Welcome to Mr Bryn Davies and Professor David Blake. We will now hear oral evidence from Union Pension Services and the Pensions Institute. Before calling the first Member to ask a question, I remind all Members that questions should be limited to matters within the scope of the Bill, and we must stick to the timings in the programme. I hope that I will not have to interrupt any of our witnesses mid-sentence. For the record, will the witnesses please introduce themselves to the Committee?
I would like to ask you both how you see the Bill’s provisions matching your expectations for a viable reformed state pension system, starting with Mr Davies.
Bryn Davies: It is broadly in line with the discussions that have been ongoing for quite a few years. I remember having a meeting in this building probably a decade ago where the Minister was present and discussing these same ideas.
In the past year, we have seen that some of the particular problems that were around are being dealt with. Those are the additional elements, and in particular there are those with significant accrued rights outside the state additional pension and the whole transitional process. What is new are the transitional arrangements, essentially.
Professor Blake: It is another attempt at simplification. We have had simplification before, but the state pension reform with the single tier is another move along the line, which is a good idea. There are transitional issues with the ending of contracting out in DB schemes, but the inevitable requirement to increase the retirement age in line with increases in life expectancy will continue, because of the increases in life expectancy and the systematic underestimation by official agencies in this country and elsewhere.
I do not see why we need to have an Act of Parliament every few years for this. Perhaps there should be a more regular arrangement, such as a longevity policy committee along the lines of the Monetary Policy Committee at the Bank of England. The simplification is to be welcomed, as well as the recognition that we are living much longer and drawing pensions for much longer, and we have not saved enough for that.
That is helpful, thank you. Secondly, I would like to know your views on the eligibility criteria for the single-tier pension, in terms of the 10-year threshold and the 35 years required for the maximum claim.
Bryn Davies: It is clearly a retrograde step. It is clear that the criteria have been introduced to meet the requirement to have no additional expense in providing state pensions. Until one understands that that is why the change has been made, one cannot follow on with the post hoc rationalisation of that objective. I think that it is a retrograde step and the scheme should have accepted where we had moved forward to in the legislation passed by the last Government.
Professor Blake: I slightly differ from that because one of the things that we do not tend to think about at all is the consequences for subsequent generations. Unless we make sure that we pay for our own pensions—most people in this country must in some sense pay for their own pension; they cannot rely on anyone else—an even bigger burden will be passed on to the next generation. This is, in part, a recognition of that. There might be inequities for this generation. There may be groups of people whose life expectancy is shorter and whose length of retirement will be reduced as a result of this, but there are bigger inequities between generations that we really have to confront.
Bryn Davies: The Pension Commission’s approach to the issue was largely driven by the problems that would arise by the ending of contracting out. There have been so many last nails in the coffin of defined benefit schemes that it is surprising we are still talking about them at all. It will have a severe impact, particularly in the private sector with the proposals for the overrunning provisions on scheme rules.
As someone who has been closely involved in negotiating pension schemes, my view is that this is an issue that should be left to negotiations. There is a high level of realism among trade unionists about the nature of funding pension promises from employers, so the issue will have to be handled.
In practice, schemes will close and people will get lower benefits from an employer-sponsored scheme. There is the associated issue of the impact in the public sector and, while the Government have said that the agreements reached with the public service schemes will be maintained, we do not yet know quite where the additional national insurance contributions that the public service employers will have to pay will figure in future public expenditure surveys. It will have a deleterious effect on pension provision in the private sector, and there will be pressures in the public sector—and we do not know how they will play out.
Perfectly fair. Mr Davies, what measures would you like to see put in place to ensure that employees in defined benefit pension schemes are protected? Do you have any thoughts on that?
Professor Blake: The defined benefit model was a very good model. We had it for 150 years; it is a great tragedy that it is coming to an end in the private sector. The amazing thing is that there are not street protests outside about this. It is amazing that we have got rid of something really quite good, although it was expensive and needed fixing, in a way that could not be done in another way.
People have lost a huge amount of their wealth. They do not understand it, and there will come a time when they regret it. It may be inevitable that we have to move to DC for a whole range of reasons: portability, job mobility and so on, but the ending of this in the private sector is a tragedy. It will lead to quite a conflict with public sector employees who still will have really good defined benefit schemes. Even though they have been reformed, there is going to be a conflict. The figure that I saw was that 20% of the work force are in the public sector, but they got 60% of the pension entitlement in this country. That, to me, is unsustainable going forward.
Your answers to Mr Selous’s first question have teased out some answers to this already. The Bill requires that people will have to work 35 years for a full pension and a minimum of 10 years to receive a pension, and we all accept that those are major changes.
You may know that, in his evidence, Chris Curry from the Pensions Policy Institute said that the changes were not going to have any major impact because by the time STP is fully operational the vast majority of people will have accrued 30 to 35 years of qualifying payments. However, Mr Davies, you said that STP is a retrograde step. Why do you think that? Is it because you do not like it? Do you think there are other reasons why the step is retrograde? For example, is it going to disbenefit significant groups of people and, if so, who?
