THE BETTER PENSIONS GROUP

  The authors come to the subject of pensions with a wide range of experience, including that as academics, pensions practitioners and activists. We were originally convened by the late Barbara Castle in 1997 to make a joint submission to the Labour Party's Pensions Review Body[20]

  This report is submitted to the 2002-03 Inquiry of the Work and Pensions Select Committee into "the Future of UK Pensions."

  Bryn Davies: Bryn Davies is a consulting actuary, principally advising trade unions and their members. In the past he has been the pensions officer at the TUC and the author of many books on both State and private pensions.

  Hilary Land: Hilary Land is Emeritus Professor of Social Policy, Bristol University. She has had a long-standing interest in poverty, especially women's poverty, and has written extensively on social security systems from both a comparative and historical point of view.

  Tony Lynes: Tony Lynes is an adviser on pensions to the National Pensioners Convention and has been writing books, pamphlets and articles on the subject for over 40 years.

  Ken MacIntyre: Ken MacIntyre is UK pensions manager for an international company, a Fellow of the Pensions Management Institute (PMI) and a volunteer adviser to OPAS-the Pensions Advisory Service, a grant-aided service which helps consumers with pension problems.

  Peter Townsend: Peter Townsend is currently Professor of International Social Policy, LSE. He was an adviser on pensions to previous Labour Governments and has published five reports or pamphlets on pensions since the mid-1990s—some collaboratively.

ACKNOWLEDGEMENTS

  Bryn Davies played a leading role in editing the text. We are particularly grateful to the National Pensioners Convention for granting permission for us to use certain passages in the middle pages from one of its recent reports.

  This is a collective report. The authors wish to say that, as is so often the case with national reports by a group of authors, there are elements in the report with which not every author would wholly agree, just as there are missing elements that one or more of the authors would have wished to introduce, or retain.

INTRODUCTION

  It was more than half a century ago that the fundamental right to social security was laid down as one of the articles agreed in the Universal Declaration of Human Rights. [21]Following the implementation of the Beveridge Report in 1946 and the steps taken in the 1960s and 1970s to add an earnings-related scheme to the flat-rate scheme of minimum State pensions, the UK seemed to have taken that fundamental right to heart. It was also beginning to catch up with the more adequate pension schemes that already prevailed in large parts of Europe.

  Since 1982, however, with the abolition of the link between earnings and the basic flat-rate pension; the reduction in the planned scope of the emerging State earnings-related additional pension; and the attempt to encourage private pensions with undeserved subsidies from public funds, the right to social security has been gravely weakened, for many future as well as existing pensioners. The measures introduced by the 1997 and 2001 Labour Governments have had a mixed effect at best, but the universal right to social security has continued to erode. This despite the strenuous efforts that have been made to persuade the Government to alter course. [22]

  In 1995 the National Executive Committee of the Labour Party put forward a plan for a Minimum Income Guarantee and a funded second tier State pension scheme to replace the State earnings-related pension scheme. The major disadvantages of the plan for working people and for the economy have not since then been conceded or even fully discussed by successive Ministers. Some of the authors of this evidence to the Select Committee on Work and pensions stated at the time that "the Labour Party seems to be on the brink of adopting the wrong policy . . . that would confirm, and deepen, insecurity among millions of working people." [23]

  The proposals were nonetheless put forward in June 1996 under the title Security in Retirement, and since 1997 have been enacted. A stream of evidence pointing out the shortcomings in the proposed policies that was submitted by many pensions specialists exerted little effect. [24]

  Others have begun to present a detailed history of the mistakes that were made. [25]This is not our concern in this paper. Here we present the case for change, taking account of such evidence as is currently available. Our main conclusion is that the structure of UK pensions has become unbalanced and that it needs to be shifted to ensure that collective or State provision regains the predominant role in ensuring future security for those of an economically active age. Essentially, the right to a minimally adequate flat-rate State pension can best be assured by means of percentage contributions from all earnings, matched by contributions of approximately the same size, or larger, from employers and a supplement from the Exchequer. This is a well-tried, successful and relatively popular system. Other complementary measures are necessary, however, and these are discussed below.

THE REAL "CRISIS" IN UK PENSION PROVISION

  There is now wide agreement that there is a crisis in UK pension provision. Only the Government appears to believe that the structure of pension provision can be left essentially as it is at present. However, much of the discussion about the nature of the pension crisis misses the point. For example, the statement that the crisis is about a lack of saving pre-empts a decision as to whether more saving is the real answer to the problems faced by most pensioners, either now or in the future. We explain below why we think that while more saving has a role to play it is not the only or even the main solution. Others suggest that the crisis is about the problems now being encountered by occupational pension schemes. Again, while we recognise the importance of such schemes to many people, we explain below why such arrangements provide, at best, only a partial way out of our present difficulties.

  The real crisis in pensions is much simpler. It is that not only are there currently too many people in poverty in old age, it is also that the number is set to increase if current Government policies continue. At a time when the country's national income is expected to grow in the medium to longer term, not only in total but also on a per-capita basis, such a situation is unacceptable.

  Our central argument is that the country can afford better pensions for all, now and in the future, and that it is the responsibility of the Government to take the steps needed to ensure that this happens. The existing policies, which are essentially about leaving the attainment of better pensions to individual initiative and private capital markets, do not address the needs of today's pensioners; nor can they provide secure retirement incomes for the future. Moreover, in the conditions of a global market, which affect every country, whether rich or poor, those with low incomes are unlikely either to qualify for, or be considered for, such pensions. Private provision has, and will continue to have, an important role to play for many millions of workers but this should be as a complement to, not a replacement for, adequate State provision.

  Government policy on pensions should be to ensure that all those who are retired receive, as of right, an assured income which will allow them to live in comfort and to participate fully in the life of the community. This constitutes a "right" which is enshrined in the Universal Declaration of Human Rights and also in the International Covenant on Economic and Social Rights—of which the UK Government is a signatory. In practice, however, far too many pensioners in the UK do not enjoy this right as they have incomes that not only do not let them maintain their living standards in retirement but also, by any reasonable standard, fall below an acceptable minimum in a developed economy.

  In itself this situation is shocking. What is perhaps of even greater concern is that with present policies things are not going to get better and, for some, will even get worse. The prospect of a continued decline in the State basic pension as a proportion of average earnings coupled with a further reduction in the proportion of working people who can look forward to receiving a "final-salary" occupational pension means that millions will be left with a choice between inadequate "stakeholder" or other money purchase schemes and the State Second Pension. As we explain below neither approach is going to provide an adequate answer to the problem of greater poverty in retirement.

  The existing system is essentially that laid down in the Child Support, Pensions and Social Security Act 2000, which replaced the State Earnings Related Pension Scheme (SERPS) with the State Second Pension (S2P). These changes were to pave the way for the eventual abolition of the earnings-related element in the State pension, leaving the provision of earnings-related second pensions to a combination of occupational and stakeholder schemes.

  The 1998 Green Paper[26] on pensions, which preceded the Act, illustrated the effect of the change. This showed that the total income that could be expected, including the basic pension, by a person who had earned (in 1998 terms) £300 a week was expected to be £89 a week; and a person who had earned £400 (about the national average for full-time workers) would have a total pension of £94 a week. Even allowing for the limited increases in the basic pension above price increases that have taken place since 1998, this will still leave the average earner in 2050 retiring on a total income of around £100 a week in today's terms. This is below the level at which means tested income support is payable at present and, by any standard, must be regarded as ensuring poverty in a developed economy. To put the prospects another way, present policies mean that workers on average earnings must look forward to poverty in retirement.

  Against this background there is widespread agreement that something must be done. Where we differ from other commentators is that we do not believe that the answer lies in forcing people to depend for a decent income in retirement on the insecure foundation of capital markets and individual initiative. As illustrated later in detail the uncertainties of the markets have greatly reduced the pension expectations from the private sector—especially for those on middle and lower incomes.

SAVING FOR RETIREMENT: THE WRONG ANSWER?

  That principle which underlies the Government's recent legislation on pensions is that those who can save for retirement should be encouraged to do so with the State's role being limited to that of helping the poorest by providing means-tested benefits. The scale of the shift in provision that it envisages is summarised by their target of shifting from the current position of 60% State provision and 40% private to 40% State provision and 60% private. Without an overall target for pensioners' incomes, these figures are fairly meaningless, but what they mean in practice, we believe, is greater inequalities of income in retirement and more poor pensioners.

  This shift in provision is being promoted without a full understanding of the consequences. First, it ignores the fact that the private provision of pensions is inherently less efficient and more costly than a social insurance scheme. The recent succession of mis-selling scandals are not isolated events but systematic evidence of the problems inherent in any system based on individual initiative. Secondly, it amounts to a rejection of the idea of intergenerational solidarity on which State pensions, financed on pay-as-you-go principles, have always been based. The significance of this is the adverse implications it has for solving the problems of today's pensioners.

  It is now widely understood, at least by those without a commercial axe to grind, that the goods and services consumed by each generation of pensioners are produced by those currently of working age. It must also be understood that funding pensions through capital markets does not necessarily, in itself, result in capital investment that would not otherwise have taken place or ensure that future generations are able to afford higher pensions. There is certainly little or no evidence to suggest that increasing the role of funded pensions will have any positive effect on real capital formation.

  Investing for the needs of future generations is clearly important and a proper issue for Government concern. However, policies to promote an adequate level of investment need to be dealt with on their own account and not as a by-product of whatever policies are needed to ensure decent pensions. This would be true even if it could be demonstrated that funded pensions did have a positive effect on real capital formation.

  As has also been pointed out in the evidence to the Committee from the National Pensioners Convention, international comparisons show that in practice there is, if anything, a negative correlation between the size of pension fund assets and the level of savings. The table the NPC prepared is included below, comparing household savings rates in a number of the wealthiest countries for the period 1985-2000, shown in Figure 2.5 of the Sandler[27] report , with the value of pension fund assets in 1993 in each of those countries as shown in Figure 8.1 of the 1998 report of the Pension Provision Group[28]:

	Household savings rate (% of disposable household income)	Pension fund assets (% of GDP)
Italy	16.7	1
France	14.2	3
Japan	14.1	45
Germany	11.0	6
UK	8.1	79
US	6.3	59

  These figures do not necessarily demonstrate a causal connection between high levels of pension funding and low levels of saving. But what is clear is the inevitable consequence of relying on funded pensions is that money is diverted away from today's pensioners. It may or may not reduce the so-called "burden" on future generations of providing pensions—the point is at best arguable. What is absolutely certain is that it means that the money cannot be used to improve pensions now in payment or in the future as the scheme matures.

  This compares with the situation with a pay-as-you-go scheme where higher contributions are immediately available to provide higher benefits for people who are already retired. A good illustration of how this works in practice is shown by the example of the State Earnings Related Scheme. One of its key advantages, compared to the proposals of the previous Conservative government, was its accelerated maturity. This meant that full pensions were to be paid after 20 years, as compared to the 45 years or more required by the funded scheme. Applying this analogy today, a substantial increase in the basic pension could be financed by an immediate increase in contributions.

