have been.

It is undeniable that the issue is important. The Government's total liabilities are a like a time bomb ticking away, and the willingness of the taxpayer to continue to fund them in future cannot be taken for granted. The requirement to meet those liabilities will inevitably mean that expenditure will not be available to maintain the capability of many of the services in the way in which we have before. The Government have recognised that problem and, consequently, have set themselves a target. I am asking them to consider whether the armed forces are an appropriate mechanism with which to reach their target, and to consider the issues that the Minister and other hon. Members have drawn attention to—principally, the question of risk. Those important issues are part of the

current debate and we will probably have to return to them. However, I tabled the new clause to probe the matter and I do not see any value in pressing it now. I beg to ask leave to withdraw the motion.

Motion and clause, by leave, withdrawn.