Bryn Davies: I am not sure I follow, but what I was trying to say in answer to the earlier question was that moving from 30 to 35 years as the required period of service to be paid a full single-tier pension compared with the basic state pension is a retrograde step, because the whole point of the change is to save a significant amount of cost to the state pension scheme, so people will get lower benefits. I think that is a retrograde step.
With respect to the protections offered to derived and inherited rights, do you think those protections are sufficient or that further work could be done, particularly on transitional arrangements?
Bryn Davies: Again, if I understand the issue to which you refer, one of my major concerns relates to the statement in the impact assessment that
“...no person reaching state pension age under the single tier will get a lower state pension than they could have become entitled to based on their own pre-implementation contributions under the current system’s rules”.
I do not believe that is correct. A large number of people will lose out from their accrued rights. As a simple example, I would instance Gill. She is a machinist in an engineering workshop. She has always worked, from age 18, and she is 53 now. She has always received about median earnings for her age group, about £23,000 now. So, in 2012 figures, she has accrued a basic pension of £107.45.
Gill has also got an additional pension of SERPS-come-STP of £43.55, so she has a total pension from the state, accrued so far, of £151. Under the new system, she will get a single tier pension of £144, so her protected payment—what is left over—will be £7. Under the existing system, the whole of the £151 is revalued in line with earnings. In earnings terms, as in the impact assessment, she gets £151 at retirement.
Under the new system, the £144 is increased in line with earnings, but the £7 is increased only in line with the CPI. Using the assumptions in the impact assessment, I calculate that that will be worth only £4.82 rather than £7, so she has lost £2.18 over the period of deferment. At retirement, her pension is lower. That is not what the impact assessment says. It states:
“no person...will get a lower state pension”.
Well, she has got a lower state pension. Remember, this is someone on median earnings. The situation will be worse for anyone earning more than median earnings. Given that it is the median, half of those who have accrued the expected level of state second pension will not have their rights fully protected, and I think that that is a scandal.
Does it not actually state that the single tier will be set above the pension credit standard minimum guarantee of £145.40, but it does not state exactly what it will be, so you are basing your figures on a starting proposition that you do not know.
Bryn Davies: The figures are going up each year. I am sorry; I have not seen the House of Commons papers, so I cannot comment on that. But all the figures go up in proportion. I do not think it eliminates my point that someone on median earnings will get less pension at retirement than they would have got under the existing system, contrary to what is stated in the impact assessment. I will be providing written evidence to the Committee and I will set out the precise figures there. It is an issue I am very keen to highlight.
On that worked example, that person will on average draw a state pension for 25 years. Whereas Gill would have had an earnings-indexed basic pension of £107 and the rest would have been CPI’d, in our world she gets an earnings-indexed £144, so is it not the case that she gets a substantially more generous indexation in retirement?
Bryn Davies: That is true, but it is not what the impact assessment says. Also, for Gill in particular, it takes her two years to catch up, so it is four years before she is ahead. The higher people’s earnings are, the longer it takes. For an extreme case, I can demonstrate that it takes someone 30 years to catch up, and so 60 years for them to be ahead, and that is from the age of 67. Remember that Gill is a woman who spent most of her working life expecting to retire at 60. She is actually going to retire at 67 and get less than the benefit that she has accrued so far.
You are absolutely right that the increases on the single-tier pension will be higher, but it takes time to catch up. Unfortunately, some people will die within the four years. If Gill died within the four years, she would never catch up, and it is no consolation to her that other people who live to be 100 end up better off.
I was going to ask about the interrelation with means-tested benefits. Are you satisfied that the abolition of savings credit will be balanced by the benefits of a single-tier pension?
Bryn Davies: Clearly the abolition of pension savings credit will leave people worse off, but one can see how it fits within the overall approach of the policy. There will be numbers of people who, because of the loss of savings credit, will get lower benefits. That is the arithmetic result of the proposals. Again, that is not an area that I am an expert on.
Bryn Davies: Clearly it is a very good deal for the self-employed. We know that lower-income self-employed people have paid as much as people on low earnings, but there are many self-employed people who have earned a great deal more and, taking on board what the employers had to pay as well, those people have paid a lot less in national insurance contributions, but will get the same benefit. So, obviously, it is a good deal for them.
In that context, it is worth pointing out that because of the “no increase in expenditure” requirement, their gain means that other people somewhere in the system are losing out. It is reasonable to ask whether that meets the criterion of fairness that is given some emphasis in the White Paper.
We do not know—the Treasury has been very unclear about this—what contribution rate the self-employed will pay in the future. There will be a disconnect between self-employed people contributing at their present level above those on particular low incomes—that point has been clearly made—but there are lots of self-employed people earning more than that level and they will get the same benefit, having paid a lot less. I find it difficult to justify that, and I wonder whether the Treasury will find that difficult to justify and therefore will, in due course, increase the national insurance contributions payable by the self-employed so that they are consistent with those paid by, and in respect of, employed people. No clear answer has been given on that issue, so we will not quite know how future self-employed people will fare under the Bill until we know the contribution rates. It is clearly a very good deal for existing self-employed people.