  We do not accept, therefore, that the only way to improve pensions in either the short or the long term is through the development of funded pensions. What we support instead is a much bigger role for social insurance, financed on a pay-as-you-go basis. We set out below the reasons why funded pension schemes—whether based on final salary or money purchase—do not provide secure and predictable retirement incomes. We then compare this with what might be achieved by greater reliance on the State Second Pension and SERPS. First, however, it is instructive to compare our current system with those of other developed countries where the role of public provision is much greater.

OVERSEAS COMPARISONS

  The British pensions system is distinctive if not unique among developed countries. Continental visitors are often amazed when they learn how it operates. In Britain, the State spends less than 5% of national income on pensions, below half the spending of its EU partners. Not surprisingly, the result is that older people in Britain have lower and more unequally distributed incomes than almost anywhere else in Europe. Many commentators who support funded pensions have placed considerable significance on the UK having the biggest pension funds in Europe. But this is only one side of the equation. We must also look at the pensions that are currently being paid and those likely to be paid in the future. Considered in this light the UK lags behind its European neighbours.

  Moreover, if you are British, you are expected to gamble with your pension. Employers are legally able to default on their pension commitments, and most fail to fund their schemes sufficiently to provide protection if the employer is insolvent. To join an employer's final salary scheme (where it is still available) is generally considered to be the best option. But how many members appreciate the risks they are taking, risks which may not emerge until decades into the future? Defined contribution plans, on the other hand, depend upon returns from the stock market among many factors. Employees can have no idea, beyond educated guesswork, of what their pension will be. They cannot know for how long they will be able to work, whether the employer's contributions will be maintained, or what the level of charges will be.

  British governments do not see their role in ensuring that the risks of retirement and old age are collectively managed. They are progressively reducing the universal insurance role and replacing it with means-tested benefits. Citizens are expected to organise their own retirement welfare, by saving via a private funded pension and not rely on the state. (The weaknesses of the private sector are discussed in more detail elsewhere.)

  The contrast between Britain and other comparable countries can be dramatic.

  In Holland, for example, pensioners enjoy a State pension of the equivalent of £130 per week, plus a holiday allowance. And to demonstrate that this is not a haven of state-funded profligacy, the Dutch also have a well developed occupational pensions sector covering 90% of the employed population. Pension fund assets in Holland are bigger than the UK per head of population. A more centralised and tightly regulated labour market (anathema to the main UK political parties) has allowed the development of industry-wide schemes offering comprehensive coverage to almost the entire working population. Dutch private sector funds are strictly regulated to insurance standards.

  Ireland manages to achieve a State pension of 29% of average earnings, the equivalent of £136 per week in UK terms. The United States, frequently taken as a role model for ideas in welfare, has its own federal social security which provides guaranteed earnings related pensions at £7,000-£10,000 a year. "Social security" is very popular and is often singled out one of the great untouchable areas of public policy. In the private sector, US employers cannot default on pension commitments as easily as their British counterparts and insurance exists to protect against employer insolvency.

  Germany, too has a generous social security system. In addition, German employers provide pensions in one of two ways. One is by making provision in their balance sheet and insuring against insolvency. In that way, funds can be retained within the business for investment. Alternatively, external funds known as pensionskassen are used and these are in effect an insurance subsidiary of the employer—and run just as strictly.

  In Sweden, the State has recently converted the social security pension into a part-funded earnings related scheme. Earnings-related contributions are recorded in individual accounts guaranteed to increase in line with average earnings. At retirement, accounts are converted into pensions on an actuarial basis related to the life expectancy of the cohort which is retiring. At one blow, the Swedes are tackling demographic changes and the challenge of longevity. Whether this is the "correct" response is not relevant here. The point is that the Swedish government does not see managing the risks of retirement as someone else's problem. In this, they share a common value with every other EU government and the United States.

  It is Britain which is the odd one out, having chosen a decidedly unique and eccentric path. Whether pensions or railways, the British people seem to be cursed by rulers who treat their country as a test bed for the ideas of mercenary ideologues.

THE ROLE OF THE PRIVATE PENSIONS SECTOR

  Employer-based or "occupational" pension schemes are a significant part of UK pensions, with an estimated £776 billion[29] in assets and between 10 and 11 million employees as active participants. Taking individual pensions into account (personal and stakeholder schemes), this grows to £1,100 billion[30]. Clearly these arrangements are of crucial importance in enabling many people to have a decent pension. The problem is that the system in the UK leaves too many gaps, with millions left out of the better provision offered by what is now a decreasing number of larger employers.

  One of the main shortcomings of private pension provision is that the coverage of occupational pensions is so patchy. According to the most recent survey, only 46% of all employees are covered by an occupational scheme, a proportion which altered little in 30 years but is now in slow decline. The public sector is still the benchmark for consistent and good quality provision, with 80% of all public sector employees covered, typically by an earnings related pension. When public sector employees are excluded just 36% of private sector employees are covered[31]. Almost two thirds of private sector employees do not have employer provision.

  This poor coverage is important because for most people, without a substantial employer contribution towards their pension, their retirement prospects and security are diminished considerably. As mentioned, pension provision is concentrated in the larger organisations, with most small companies having no provision. There are 217,000 occupational schemes[32] but most of these are either closed with no further contributions being paid or have one or two members only. The great majority of scheme members are concentrated in the largest schemes. At the same time the system is fragmented and difficult to police. The large number of schemes and differing administration systems makes co-ordination very difficult, fails to capture economies of scale and enshrines inefficiency. Rationalisation is urgently needed.

  The results actually achieved by occupational pensions appear modest. Despite being hailed as a great welfare success story, the median pension paid to younger single male retirees in 2000 was £81 per week. This means that for half of those recently retired males, occupational pension income adds less than £4,200 to their annual income. And for women the position is, not surprisingly, less favourable. Of the 39% of single women who had some occupational pension income, the comparable figure is £2,400 (for married women it would be considerably less). [33]A survey by Incomes Data Services of a sample of occupational pension schemes came to a similar conclusion: the average pension being paid was just over £4,000 a year. [34]

EROSION OF CONFIDENCE

  Confidence in the private sector is at a low ebb, mainly caused by a series of scandals in the last decade. People were shocked when the theft of pension assets by Robert Maxwell to shore up his collapsing business empire came to light after his sudden death. Few had realised the extent to which employers controlled pension funds or how feeble UK trust law was in protecting members. Had Maxwell lived and his machinations succeeded, the theft might well have gone unnoticed. Under the Conservative government, there was pressure, including the provision of subsidies effectively by the tax payer, for the promotion of personal pensions (individual insurance contracts). Personal pensions were recommended as superior to the nanny State collectivism of State and employer-based provision. The consequence was "mis-selling", the near-fraudulent sale of personal pensions with blatant disregard for regulatory discipline, to people who would have been better off with their employer's or the State scheme.

  Eventually, several years later when the smell of scandal became too strong to ignore, something had to be done and the compensation to the victims has reached £14 billion to date. Despite the scale of the scandal pressure from the GMB union failed to generate the interest of the Serious Fraud Office in the biggest financial scandal of the 20th century. Not one insurance company officer or director has been prosecuted. The erosion of confidence in retirement saving is in no small part due to the half-hearted approach of government, regulators, and law enforcers in this sorry saga.

  The collapse of Equitable Life at the end of 2000 has also delivered a body blow to confidence in retirement saving. Equitable was a venerable institution, one of the first mutual insurance societies and a pioneer of actuarial science. Its name was a benchmark for quality, and its main business was providing good quality retirement savings plans for the English professional classes and members of occupational pension schemes. It did not pay commissions but sold direct to the public, advertising heavily in the weekend broadsheets. With Profits funds were devised to provide small investors with guarantees and secure, steady returns unaffected by the ups and downs of the stock market. In good years, some of the returns would be held back in reserves, to be released in the leaner years.

  Equitable's fundamental mistake was to ignore this principle and pay out as much in final bonus—the addition to the policy at retirement—as possible. During the 1980s and 90s when stock markets were generating phenomenal returns, this enabled Equitable to top the performance league tables. There was considerable commercial pressure to behave in this way and Equitable was not the only offender. However as a small mutual, it depended on a flow of new business to finance investment and expansion, and so was especially vulnerable. Matters came to a head when some customers with annuity guarantees in their contracts demanded the same level of (unsustainably high) bonus payments as those without annuity guarantees. Their case was upheld by the House of Lords and landed Equitable with a huge and unknown liability. Whatever the underlying cause, what we have seen is the destruction of a leading pensions company and severe if not terminal damage to the With Profits concept.

FINANCIAL ENGINEERING AND HEDGE FUNDS

  This financial engineering by some of the most blue chip and respected organisations was accompanied by a gung-ho approach to equity investment. Pension funds invested on average some 80% of their assets in company shares and still do. Equities are risky investments. The natural home for pension funds is long dated bonds, principally government stock (known as gilts). These generate a secure steady stream of income which matches the liabilities that pension funds are intended to meet. Instead of behaving like insurance companies, however, pension funds are operated as aggressive hedge funds, covering their pension liabilities with equities.

  Equities tend to generate higher returns because they are risky. In the euphoria of the 1980s, when there was loose talk of economic miracles and the end of history, it was possible to believe that equities were a risk-free bet. The actuarial profession, the financial navigators of the final salary scheme, assumed that equities would always beat bonds in the long term. Long-term promises were valued on this assumption. But by the turn of the century the bull market had collapsed and the shortcomings in this approach were all too apparent.

  History had not, after all, ended. The laws of economics had not been overturned. Scheme surpluses were evaporating. The response from employers has been instructive. During the good years, they and their advisers had argued that as the employer was obliged to pick up the tab for pensions when times were hard, they were entitled to use their discretion over scheme surpluses to benefit the company balance sheet. Now that times are tougher, employers are backing away from final salary pensions and introducing money purchase or defined contribution plans where the employer's obligation is restricted to putting in contributions at a defined level and the employee's pension depends ultimately upon the vagaries of the stock market and long-term interest rates.

  A recent survey by actuaries Lane Clark and Peacock of FTSE 100 company accounts showed widening deficits in large final salary schemes. [35]Much more disturbing for members is that some companies have pension funds several times bigger than the company itself. A big deficit in the pension fund on the MFR basis could, potentially, be enough to bankrupt the company. Shareholders are entitled to ask why company managements and trustees choose to take such a big investment in equities whose wildly fluctuating fortunes is the primary cause of the deficits and the spiralling costs. A more sober approach rooted in investment in bonds might have meant no contribution holidays but less pain now. That is what the Boots pension fund has now done. After all, few individuals would try to lower their mortgage borrowings by gambling on the stock market, but that is exactly what most British companies and trustees have done with their pension funds.

MFR: A RICKETY FOUNDATION

  Worse still, the rickety nature of funding and investment policies has been exposed by company failures. Companies can and do go out of business. This is a normal indeed some would argue, an essential feature of a dynamic market economy. In the UK, they almost always leave an insolvent pension fund. This is what consultants PricewaterhouseCoopers[36] describe as the double jeopardy of the British employee; lose your job, lose your pension. Germany and the USA have compulsory longstop insurance arrangements to protect employees from at least the worst consequences. In Britain, only fraudulent plundering of a pension fund is covered and even then only up to the statutory minimum funding requirement (MFR).

  The MFR was the product of the Goode Committee, set up to report on pensions regulation following Maxwell, and the wish by the then Conservative government for a quick fix. The end result was a funding standard which was meant to make schemes build up sufficient assets to be able to pay what they promised. Unfortunately, pensioners excepted, it is an equity based funding standard and since pensions are best measured against the return on long bonds, one that is inappropriate. In current financial circumstances it means that a fund which is fully funded on the MFR basis is well short of the assets needed to secure benefits in the event of it being wound-up. Nevertheless, employers are not obliged to fund beyond MFR, even when they have the resources to do so. The result is that non-pensioners, who come last in the order of priorities, can get 50% or less of what they had thought was due to them. This—and the equity-bias of pension funds which makes insolvency from time to time inevitable—is a major driver for failed companies failing also to deliver on their pension commitments. The MFR has been a calamitous standard promising something which it cannot deliver.

  There is nothing, also, to prevent employers winding up pension plans and walking away from the promises, with the ridiculously low hurdle of the MFR as the limit on their legal liability. The only constraint on such conduct is moral pressure from members and the potential long term damage to employee and public relations. In a post-Enron world, employers ignore damage to their reputations for fair dealing at their peril, because it can hit them where it hurts—in the share price. Nevertheless, members should not have to rely on moral pressure and bad publicity to get what they have been promised. It is extraordinary that a commercial contract can be entered into without any obligation on one party to deliver. A proper system of funding and insurance is long overdue.

ELITE CONCERNS?

  The focus on occupational pension schemes is in many ways, an elitist concern. Not only are nearly two-thirds of private sector employees excluded from employer-based pensions, only 3.8 million continue to be covered by final salary schemes. Further, the sector is subsidised heavily by regressive tax relief and rebates on National Insurance contributions. The system of "contracting out"—giving rebates to allow private pension schemes to replace the State earnings related pension—began as a means of drawing the larger, better quality occupational schemes into partnership with the state. Members of contracted out schemes were underpinned by a State guarantee, though few were aware of the fact. All this has changed so that contracting out is pure privatisation and one which is neither efficient nor fair.

  Although large amounts of public funds go into private pensions (in contrast to the State pension scheme which receives no tax subsidy and is wholly financed by contributions), they generally benefit the more affluent, are used inefficiently and much is absorbed in expenses. A substantial consulting and fund management industry feeds off these subsidies[37], but, as we have described, delivers little. Tax relief must be better directed and not used to improve the pensions of the better off. The contracting out rebates should either be used to promote a genuine public-private partnership, as Barbara Castle proposed in the "Better Pensions" White Paper[38], or else the hideously complex mess scrapped and the savings deployed to improve the State pension.

  With a better State pension, the private pensions sector would be better placed to carry out its appropriate role: providing a voluntary supplement to a strong State underpin.

PROBLEMS WITH FINAL SALARY SCHEMES

  The final salary scheme has been the benchmark for good quality pension provision. However, outside the public sector, the record has been much more problematic. Over the last 30 years, governments have had to legislate to ensure consistent minimum standards and to narrow employer discretion. Only fairly recently has it been made compulsory for schemes to provide pensions which are to a limited extent protected against inflation, both before and during payment. Leavers, people who change jobs, were and still are, routinely and with few exceptions, discriminated against. This is because their pension was fixed to the salary at leaving and not increased or, more recently, increased only in line with prices, ignoring the real wage increases they would have received between leaving and retirement. Many people came to retirement finding that the pension they thought that they had earned was almost worthless. Pensioners did a little better, but often relied on discretionary increases which depended upon the good will of the employer and the trustees. This hidden subsidy concealed the true cost of final salary benefits to employers. Many schemes were sold by consultants on the basis that the directors could promise themselves generous pensions in the sure knowledge that their legal obligations (and so the enforceable costs) were minimal.

  The requirement to pay real pensions, ie deliver what they actually promise, was always going to increase the cost of final salary schemes. However, this rising cost was masked by a rising equity market from 1975-2000. Stupendous returns from equities coupled with the 1980s fashion for "downsizing" (sacking people) meant that pension funds generated surpluses. Many had far more money than they needed. Companies saw that the pension fund could be run as a profit centre, as an adjunct to the main business, and so flatter the company balance sheet. Surpluses could appear as company assets even though there was no direct access to the funds. The wholesale suspension of employer contributions—"Contribution holidays"—became standard practice[39]. Actuarial and accounting standards permitted this sort of manipulation which was met with amazement by scheme members who, naively perhaps, thought that the pension fund existed to pay pensions. Even more bizarrely, the accounting standard allowed companies to record pension "income", negative pension contributions, in their profit and loss accounts, even though no money was received. There was nothing illegal in any of these manoeuvres.

  Even when they are well funded, final pay schemes still have certain drawbacks for many employees. They are designed, essentially, for employees with steady employment, earnings that do not fluctuate and relatively few job changes. If employees fall outside this restricted group, which consists mainly of male white-collar workers, the benefits which they receive can be much more limited that many expect. For such workers other types of scheme might be more appropriate. For example, for manual workers whose earnings tend to decline in real terms as they get older, it might be better to have a formula based on average career earnings, like that for SERPS, where each year's earnings are revalued in line with average earnings up to pension age.

  The final and possibly the greatest drawback of final pay schemes is that their coverage is limited, in practice, to only part of the workforce. For whatever reason, a large proportion of employers are unprepared to provide such schemes leaving their employees to fall back on whatever minimum provision is mandated by the State. This currently means, in effect, that such people are faced by a choice between S2P and stakeholder schemes on a money purchase basis.

MONEY PURCHASE SCHEMES

  Under the 1975 Pensions Act as originally enacted, only defined benefit occupational schemes were allowed to contract out of SERPS—a defined benefit State pay-as-you-go scheme. Ten years later, the Conservative government, after considering and rejecting the idea of abolishing SERPS, decided to allow group or individual money purchase schemes to contract out, at the same time offering a financial incentive for the establishment of such schemes.

  Despite the mis-selling of personal pensions that ensued, money purchase pensions have attracted surprisingly less searching public criticism that they deserve. The main focus of criticism has been the widespread failure of employers to contribute more than their share of the contracted-out rebate. The fundamental defect of money purchase schemes, however, is not the amount of money invested in them but the fact that they cannot provide pensions of a predictable value. They are a gamble, the outcome of which depends on long-term investment yields, the State of the investment market when the person concerned reaches pension age, the luck or skill of the investment managers and the fluctuations of annuity rates. If the purpose of a pension scheme is to provide an assured level of retirement income, a money purchase scheme does not and cannot achieve that purpose.

  The prospect of a majority of employees becoming dependent on money purchase pensions for a major part of their retirement income is, therefore, extremely alarming. Yet that is the direction in which current government policy is moving. Employers with five or more employees, who do not provide occupational pensions for all of them, are obliged to arrange access to money purchase stakeholder schemes; and, while employees are not obliged to contribute to these schemes, refusal may mean losing the benefit of the employer's contributions.

  Stakeholder pensions have been presented as a simple, secure and low-cost way of providing funded pensions for those not covered by occupational schemes. It is true that they have a number of advantages over the personal pensions of the 1980s. In particular, they are more truly "portable" (there are no penalties for ceasing to contribute to a stakeholder scheme) and they offer better value for money, management charges being limited to a 1% annual levy on the value of the accumulated fund. Their apparent simplicity, however, is largely negated by the number of different schemes on offer. As the Pickering report says, "A key complicating element within pensions is the sheer number of money-purchase products and the marketing wrappers that confuse the nature of the underlying product". The legislation explicitly relieves employers of any responsibility for the quality of the particular scheme offered to their employees.

  As for "low cost", while the 1% ceiling is certainly an improvement compared to the charges imposed on many personal pensions, it remains high—many times higher than the cost of administering the State scheme. It is not generally realised that, depending on the rate of interest on the fund's investments, an annual 1% charge can reduce the pension that is ultimately payable by 25% or more, depending on how many years there are to run up to retirement. The complaints made by the insurance industry at the low level of the charges that can be made in stakeholder schemes illustrates the way in which the industry has had it soft for too long.

  Finally, as we have already noted, whatever else stakeholder pensions may be, secure they are not. There is simply no firm basis for predicting the amount of pension earned by contributions to a money purchase scheme. The magnitude of the risks involved has become much clearer in the light of the performance of investment markets and the insurance industry in recent months.

  For these reasons, while we recognise that stakeholder pensions may offer a convenient method of saving for retirement, not least for self-employed people, we would strongly oppose any suggestion that membership of such schemes should be compulsory. What we would prefer is that everyone should have the opportunity of joining a State provided earnings related scheme based on a revitalised SERPS.

WHY WOMEN HAVE WORSE PENSIONS

"The simplistic argument is frequently heard that since we are ageing and that older citizens will be more numerous in the future, we must save more for future retirement needs. Hardly anyone would have a quarrel with this statement but the very tricky political issue for society is how to save more for the future. One must constantly return to the issue of fundamental objectives. Is the objective to achieve adequate pension protection for the working population? Is the objective to meet income distribution goals by redistributing income transfers within a generation of workers as well as between generations? Is the objective to reward those who work longest by linking retirement income as closely as possible to past earnings? Is the objective to compensate, even partly, some members of society who bear the burden of raising children or caring for older people with disabilities? Is the objective rather to increase national savings and to strengthen capital markets through the building up of important pension reserves?"

  (Dalmer Hoskins, Secretary-General, International Social Security Association, 2002)

  Women are the majority of pensioners because they live longer and currently retire earlier than men. Women are disproportionately found among the poorest pensioners. While younger women now spend more years in paid employment than their mothers or grandmothers, most still spend fewer years than men in full time employment. In 2001 43% of women in employment worked part time compared with 5% of male employees. [40]Their earnings are still significantly lower. In 2000 women in the UK working full time earned 82% of men's earnings levels[41]. Average hourly earnings of women working part-time in the UK were 62% of those for men working full-time[42]. The challenge that pension systems face if women are to avoid poverty in old age are examined below.

  The government wants to develop a "fair" pension system, which guarantees pensioners a share in rising national prosperity, as well as providing an adequate income for all pensioners. This means abandoning the model of a "typical" working life of 40-45 years of continuous full-time employment. Many of the early private and public sector pension schemes were developed as a reward for long service. Early leavers lost out. Beveridge assumed that men would and should be in employment for 45 years and that women once married would leave the labour market. When National Insurance contributions were flat rate men paid higher contributions than women, not only because they earned more than women but also because they were contributing to their wives' pension as well.

  Today neither marriage nor motherhood remove women from the labour market permanently. Men's employment patterns have changed too. Until the early seventies five out of six boys and girls left school at the minimum school leaving age and went straight into full time jobs. Also today young people are more likely to combine full-time education with part-time employment and are not in continuous full-time employment until their early twenties. Men retire earlier and the proportion of men in their early sixties in fulltime employment has halved in the past 30 years. Many leave the labour market in their fifties. Those who are still in good health and can find employment supplement their occupational pension by working part-time. In 2002 there were 1.8 million men working part-time.