May I ask about the state pension? Do you believe that there are specific groups of workers who are likely to be disadvantaged by increases in the state pension age? We know of the social class and occupational issue so, in that particular context, are there any mitigating measures that you would like to propose?
Bryn Davies: Social class is clearly one of the main determinants—this is well-trodden ground. There has always been this debate about people in heavy industries. For example, when we were first discussing this issue, one referred to coal miners and steel workers. These days, there is not such a big number of people involved in such jobs, but the issue of whether those who have had a hard working life should be entitled to take a state pension earlier than others has been the subject of a lot of discussion. I cannot really add any more than that.
May I move on to the private pensions issue, on which I know you and the Pensions Institute at Cass have done a significant amount of work? Would you care to comment on either or both of the provisions in the Bill that give the Secretary of State powers in the private pension sphere and, more specifically, on the issue of the transfer of stranded pots?
Professor Blake: Thank you for that question. The issue of dormant pots is clearly going to be a serious one. In a sense, when this system was set up—I advised a Committee here some years ago about setting up the Personal Accounts Delivery Authority—it would have been better if, instead of the pot following the member, it was the scheme that followed the member. If schemes were well designed, the scheme would stay with a member when they moved jobs. The whole point about DC is having efficient portability. As we know, people move jobs 11 times in their careers, and a whole range of people will be moving much more frequently than that. Every time they leave a job, we have the issue about whether to keep the pot or move the pot simply because the current legislation relies on the employer setting up the pension plan, meaning that people move across pension plans when they move employers. I think it would be better if the scheme followed the member.
Clearly that is not going to happen under the Bill, so we need to try to find other ways of having efficiencies and economies of scale built in. There is a whole range of ways you might think of, and the aggregation of pension pots might be one way. However, we must have efficiency and economies of scale, and having 20 million dormant pots at the £10,000 limit, or 50 million dormant pots at the £2,000 limit, is just so inefficient.
On the broader issue of the powers that the Bill confers on the Secretary of State, such as the power to cap charges, I believe that the Pensions Institute and yourself have done some work on that issue. Would you care to comment on that?
Professor Blake: Yes, that is another important issue. Charges are a real killer for reducing the value of pensions when someone retires. As we know, charges of 1% or more can take 20% or 30% of the pension pot, so the charges have to be brought down. I am not sure whether capping or competition is the right answer, but charges have to be brought down to something like 50 basis points, and we cannot have legacy schemes with more than that being used for auto-enrolment or else you will get this detriment to the value of the pension pot for those members. We are going to do some more work on this.
Do you have evidence from your research so far that high charges are a widespread problem? If so, is it a good thing that the Bill gives the Secretary of State the power to cap charges?
Professor Blake: Yes, this is an important point. Some of the legacy schemes that could be used for auto-enrolment still have high charges of 1.5% or more. The industry is trying to get charges down below 1%, but there is some evidence that schemes with those high charges will still be in use, so the issue is with the legacy schemes. My feeling is that the legacy schemes should not be used for auto-enrolment if they are poorly designed and have high charges.
Bryn Davies: May I add something on the issue of pots following members? I have been watching the proceedings of the Committee and a lot of views have been expressed on that, and I think that the balance of views has been in favour of aggregating. My only thought is that whatever solution is reached at this stage is bound to be provisional until we have a clearer idea of how DC provision will work out. Big changes are taking place in DC provision. Until we have a clear idea where that will go, whatever you decide on pots following members will be provisional.
Professor Blake: That is right. The recently introduced auto-enrolment schemes, of which NEST is one, are as well designed as you could possibly have with good investment strategies and low charges, and that is the kind of model that we want to encourage. I agree with my colleague. We really want only a small number of big schemes. That will lead to efficiency at the end of the day; having all these small schemes is just so inefficient.
We want to move as quickly as possible and to incentivise the movement to having a small number of large schemes so that it will not matter which scheme the individual is in because the schemes will be roughly the same. For example, when we fly in an aircraft, we cannot tell the difference between Airbus and Boeing because they are both well-designed aeroplanes. I would like us to move towards the equivalent of that with pensions schemes, and to have a small number of large, efficiently run, well-managed and well-governed schemes. It will then not really matter in which scheme the individual ends up, because they will roughly get the same thing and then such problems will not be so obvious.
Let me take you on to short service refunds. Clause 32 removes the facility to refund pension contributions to employees who leave the scheme after a short period and for the employers’ contributions to be retained within the scheme. Do you regard that change as potentially detrimental for employers?
Professor Blake: To reinforce what I said in answer to a previous question, if we have a small number of well-managed, good-governance schemes that are efficiently run with low charges, I do not think that will be a problem. I do not think that we will end up in a position of people having their pots transferred from an efficient scheme to an inefficient scheme simply because they change jobs. We need to be very conscious of that being a problem, but the solution is to make sure that the schemes are well run and efficient with good governance and low charges. That is what we have to move towards because then those problems will not be so important.
Professor Blake: We have to know where there are economies of scale and where there are diseconomies of scale. There are economies of scale in administration and record keeping. There are economies of scale in fund management, depending on the asset class and the size of the fund. We have to be very conscious about where the diseconomies begin to bite in the different activities of the scheme, and we are doing work on that.