  Mothers' working lives are still different from their brothers and childless sisters. Women are most likely to work part-time in their thirties and forties. The majority of the 5.8 million women employed part-time have children or, if in they are in their fifties, they have other caring responsibilities. Over the past 15 years a growing number of women are combining motherhood, even when the children are very young, with employment. In the case of highly paid and qualified mothers this is increasingly likely to be full time employment. In 2001,73% of highly qualified mothers with a pre-school child were in employment compared with 64% in 1989. There was no change among those with no qualifications. Taking mothers with dependent children of all ages, 39% were in full-time employment and 30% were in part-time employment in 2001[43].

  Differences in employment patterns and earnings levels have grown in Britain, particularly since the early 1990's." The low skilled mother of two is calculated to forgo earnings of over £250,000 (almost 60% of her potential earnings after childbirth), compared with £140,000 for the mid-skilled and under £20,000 for the high-skilled mother of two (just 2% of her potential earnings after childbirth)." [44]Differences between men's and women's earnings remain not least because part-time wage rates in the UK are only 2/3rds of full-time wage rates in comparable jobs. The proportion of all earnings received by women increased from 20% to 31% between 1968 and 1990, while the proportion of employees who were female increased from 37% to 48%.[45]

  Overall the number of full-time jobs in Britain has declined while the number of part-time jobs, which in 1951 comprised only 5% of the labour market, has grown. It is therefore misleading to assume that increasing women's activity rates mean that the differences between men and women are either diminishing or converging to a standard "traditional" pattern of continuous full-time employment for 40 plus years. Men are yet to be heavily involved in childcare but they do become informal carers in their 50's and 60's. A recent study of 50 year men and women, funded by the Joseph Rowntree Foundation found that six out of 10 had living parents and a third had grandchildren. One in three looked after an elderly relative or friend and one in six provided care for a grandchild. One in 10 did both.

  Based on national figures, in 2000 over 20% of men and nearly 30% of women aged 55-64 years old were providing at least 35 hours a week informal care. Among the 65-70 year olds the proportions were nearly 20% for both men and women. Proposals to raise the retirement pension age to 70 need to take this into account, for these proportions are unlikely to diminish as the numbers of the very old are increasing and health and community care policies assume the availability of an informal carer. In addition, one in five men and women currently retire in their 50's because of their own ill-health or disability.

  A State pension scheme must therefore address the needs of women and men who have either interrupted or shortened working lives. Following the Pension Act 1975 this was to be achieved within the national insurance contributory system by paying a basic flat rate pension, index linked to average earnings or prices, whichever was higher, together with an earnings related pension (SERPS) based on the best 20 years earnings. Carers' basic pension rights were thereby protected while they were caring for children (up to the age of 16) and while they were looking after a sick or disabled adult, as long as they made a total of 20 years of contributions paid for out of earnings.

  As both the basic pension and SERPS were based on contributions there was no disincentive to either save or contribute to an occupational or personal pension as there is in means tested systems. Moreover, unlike means-tested benefits which take the couple as the unit of assessment, married women could receive a full pension in their own right rather than one worth 60% of their husbands' pension (A category B pension.) In other words this scheme reduced inequalities between men and women as well as between women in retirement.

  The scheme also redistributed income between higher and lower income groups and guaranteed pensioners a share in rising prosperity. Contributions were levied over a range of earnings up to 150% of male average earnings or seven times the basic pension. Once the link with earnings was broken, the range of earnings over which contributions were levied fell and the upper limit is now little more than average male earnings. Thus the re-distributive impact of the State scheme has been reduced and more highly paid men, in particular, are contributing a dwindling proportion of their earnings to the national insurance Fund. Moreover, the Treasury contribution has been phased out. Nevertheless the Fund has had a surplus of income over expenditure for most years since the earnings link was broken in 1980.

Mooney and Statham, 2002Family Resources Survey, 2000-01

  The majority of pensioners are women, so the measure of adequacy of any pension system must include how women fare once they retire. In March 2002 there were 4.1 million men and seven million women in receipt of a State pension. A further test is how well a pension system meets the needs of older pensioners. Women may spend as much as a third of their lifetime as pensioners. In the current system single women are the poorest pensioners. Two out of three of those claiming Income Support are single women.

  In 2000 the average State pension received by a male pensioner was £88 and female pensioners received £64. In 2000-01 the average net weekly income for single men aged 65 and over was £183 and that for single women was £153. This is accounted for by the difference in occupational pension incomes. The claims women have on their spouses' pension are still important. A total of 1.17 million women in 2000 were receiving a category B pension based on their husband's contributions, compared with 1.5 million 20 years earlier. A larger proportion of married women are now entitled to a basic pension based on their own at a higher rate than they would receive based on their husbands' contributions. As divorce rates increased in the 1970s and 1980s the claims women have on former spouses is of growing importance.

"Promising work as the best form of welfare is central to tackling poverty at all stages of the life cycle." [46]

  The Labour government expects more and more women to combine motherhood with earning. Failure to do so will seriously impair their pension rights. Those who have gaps in the standard 40 year working life on which occupational schemes are based fare badly, particularly if the gaps occur early on. The cost of taking even a five year "career break" while having children is considerable. Fleming Pensions calculated that a woman who starts contributing when 25 years old and takes a five year break starting when she is 30 will have a fund worth 22% less than what it would have been if she had worked continuously. If she waits until age 38 before having a child the reduction is 18%. Those who do not start paying contributions until age 30 will build up a fund worth 25% less at 60, even if they have no break.

  This means that women who have their children in their twenties are more heavily penalised than those who have their children later. The latter in any case are likely to be more highly qualified, better paid and to have paid maternity leave, and therefore able to make up for lost contributions. In 2000, over 81% of full-time employees earning over £600 a week across all industries belonged to a pension scheme but among workers earning less than £200 a week only 30% belonged to a scheme.[47] "Part time female employees in low status jobs fare particularly badly"[48]

  The proportion of childless women appears to be growing. It is estimated that 14% of those born in 1931, compared with 21% of women born in the mid 1960's will remain childless.[49] They will fare best as long as they also avoid caring for older or less healthy members of the family, until after they reach the age of 60. However, as described above, there is growing evidence that this will not be possible for many.

  The answer is not, as the private pensions sector suggests, to allow carers "to contribute towards their future standard of living with the same tax privileges granted to those who have earned income"[50]. Such a change would only help a minority of mothers or carers with highly paid partners or unearned income of their own. Neither is the answer to make contributions to a money purchase scheme compulsory, even if that scheme is properly regulated and has modest charges, as is claimed for Stakeholder Schemes. Tax breaks and compulsion do not create the income from which to make contributions to a pension scheme. This is no doubt one of the main reasons for the low take-up of Stakeholder pensions. These schemes are a form of personal pensions, which, as the name suggests, are for individuals and have no mechanism for redistributing resources from those who can make high and continuous contributions to those who have periods of no earnings or low earnings.

  The introduction of the State second pension, which in effect creates credits for those who have caring responsibilities (defined as being in receipt of either child benefit until the youngest child is aged five or the invalid care allowance), is a very modest step in the right direction. These credits replace the proposed "home responsibility protection" (HRP) as part of SERPS, which, had it been introduced, would have favoured higher earners. However, the resources that are available to finance for such credits are limited to the resources HRP would have attracted in 2030, namely £2.3 billion. The government estimates that the SSP will benefit a total of 18 million people including two million carers and two million disabled people with broken work records.[51] As we rely more heavily on means-tested Minimum Income Guarantee/Pensions Credit women with partners may find the carer's pension makes only a limited difference to their overall income, with only 60% being disregarded in estimating the couple's income.

  SERPS dealt with this problem by basing the benefit on 25% of the average over the best 20 years of earnings, thereby excluding periods of low or no earnings from the calculation. This compares with the current system, as illustrated in Figure 7.5 in the Government's Green Paper, which shows the pension income of a woman retiring in 2050 after a "typical" working life: "It is assumed she works for around 30 years, slightly less than half of which is made up of part-time work. Most of the rest of the time before State Pension age is spent caring full time." Her pension under the post-2002 system includes an extra £30 a week from the S2P, compared with what she would have got under SERPS in its pre-2002 form. However, a subsequent answer to a Parliamentary Question showed that, if the 20 best years provision had not been repealed, the SERPS pension would have been £87 a week instead of £33, or £20 more than the S2P.

  The second State pension is therefore a modest component in State pension provision. Moreover it should be remembered that the State pension scheme, as a result of raising the pension age of women from 60 to 65 beginning in 2010, will save £400 million initially, rising to £4 billion in 2025, falling to £3 billion in 2035.[52] It is therefore clear that the second State pension is not an effective means of channelling additional resources to women.

  The Pension Act 1995, the Family Law Act 1996 and the Welfare Reform and Pensions Act 1999 have increased the claims individual spouses have on the pension rights of the other spouse. This will result in some redistribution of pension resources from individual men who will debit part of their pension in the form of a cash equivalent transfer value, to individual women who will receive a pension "credit". This will improve the income which some divorced women can expect in retirement.

  However it is no panacea. The last major DSS study on this topic, Women and Pensions, found that a third of divorcing couples had no private or occupational pension rights to share.[53] Moreover, because following the Child Support Act 1991, it has not been possible to offset maintenance against the right to occupy or to a share in the equity in the matrimonial home, the practice has been to offset the value of the matrimonial home against the value of pension rights[54]. Latest figures from the Lord Chancellors Department found that of the 300,000 divorces since 2000 only 1,030 involved a pension credit[55]. Without adequate State provision divorcing women may be forced to choose between a roof over their heads while they have children or poverty in old age. As a family lawyer commented:

"Where assets are tight and are largely represented by a family home in which a divorced wife and minor children are still living, it can be impossible to reach a settlement of the pension rights figure because there are simply not enough realisable or dividable assets to go round. The transfer of the former matrimonial home to the wife is perhaps the most common form of capital adjustment and may take account of the pension imbalance between spouses; in terms of needs, however, it will provide a home but often fails to address the problem of lack of income after retirement age." [56]

  Widows are still amongst the poorest of pensioners. The State second pension, by improving the pension rights of those who have had caring responsibilities, will make survivors' pensions less important in principle. However, expressing minimum standards for occupational and personal pensions in terms of defined contributions rather than as defined benefits, as in the original SERPS, may result in survivors' pensions being very small. The requirement to provide survivors' pensions applies only to a minimal part of private pensions, so contributors may choose not to include this benefit in any additional pension provision they make. Moreover spouses have no right to know the amount of survivors' pensions they will receive.

  One of the little discussed results of the movement out of occupational pension schemes with defined (and often generous) benefits for survivors into APP's has been to reduce the value of many survivors' pensions. Spouses should have the right to know what their position would be if widowed.

  There is much confusion and ignorance about pensions, not only among women but also among solicitors and other advisers. However, the DSS study cited above showed that the least understood part of pension provision were personal pensions (under half) and the best understood were the basic State pension and occupational pensions (90%). Two-thirds thought they understood SERPS[57]. The extent of confusion and mistrust, following the miss-selling scandals, the failure of a long established mutual society, the Equitable Life, and the rapid decline of final salary pensions, is now much greater. The evidence is that a growing proportion of young people, including young women, are concerned about making pension provision, but do not know what to do and who to trust.

  In the mid 1990s 37% of 25-34 year olds were members of a private scheme but only one in eight thought it would be their main source of income in retirement, compared with one in five who expected to depend mainly on the State pension. In 2000-01 only 51% of men compared with 37% of women were paying into non-State pensions. (DWP, 2002, P.178.) Defined benefit schemes are much easier to understand than defined contribution schemes, although it is unlikely that many fully understand that one result of index-linking the basic State pension to prices rather than earnings had been to shift the cost of the State schemes towards those earning below average male earnings. As a result the lower paid are paying earnings related contributions in return for a flat rate pension, while the higher paid are paying a diminishing proportion of their earnings into the National Insurance Fund. How can this be "fair"?

  In addition, the tax relief available to those who pay contributions into a personal or occupational pension favours the higher earner. Adrian Sinfield has estimated that:

"In the United Kingdom in 1996-97, over £12 billion of taxpayer's money was directed by the government through tax reliefs to encourage and help people to make better private provision for their old age. According to these official figures, this tax subsidy to non State support costs the tax payer some 40% more than all selective or means tested social security assistance paid to the poorest old people in the same year."[58]

  The average rate of tax relief on pensions contributions was 29% in 2000-01[59]. At least the Government recognises the importance of giving individuals an annual statement of their pension rights in the basic State scheme, occupational, stakeholder and the second State pension schemes. If the statement had to show the projected value of the State pension, both if indexed to prices and if indexed to earnings then it might be more difficult for governments to pursue present policies.

  Women pay a heavy price in forgone earnings by giving priority to bringing up children—the future pension. Mothers and other carers are stakeholders as much as any other citizen. As Tony Blair said in his speech in Singapore, 8 January 1996:

"The stakeholder economy has a stakeholder welfare system. By that I mean that the system will only flourish in its aims of promoting security and opportunity across the life-cycle if it holds the commitment of the whole population, rich and poor. This requires that everyone has a stake. The alternative is a residual system just for the poor!"

  As marriages and employment become less secure the need for pension provision which compensates for this insecurity instead of exacerbating it becomes more rather than less important. Private pension provision cannot do this and defining minimum standard in terms of contributions rather than level of benefit to be paid has removed the floor from the private sector and transferred the risk of a low rate of return on investments to the individual. If everyone is to have access to an adequate and secure second tier earnings related pension this must be a pay-as-you-go defined benefit scheme.

  A basic State pension index-linked to earnings must remain the foundation for an adequate and fair pension system. Private sector pensions, while in payment, are at most index-linked with prices. As pensioners get older even those with private pensions will find that the State pension tends to become a more important determinant of their standard of living. By the year 2010 the average life expectancy of men reaching the age of 65 will have increased to over 80 and for women it will be even older.

  The redistribution of income between high and low earners and between men and women-within marriage as well as within wider society-remain important objectives in any State pension system. So too is equity between those who spend time caring either for children or older people with disabilities -or both! The private pension market is not in business to address these issues. As many men's working lives become more uncertain in the flexible labour markets found in the UK and US, and if men become more involved in caring, the factors which cause women's poverty in old age will apply to growing numbers of men. Raising the State pension age, far from "solving" the problem of resourcing an adequate basic State pension, would make it even more urgent to address the issue of how to value care and ensure carers share in rising national prosperity as well as protecting them from poverty during their working lives and in old age.

WHY WE NEED STATE PENSIONS

  The argument so far has been that private pensions and funding cannot carry the main burden of providing pensions both now and in the future. We believe that instead the predominant role in pension provision should be collective, and fall on the State. This section looks at the State basic pension and what needs to be done to make it a genuine "foundation" for pension provision.

  The future of the basic pension is uncertain. Its value, as a proportion of average earnings, has been severely eroded since the breaking of the earnings link in 1980. If it had continued to rise in line with earnings, the pension rate for a single pensioner would now be £102.60 instead of £75.50. Yet there was little public awareness of the consequences of the breaking of the link until April 2000 when the low inflation rate resulted in a derisory increase of 75p per week. The government has reacted to criticism by announcing a series of ad hoc increases above the rate of inflation. Nevertheless, in reply to a Parliamentary Question on 24 July 2002, the Pensions Minister admitted that the increase in the basic pension over the whole period since April 1998 had still been less than if it had been up rated in line with average earnings.

  The present expectation is that up ratings from 2004 on will normally be based on prices rather than earnings but, to prevent a repetition of April 2000, it has been announced that the pension will be increased by 2.5% in any year when inflation is below that level. Moreover, in the face of persistent demands for improvements in the basic pension, further ad hoc increases are almost certain to occur from time to time. Despite such increases, so long as the Government refuses to restore the earnings link, the value of the pension seems certain to fall to an even smaller proportion of average earnings than now; though it is impossible to predict how far and how fast it will fall.

  We therefore believe that there should be a substantial increase in the basic pension, immediately, or at worst in stages over very few years, to bring it up to the level of the means-tested minimum income guarantee (MIG). When this level has been achieved it should thereafter linked to national average earnings. This would then provide not only a genuinely guaranteed minimum income for today's pensioners but a firm and dependable foundation on which people in work could plan for their retirement.

  Such changes have been resisted on the grounds that they would be a wasteful use of public funds, boosting the incomes of the wealthiest pensioners while giving no benefit to the poorest. These objections ignore a number of crucial facts. First and most importantly, although routinely ignored by the Government, the money would go directly to those who are really the poorest pensioners, ie those who are entitled to the MIG but not receiving it. Their numbers are estimated to be at least 500,000. Secondly, from October 2003, MIG recipients would also benefit, since the effect of the Pension Credit will be to increase their net income by 60p for each £1 of pension above the savings credit threshold of £77.45 a week. Thirdly, the wealthiest pensioners would pay higher rate income tax on any increase in the basic pension. Finally, all pensioners will have paid their contributions expecting to receive decent benefits, and it is a breach of faith to pay them benefits which are less valuable than those which could be afforded in the past.

  The case for raising the basic pension to MIG level and restoring the earnings link is, therefore, stronger than ever.

PAYING FOR BETTER STATE PENSIONS THROUGH SOCIAL INSURANCE

  Even if it is accepted that pensioners are entitled to a basic pension which is at a higher level and tied to national average earnings, the question remains as to how this is to be paid for. Our response is that it should be funded through re-establishing and thoroughly updating the collective system of social insurance upon which our system of National Insurance was originally established.

  British State pensions are still nominally part of National Insurance: a pay-as-you-go social insurance system. People in work and their employers contribute a proportion of their earnings to pay for benefits currently in payment. In return, they acquire rights to future defined benefits, including a pension payable on retirement. Pay-as-you-go financing has many advantages but its long-term viability depends on the confidence of contributors that their contributions are being used for the intended purpose, that acquired rights will not be reduced or removed, that they will know what rate of benefit to expect, and that the sources of income on which the scheme depends will be maintained over the years. Those conditions have not been fulfilled by National Insurance in recent years.

  There have been radical changes in both benefits and contributions since 1979. On the benefits side, the link between the basic pension and earnings (which, although having statutory force for only a few years, operated in practice over most of the period from 1948 to 1980) was repealed. Cuts were made in the value of SERPS pensions, some of which (eg the repeal of the "20 best years" formula and the halving of widows' benefits) affected rights based on past contributions. Some benefits (eg the death grant and earnings-related invalidity benefit) were abolished without any transitional protection of rights already acquired.

  On the contributions side, the Treasury contribution, which existed from 1911 to the 1980s, was abolished, increasing the proportion of benefit costs financed by employees' contributions of which, because of the higher earnings limit, the rich do not pay a fair share—an anomaly which is long overdue for removal. Restoring the Treasury contribution, assuming no change in other contribution rates, would increase the income of the Fund by some £10.6 billion a year—almost enough to meet the gross cost of raising the basic pension to MIG level.

  Employers' contributions have been cut repeatedly to compensate employers for a series of "green" taxes: first the Landfill Tax and then the Climate Change Levy and the Aggregates Levy. The cuts are costing the NI Fund £2 billion a year. While there are strong arguments for using the proceeds of these taxes to reduce employment costs, it is entirely wrong that the burden should be transferred to the NI Fund.

  The cuts in current benefit expenditure have actually outweighed the loss of contribution income, with the result that the Fund has accumulated a large and rapidly growing surplus. The Government Actuary's report on the 2002 up-rating shows that the Fund's receipts were expected to exceed its expenditure by nearly £3.4 billion in 2002-03, leaving a balance of £27,577 million at the end of the year—about £18.7 billion more than the "reasonable working balance" recommended by the Actuary. In a funded occupational pension scheme, a surplus of this size would be good news. In the pay-as-you-go National Insurance scheme, it simply means that large sums of money contributed by working people and their employers to meet current benefit costs are not being used for that purpose. Instead, NI contributions are being treated as a convenient form of taxation.

  It is hardly surprising that people have been losing confidence in National Insurance and feel that, because there is no "real fund", there is nothing to stop the Government—or any future Government—from changing the rules at their expense. If confidence is to be restored, the NI Fund and contribution system must be seen to be fair and protected from manipulation for purposes unconnected with the financing of pensions and other benefits.

  Stronger Treasury support for national insurance benefits, including a basic pension, also has considerable political and economic advantages over alternative support for the Minimum Income Guarantee and other means-tested benefits. It would be, and would be seen to be, socially "inclusive." In the two years of the last 100 years when the Government of the UK greatly expanded compulsory social insurance—ie 1911 and 1946—there was also a surge in private savings. And in other countries as well as the UK social insurance contributions have always been regarded more favourably in public opinion than other taxes—because of course there are expected personal benefits of a specific kind tied to the compulsory weekly contributions. And for many other reasons—less administrative waste, simpler information to communicate, the sharing of information between the generations and through neighbourhoods, security of knowledge about expectations in the future, ability to plan for future eventualities—social insurance is of demonstrable advantage.[60]

  We therefore believe that to give National Insurance the protection that it deserves there should be a separate and largely autonomous financial institution, with a governing commission consisting largely of representatives of contributors and pensioners which would be responsible for fixing benefit and contribution rates and for proposing structural changes, such as the introduction of new benefits or the modification or abolition of existing benefits.

  Structural changes in the pension system outlined above would have to be endorsed by the relevant government departments, including the Treasury, and by Parliament. The governing body would also be required to have regard to the financial equilibrium of the system, both short term and long term; to the reasonable expectations of contributors as to the benefit rights acquired by their past contributions; to the available evidence as to the benefits and rates of benefit for which contributors would be willing to pay; and to the broader economic implications of its actions. Its primary responsibility would be to ensure both the effectiveness and the financial viability of the social insurance system and to justify its actions and proposals in terms of these objectives.

  Should a Government ever wish to impose changes in benefits or contributions contrary to the views of the Commission, they would have to lay before Parliament a full statement of their reasons, to which the Commission would have the right of reply. As a result the use of the Fund's resources for purposes unrelated to the proper functioning of National Insurance or the removal of rights based on past contributions would lay the Government open to serious and embarrassing criticism. Examples of improprieties which might have been avoided if such a body had existed include the incentive payments from the NI Fund to personal pension schemes between 1987 and 1993, the raiding of the Fund to compensate employers for "green" taxes, and the abolition of earnings-related invalidity benefit in 1995.

PENSIONS AND DISABILITY

  The essential role of the State in pension provision is particularly apparent in the case of people with disabilities. Older people whose earning capacity, or ability to earn at all, has been impaired in the course of their lives by long-term disabilities are inevitably dependent on State pensions and other social security benefits for most of their income. They are unlikely to have had the opportunity of acquiring occupational pension rights and still less likely to have substantial savings. At the same time, their needs are greater because of the additional costs resulting from their disabilities.

  A State pension scheme, unlike private schemes, can make allowances for periods of non-earning, whether due to caring responsibilities or to sickness or disability. The new State Second Pension does this to some extent, through a system of credits which, however, is much less generous than the original SERPS "20 best years" formula. The contribution conditions for the basic pension enable disabled people to qualify for it on the basis of a short period of paid employment. The social security system also provides non-contributory benefits to meet some of the costs of disability: Disability Living Allowance (DLA) for those aged under 65 and Attendance Allowance (AA) for those aged 65 and over.

  Despite these provisions, most severely disabled people do not now, and without major changes will not in the future, have adequate retirement incomes. Disability benefits, as a whole, are beyond the scope of this report, but there are a number of measures which would particularly benefit older disabled people.

  First, Attendance Allowance (AA), payable without a means test at two rates (£57.20 and £38.30 per week from April 2003), should be raised (as should DLA) to a more adequate level. Like the basic pension, AA rises annually in line with prices, not earnings. This is particularly anomalous given that the cost of paid attendance is directly related to wage rates, not to other prices. AA has not even shared in the limited above-inflation pension increases that have taken place since 2000. It should not only be increased to restore its value relative to average earnings, but should be earnings-indexed from now on.

  Secondly, effective action is needed to ensure that AA is paid to all pensioners who are entitled. Even at its present rates, it is a significant addition to the incomes of those who receive it. The most recent official estimate, for 1996-97, quoted in the recent National Audit Office report[61], put take-up of Attendance Allowance at between 40 and 60%, implying that there were between 750,000 and 1.7 million pensioners are entitled but not receiving it. The NAO report notes that, while the numbers claiming have risen since 1996, many of the new claims were unsuccessful; and that the Government is, therefore, "developing a simpler and more targeted claiming process as well as an improved assessment and decision making process before considering any significant disability benefit awareness campaigns". It is encouraging that the problem is at least being taken seriously, but urgent action is needed.

  Thirdly, while DLA comprises both care and mobility components, AA does not include the mobility component (£39.95 or £15.15 per week in 2003-04). People over 65 when their mobility becomes restricted do not, therefore, receive financial help for their mobility needs, though those already getting the DLA mobility component at that age are allowed to keep it. When the Mobility Allowance was first introduced, the age limit was defended on the grounds that this was a benefit aimed at helping people of working age to get to work. That excuse has never been very convincing, given that a large proportion of recipients of the benefit are unable to find employment even if they are capable of working. With growing recognition of the rights of older people to participate fully in the life of the community, their exclusion has become indefensible. Attendance Allowance should, therefore, be replaced by the extension of DLA entitlement, including the mobility component, to those aged over 65. This would also mean that less severely disabled older people would qualify for the care component of DLA, which is not available to AA claimants.

  Fourthly, better provision is needed for those forced by disability to retire before the normal pension age. The 1975 Pensions Act introduced an earnings-related addition to the invalidity pension, for which people below retirement pension age could qualify, calculated in the same way as the SERPS pension and covering all employees, including those contracted out of SERPS for retirement pension purposes. This was abolished in 1995, despite the fact that people had been paying contributions for it since 1978. All that now remains, in most cases, is the flat-rate Incapacity Benefit of £72.15 a week in 2003-04 (slightly higher rates are paid to those whose incapacity began before age 45). This is plainly inadequate—it is not even as much as the basic pension. At the very least, the qualifying age for the State Second Pension should be extended to those retiring early on grounds of ill-health or disability.

  Finally, it should be noted that the level of the basic pension is particularly important for disabled people, whose entitlement to an earnings-related additional pension is always likely to be reduced. This fact further strengthens the case for the improvements in the basic pension for which we have argued.

  There are at least two models of pension reform in relation to disability that deserve to be widely recognised and debated. One is a model that might be entitled a "Participatory Rights" model. This model is reflected in many European countries—maintaining state provision of a more generous kind for both elderly and disabled people than has characterised British developments in the last 22 years, but within that model accepting the need for extensive private sector "topping up" in order to align national schemes of social "protection" and "opportunity" with the realities and forces of the international market. This model accepts that large sections of the population can only play at best a marginal part in "welfare to work" programmes, and that serious complementary programmes have to be developed to ensure their rights to full membership of society. The national Government has a pre-emptive and not only interventionist role to play. The pre-emptive role in anticipating, and planning for, the risks to the individual of disablement and ageing has to be imaginative and inclusive, and will continue to evolve.

  The alternative model is the "Conditional Welfare" model. This is reflected in the policies of international financial agencies like the IMF and the World Bank, as well as in the UK by the "Welfare Reform" statements of the late 1990s by the Labour Party (for example, the 1996 statement on "Security in Retirement") to cut public expenditure and taxes, reduce universal welfare entitlements in favour of means-tested provision for those in greatest need, and shift decisively towards the privatisation of benefits and services. Among the problems of applying this alternative model is that of appearing to ignore issues to do with severe restrictions on the choices as well as resources available to large sections of population with restricted capacity.

TAXES AND SAVINGS

  According to the Treasury, there are now eight different tax regimes governing pensions, each with unnecessarily complex rules. Among the measures for simplification proposed is the restriction of tax relief to a maximum lifetime amount of £1.4 millions (and a maximum of £200,000 a year) per person of pensions savings that can attract favourable tax treatment. And the maximum lump sum payable to a person at the start of retirement is to be set at 25% of the value of matured pensions savings.[62]

According to a report in the Observer (2 Feb 2003) "a survey of boardroom benefits has found that 249 executives at the 100 top companies are guaranteed an annual pension of more than £100,000."[63] Pensions contributions qualify at present for tax relief even at the 40% rate, and there is a strong case for cutting such relief at the highest levels of income. Part of the case arises from the total "cost" of tax relief on pensions, currently running at approximately £12 billions per year. Savings on such huge concessions could materially assist plans to finance higher basic state pensions (including the restoration of a Treasury contribution discussed above).

  Linked with the need to review tax relief for specially large pension contributions is the need to ensure better payment of taxes by large companies. A former director of the Inland Revenue was reported in 2003 to have called for a major crack-down on tax-dodging companies. For example, it seems that extra tax secured from all non-compliance investigations by the Inland Revenue had fallen steadily from £5.5 billions in 2000 to £3.8 billions per year in 2002. [64]

  Most observers have concluded that Britain's complex pensions scheme has not been successful in prompting savings activity—either in relation to savings for private pensions or generally. Thus in a recent review the Economist concluded "The Government's pensions rethink doesn't solve the central problem: that the design of Britain's state pensions system discourages people from saving."[65]

SERPS—A PENSIONS' SUCCESS

  A higher basic pension is only part of the answer to current pension problems. What people also require is an additional pension which is based on their income while at work. In providing this there are important and useful lessons the State Earnings Related Pension Scheme (SERPS), that the pension scheme introduced by Barbara Castle, offers for the development of future pensions policy. The key message, but one that appears to be little understood, is that SERPS has so far been a great success in the terms of the only test which really counts, ie it has up to now delivered worthwhile and secure pensions to people when they have retired. It has also, at least up to now, provided an essential underpin for all those in occupational pension schemes and in personal pensions. SERPS has now, of course, been replaced by the State Second Pension (S2P) but it still has what is essentially the same structure and it is still referred to below as SERPS, except where the context determines.

  The success of SERPS goes almost entirely unrecognised, except perhaps those who currently receive its benefits. This contrasts with the claims that have been made for occupational pension schemes, not least by in the Government in its Green Paper, Partnership in Pensions, published in December 1998, that they are a great welfare success story. With only a little hindsight such claims are now beginning to look a little threadbare, with declining stock-markets and many employers seeking to cut back on their pension provision or to switch to less satisfactory money purchase schemes.

  Even before these problems became so apparent it was clear that occupational pension schemes suffered from the serious shortcoming that they were of benefit to less than half of the working population. As far back as 1955 one of the authors emphasised the danger of two nations in old age and because of that reached what was then the radical conclusion that compulsory "security" in old age had to be partly related to income while at work[66]. This was as true for the 50% plus of the employed population who were not in an occupational pension scheme as those who were. After some debate the Labour Party adopted such a policy following the publication of National Superannuation[67] in 1957 and remained committed to it until Barbara Castle had the opportunity to actually carry the necessary legislation in 1975. The point of repeating all this is to make clear that current debates in pensions are not new, that SERPS was the result of such debates and that it has subsequently delivered on what it was required to do.

  It is also important to appreciate that SERPS has not only benefited those who have accrued SERPS benefits. It has also provided a floor for those in contracted-out pension schemes as well as a fall back arrangement for the unfortunate few whose contracted-out occupational pension schemes have failed to deliver their promises. The biggest single period of improvement in occupational pension schemes took place between 1976 and 1978 as many employers made significant improvements in the occupational schemes they sponsored to enable them to contract out. This was particularly of benefit to many manual workers who previously had been consigned to membership of inferior schemes on a flat rate or fixed pay band basis. It also led to significant improvements in ancillary benefits, with many pension schemes having to introduce, for the first time, spouse's benefits. Unfortunately the standards set for schemes which contract-out have been consistently reduced with the abolition of the requisite benefits test in 1988, the abolition of GMPs in 1997 and proposals for a further weakening of the reference scheme test in the December 2002 Green Paper.

WHY SERPS WAS INTRODUCED

  SERPS began operation in 1978 and has since been changed by provisions in the Social Security Act 1986, the Pensions Act 1995 and the Child Support, Pensions and Social Security Act 2000. However, despite all these changes, its essential structure still remains as it was when first proposed and, in particular, it provides current retirees with broadly the same level of benefits as originally determined in Barbara Castle's Social Security Act of 1975. It is only in future years that the various cutbacks that have been made will begin to have a significant impact on the income of new retirees.

  SERPS is, in effect, the fall-back arrangement for employees who do not have any other second tier pension scheme. However, as a result of the development of personal pensions the total number of employees in SERPS fell considerably. Thus in 1994 there were 3.5 million men and 3.0 million women in SERPS, compared with 6.0 million men and 6.1 million women prior to the introduction of personal pensions in 1986. What is still far from clear, however, is how all these people who gave up their SERPS benefits in favour of individual contracts have fared. The recent falls in investment markets suggest that many of those who are retiring at present will find that they have made the wrong decision. This lack of information is important as it seems unwise to promote a further shift away from SERPS to private provision when it is still far from clear what has been the effect of these earlier experiments.

  The pension that is paid by SERPS at retirement is based on an individual's average lifetime earnings between the Lower and Upper Earnings Limits, currently (2002-03) £3,900 and £39,420 per annum respectively. To allow for general increases in living standards the average is calculated after each year's earnings have been revalued up to the date of retirement in line with increases in national average earnings over the same period. The individual then gets a percentage of those average earnings (the target percentage), varying between 25 and 20%, depending on when they retire.

  Originally the proportion of revalued average earnings paid as the pension was based on a relatively simple formula, ie 25% for all those retiring after 5 April 1998. Those who retired earlier were entitled to a proportion of that figure, depending on when they retired between the Scheme's introduction in 1978 and 1998. However, the changes made in the 1986 Social Security Act, mean that the target is being progressively reduced to 20%, starting with those retiring after 5 April 2000, but only for post-1988 accruals. The original 25% target was kept for SERPS pension rights accrued prior to 1988-89, whenever the individual retired. All this has been made even more complicated from April 2002 onwards with the introduction of S2P. This works in very much the same way as SERPS but offers a higher target for those earning less than the lower threshold, which is currently £10,800, but with the effect tapering off so that for those earning above the upper earnings threshold, currently £24,600, there is no change. The threshold figures are increased each year in line with average earnings.

  All this means that those people who entered SERPS from 5 April 1988 onwards and hence will be retiring from 6 April 2037 onwards, have a target percentage of at least 20%, while those who retired prior to 6 April 2000 had a 25% target. Those who retire between these two dates have a target which is somewhere between the two figure. The exact figure depends on when they retire and how much they earned prior to 5 April 1988 as a proportion of their lifetime earnings. In addition, where their earnings were below the lower earnings threshold their target is effectively higher.

HOW GOOD ARE SERPS PENSIONS?

  SERPS was announced in the 1974 White Paper: Better Pensions.[68] Although the White Paper does not say so explicitly, the intention demonstrated by the figures in the White Paper's tables, was that the State scheme should ultimately provide what had previously been described as half-pay in retirement for those on average earnings. Thus, the 1969 White Paper for Labour's previous attempt at similar pensions legislation, "National Superannuation and Social Insurance"[69] stated that "When the new scheme has been running long enough for the bulk of pensioners to be receiving pensions at the fully mature new rates—that is, some time around the turn of the century—the pensions provided might amount on average to around half the average income of the rest of the population." The loss by the Labour Party of the 1970 General Election delayed the attainment of that target but only by a few years.

  The result is that a large proportion of the people who retire at present, even if they are only entitled to a State pension, still get an acceptable minimum income. The total pension for a married couple could be as much as £245 per week, including a SERPS component of £125 per week, although to get such a benefit it would have been necessary to have earned at or above the Upper Earnings Limit since 1978. However, even those retiring with earnings records that are more like the average will have a total State pension that, although lower than this in cash terms, is still acceptable as a proportion of their lifetime earnings.

  The following table shows the total amount payable as a State pension in cash terms and as a percentage of pay for a range of levels of current earnings, on the assumption that those concerned have earned the same amount as a proportion of average earnings for the past 20 years. The figures are shown with and without the addition to the State basic pension for a spouse.

TABLE 1: STATE PENSIONS PAYABLE IN 2002-03

Earnings pa	Total State Benefits (SERPS + Basic Pension)
	Without Spouse's Pension	With Spouse's Pension
	£ per week	% of pay	£ per week	% of pay
£8,000	95	62	140	91
£12,000	114	49	159	69
£16,000	132	43	178	58
£20,000	151	39	196	51
£24,000	170	37	215	47

  Given that national average earnings are now around £24,000 it will be seen from the table that the half-pay target is achieved for those who retiring in the current year, if the spouse's pension is included, on the assumption that they have received average earnings since 1978. Even without the spouse's addition the total State pension is still not an unreasonable figure, at least when considered as a minimum upon which voluntary provision can be built by those who want a higher pension.

  The "half-pay" on retirement target can be expressed in terms of the flat-rate State basic pension for a married man, or for a single person if based on income net of State deductions. Either way, it offered in 1978 and still offers a not unreasonable level of income for the great majority of employees. The remarkable thing to note, therefore, is that this sort of target is still just about being achieved, despite all the cutbacks in State provision over the last 20 years. The main reason for this is that the SERPS pension component payable to those retiring from the scheme when benefits matured, ie in the year 1998-99, was still be at or even above the level originally planned.

  Nevertheless, it must be accepted that those on low average incomes still receive an inadequate pension. However, it is important to emphasise that the main reason why State provision is now starting to fall behind the target set by Barbara Castle and will do so increasingly in years to come, particularly for the low paid, is not because of shortcomings in SERPS, even with the cutbacks. The real reason is the fall in the real value, compared to earnings, of the State basic pension.

  The Government were therefore disingenuous when they criticised SERPS for not doing enough for the low-paid in the 1998 Green Paper. SERPS was planned on the basis that it would work alongside the basic pension that was linked to earnings and it is the cutbacks in the latter, through being tied to prices rather than earnings as originally envisaged, which has weakened the overall package. While it is true, as the Government have pointed out, that the more complicated formula adopted in S2P delivers a better deal than SERPS for the low paid, this only became necessary because of the reduction in the basic pension.

  It will be seen that the SERPS pensions that become payable up to the year 2000 are as good as those intended in the original legislation and it is only after 2000 that the SERPS pensions paid to new retirees has begun to fall in real terms. The main reason for this decline is the changes made in the 1986 and 1995 Acts and, in particular, the phased reduction in the target percentage described above. A further reason for the expected decline in the value of SERPS pensions that become payable in the longer term is the linkage of the UEL to prices, rather than earnings. This means that the UEL is falling in proportion to average earnings and that, as a result, SERPS pensions for those earning over the UEL will be based on a more and more limited band of earnings.

  The overall result, even if we assume that S2P remains unaltered, is that within 40 years total State benefits for someone retiring on average earnings will decline from just under 50% at present to less than 25%, with both elements of the pension declining in step. This is the reason why the prospects for those on lower incomes who are not making significant additional provision for their retirement are so bleak and why, in the absence of any improvements in pension provision, we will increasingly have two nations in old age.

  Another reason why future SERPS pensions will be worse than originally expected is the removal of the best 20 years rule whereby the revalued average earnings taken into account are based on the average of the best 20 years rather than over the whole lifetime. This rule would have started to have had an effect after the scheme had been running for more than 20 years (ie retirements from 1999 onwards). The intention of the rule was that it would help those workers, mainly women, who have periods out of the labour market or in part-time employment. However, the provision was abolished in the1986 Act before it could come into effect. As a result, years of part-time earnings, or years when earnings stopped half-way through the year, will reduce the average figure for earnings, and therefore the SERPS pension.

  Originally the effect of this change was to be partially offset by the extension of Home Responsibility Protection to the SERPS pension, which would have meant that years without any earnings would have been excluded from the calculation, providing the individuals concerned had family responsibilities during those years. Now this idea has been dropped and instead the Government has introduced credits for carers in the State Second Pension. This is a very much cheaper alternative and will leave women with family responsibilities with much smaller pensions than those with uninterrupted earning careers.

THE ADVANTAGES OF SERPS

  Given all the cutbacks that have been made to SERPS, there is a widespread perception that it offers a poor deal to pensioners. This is a gross oversimplification, however, as well as being unfair. First, because the cutbacks have so far had only a limited effect on pensions actually in payment and, as shown above, SERPS is currently paying worthwhile benefits to new retirees. Secondly, because it still possesses many of the attributes of the sort of second tier pension scheme that have been identified as essential elements in the Government's reform of pensions. It is only in the longer term that it will fail to deliver the sort of benefits that might be regarded as an acceptable target for a mandatory pension scheme.

  Thus, as well as providing worthwhile benefits to current new retirees, SERPS possesses a range of features that are the hallmarks of a desirable second tier pension scheme, including:

—  equity between members, with benefits and contributions based on each member's full earnings record;

—  full transferability of rights, with no penalty on switching from employment to employment;

—  full protection of rights in line with average earnings up to retirement and inflation thereafter;

—  low costs of administration; and

—  protection against investment risk.

  These are all virtues that were identified by the Government as key objectives for their new system of Stakeholder Pensions. The question arises, therefore, as to why the Government is seeking to replace one system for topping up the State basic pension with an earnings related addition, ie SERPS, which has been shown to work successfully, in favour of another system, ie stakeholder pensions, which is known to have significant shortcomings and is completely untested? The answer appears to have more to do with an ideological preference for private sector solutions than with an adequate analysis of the problems which undoubtedly faced SERPS in the 1990s.

  The main practical problem which faced SERPS was that the projected costs escalated significantly, particularly as the projections went further into the 21st century, at each quinquennial review by the Government Actuary of the finances of the National Insurance scheme. This increased cost was mainly the result of greater that anticipated longevity and a lower birth rate, leading to fewer people at work to pay National Insurance contributions to support the increasing number of pensioners. The end result was National Insurance contribution rates that were claimed to be unacceptably high. However, there are three things that this analysis fails to take into account.

  First, the ratio of those at work to those in retirement, the so-called pensioners' support ratio, is not important in itself. What really matters is the productivity of those at work, not their absolute number. And most analyses project a continued growth in productivity that is sufficient to enable not only those at work to enjoy better living standards but those in retirement as well.

  Secondly, while a shift to higher contribution rates may be unacceptable if it had to be achieved at one go, the effect is much less daunting when achieved over a long period of years. Throughout this period real wages are expected to increase sufficiently so that take home pay will still increase each year, despite the higher contributions.

  The final and most important point that was not taken into account is that the same problem of higher costs will face any pension system, whether funded or un-funded. The real issue, therefore, is what level of benefits should we regard as acceptable in future and it is clear that, if anything, benefits at the level produced by SERPS are towards the lower end of the range of acceptability and certainly cannot be regarded as excessive.

  Set against general expectations of a growing economy, with increasing per capita income, it seems inconceivable that we cannot afford to pay, as a minimum, pension benefits that are broadly in line with those that were anticipated under SERPS. We discuss below whether there is a need to make some adjustments to the original SERPS formula but we are convinced of the general principle that decent earnings-related pensions are affordable. In particular, the increased cost can be met while the working population also continue to enjoy an improving standard of living. Clearly, to the extent that the retired population enjoy a higher standard of living then less resources will go to those at work. But this does not mean a cut in living standards for those at work, simply that their living standards will not grow as fast as they would if pensioners remained in poverty. The wide support that State pensions enjoy suggests that most people will regard this slower growth in their living standards as a price worth paying for the expectation of better incomes for pensioners both generally and when they retire themselves.

  The concern that was expressed at the increasing cost of SERPS was coupled with a presumption that private pensions were in some sense better that State provision. There are those who simply believe that private provision is better, whatever the circumstances and whatever the outcome. This is usually coupled with the idea that people prefer to have their own pot of money set aside for their retirement, rather then rely on future generations of contributors. In practice, however, there is little evidence that this is true, with State pensions continuing to enjoy a high level of support when people are actually asked how they were prefer to have their pension provided.

  Where the State scheme does lose out, however, is a concern that promises might not be kept which, given the way in which the State basic pensions has been cut back, the retirement age for women increased and SERPS has been changed, is not that surprising. What this requires, however, is not a rejection of State benefits in favour of the uncertainties of private provision but the adoption of measures that will better protect members' rights in the State scheme. This is partly a matter of adopting an independent National Insurance commission, as proposed above, and partly by better informing people on a regular basis of their benefit entitlements from the State. We therefore favour annual benefit statements being sent to all members of the National Insurance scheme. It is clear that past Governments have been able to get away with substantial changes to State pensions simply because most people have been unaware of their impact on them individually.

  Even leaving such arguments on one side there is a widespread belief that if pensions are privately financed through pension funds that they in some way become more affordable than if paid for through the State, on a pay-as-you-go basis. The earlier section on private pensions explains how this is in practice an error and that there is no hard evidence that demonstrates that putting more money into funded pension schemes generates any real capital investment and consequently enables future generations to afford higher pensions. It is even possible that paying higher contributions into funded pension schemes might have a deflationary effect and would lead to the economy being worse off and less able to afford to pay decent pensions.

  The final reason why SERPS fell out of favour is that for too long it had no organised interest group to argue in its favour. For most of its existence SERPS was strongly backed by the Labour Party which had a clear commitment, while in opposition, to restore full SERPS benefits on its return to office. Those who backed SERPS felt no need to campaign in its behalf as all they had to do was await the return of a Labour government. However, this complacency was proved to be misjudged when the Labour Party changed its policy on SERPS shortly before coming back into power. This left SERPS with no powerful advocates, compared to the strong and well funded interest groups that for commercial and political reasons support the alternative of funded pension provision. The hard truth is that no one makes any money out of promoting SERPS, so there are no vested interests to put resources behind its promotion.

A FUTURE FOR STATE EARNINGS-RELATED PENSIONS

  Given the success of SERPS it is worth considering options for the future of compulsory second tier State provision, based on the existing S2P. It is taken for granted, in doing so, that rights to S2P benefits that were accrued prior to any change should be fully protected, which has the important consequence that, in any event, some sort of structure for the provision of State earnings related benefits will have to be maintained for many years to come. There is also the important question as to whether the existing system of contracting-out should be retained with the re-introduction of a guarantee that no one should end up with less benefits than they would have had, had he or she remained in S2P?

  The Government has now replaced SERPS with the S2P on a similar basis but its longer term aim is still, at least in theory, to change S2P fundamentally to a flat rate benefit. This will result in the removal of any State provision of earnings-related second pensions, despite the undertaking in the Labour Party's 1997 election manifesto that "Labour will retain SERPS as an option for those who wish to remain within it". The intention is that the S2P would remain, but only as an additional flat-rate pension for low-paid, mainly part-time, workers and those unable to contribute to funded schemes because of long-term illness, disability or caring responsibilities. The underlying idea was that Stakeholder pensions would be able to replace the need for the State to provide earnings-related benefits.

  The Government left it open, however, as to how quickly the move to a flat-rate S2P would precede. It was also unclear what criteria would be used to determine when the change took place. However, the indications were that at the earliest it would not take place until at least five years after the introduction of stakeholder pensions (ie in 2006) when they have had the opportunity to prove their value. Even then earnings-related pensions would be retained for those "with a significant part of their working lives still remaining (for example, those aged under 45 at the point of change)". All this meant that S2P benefits would remain a significant element in pension provisions for the better part of the current century.

  It is not clear, however, whether the Government still envisages that this timetable will be adhered to or, indeed, that earnings related State pensions are still to be abolished at all. Nothing new is said in the Green Paper issued in December 2002 and present indications are that stakeholder pensions are far from being taken up as enthusiastically as the Government hoped. The future of S2P therefore remains even more uncertain than that of the basic pension. The problem is that the threat of abolition has produced a "planning blight" with the effect that nobody is interested in considering options for the reform of earnings-related State pensions, while the scheme is threatened with demolition.

  We do not believe, however, that it would be acceptable for S2P to be retained as it is, even if the Government did not proceed with the proposal to abolish the earnings-related element. While, by definition, there would be no additional cost arising from this approach, as this is the basis for the Government's estimates of future public expenditure, it would result in increasingly inadequate benefits particularly as the Upper Earnings Limit declines in relation to living standards. The probable result would be a lingering death for State involvement in second tier provision and much needless pensioner poverty. Given these drawbacks this is not considered to be an acceptable option.

  We also reject the idea of retaining earnings-related State pensions simply as a vehicle to provide second tier pensions for special groups who need to be credited with rights or for whom private provision is uneconomic, eg the groups covered by S2P credits and workers on earnings near or below the lower earnings limit for National Insurance purposes. Experience has made it clear that pension schemes which are aimed only at the poor inevitably become poor pension schemes.

  On the other hand we do not consider that it would be politically feasible to restore earnings-related State pensions on the lines of SERPS as originally established. In terms of political practicality this would be a costly option, mainly because of the impact of reintroducing the best 20 year rule. We are undertaking further work on the exact form the new earnings-related scheme should take but, in any event, it will incorporate the virtues of SERPS but with a lower long-term cost while establishing widespread support among its members. It is also clear that it will incorporate a system of pension credits for those with gaps in their employment, much along the lines of that currently offered by S2P for the low paid, but on a more generous basis.

  The main reason in favour of State retaining a role in second tier pensions is that it would offer everyone the chance of a low cost and efficient way of providing themselves with an earnings related pension on top of the basic State pension outlined in the previous section. There will be many people at all levels of income who are less optimistic about future investment returns and would value the option to reduce their exposure to investment risk. However, there is no doubt that it would be particularly appropriate for those on low pay and in uncertain employment who are less able to afford the downturns that inevitably arise in investment markets.

  It is suggested, therefore, that the State should develop S2P, building on the positive features of SERPS to achieve the support and understanding among those who belong to the new scheme, which is critical for its long term success. The scheme should also be open to anyone else who appreciated its virtues, in particular its greater protection against investment risk; fairer treatment of early leavers; and guaranteed protection against inflation.

  A further advantage of this approach is that it would, like SERPS did in the past, provide a clear standard against which private sector second tier provision, whether contracted-out occupational schemes, appropriate personal pension or stakeholder pension, could be judged. Whether these other forms of provision should be required to match the new scheme's benefits is a separate matter. However, in the longer term, it will make it easier to judge how far these other forms of second-tier provision produce acceptable pensions for all and, if they do not, to tighten up on the requirements for contracting-out.

  Finally, we believe that a State scheme along the lines we suggest is a vital element in any move to greater compulsion in pension provision. There is a strong case for compulsion; but compulsion is justifiable only if all those to whom it applies have access to an adequate, efficient, equitable and secure pension scheme. The only way in which that can be achieved is by raising the standards of the State scheme so that it provides a realistic alternative for those whose needs are not met satisfactorily by occupational or stakeholder schemes.

CONCLUSIONS

  There is a fundamental crisis in UK pension provision. This is not about people failing to save enough for their retirement, although there are many people who would benefit from saving more while they are at work. Nor is the crisis really about the problems with pensions costs that have arisen from people living longer and poor investment returns, although their impact in disappointed expectations is serious enough. The real crisis is that pension schemes in the UK, taking State and private provision together, fail to provide pensions that are either adequate or predictable. The end result, for too many people, is an income in retirement that is unacceptable in what is still a prosperous and growing economy.

  The Government's existing policies, which favour the development of private money purchase arrangements at the expense of the State scheme, offer neither the hope of a substantial improvement in the quality of life to today's pensioners, nor any real security to the pensioners of tomorrow. All that the present system gives us to look forward to is a continued long term decline in the living standard of pensioners, compared to that of the working population. The present Government has promised repeatedly that pensioners will "share fairly growing living standards", most recently in the 2002 Green Paper. But they have not put in place policies which will ensure that this commitment will be met.

  The answer to this problem does not lie in extending the private provision of pensions. There are occupational pension schemes and money purchase schemes. For many people final pay occupational pension schemes have offered a chance of a decent retirement, although, as witnessed by the problems such schemes have encountered in recent years, this is far less certain now than it was. Such schemes cannot be relied upon to deliver the benefits that they have seemed to promise, whether because of a failure to protect adequately the rights of early leavers; or because the final pay formula is inappropriate for those workers whose earnings decline in the years up to retirement; or simply because employers are now failing to honour the pension agreements that seemed to have been made. In any event, whatever their other virtues, these schemes do not cover substantial sections of the working population. Millions among the workforce, typically in lower paid and less secure employment, especially women, have to look elsewhere for their retirement income.

  Alternative money purchase schemes, whether on a group or a personal basis, are even less secure. Such schemes promise nothing but instead offer only a gamble which, like any gamble, will leave losers as well as winners. It is no comfort to those who are forced to retire at a time when markets are against them, to know that others might be more lucky in their timing. Such schemes might be appropriate for the few who can afford to take such a gamble with their living standards in retirement. For the majority who are outside satisfactory occupational schemes they are intrinsically unsuitable. The schemes are also expensive in the fees they charge and in their administrative costs.

  Policies based primarily on the privatisation of pensions are therefore doomed to failure. If they are to be followed, the existing deep and unjustified inequalities in pensioners' incomes in the UK will grow.[70] Instead, there should be a return to a significantly greater emphasis on collective and public provision than on private provision, with a key role for the State. In short, the best hope of better pensions today and more secure pensions for tomorrow is a revival of social insurance, based on pay-as-you-go funding.

  Against this background we urge the Government to accept the following points of principle, as a sound basis for its future pensions policies.

  1.  A Greater Role for State Pensions: In planning the future of pension provision in the UK, the role for State pensions and other collective provision must be significantly greater than is presently envisaged. We would expect this to result in an increase, rather than a reduction, in the proportion of pension finance coming from the State. However, the relative levels of State and private expenditure on pensions are not, in themselves, targets but rather the end result of achieving a durable pension system that provides adequate and secure retirement incomes both now and in the future.

  2.  A contributory scheme on a pay-as-you-go basis: The expansion of State pensions must be funded on a pay-as-you-go basis, with broadly equal contributions paid by individuals and employers, together with a restoration of a substantial Treasury supplement. With appropriate credits being made for special groups, such as those with family responsibilities, the principle of the right to a decent pension being tied to compulsory contributions will be seen to be both fair and inclusive.

  3.  Popular savings: Higher State pensions mean less reliance on means-tested supplements and, consequently, a greater propensity to save among young as well as older people. In many countries contributory savings through social insurance have proved to be a good foundation for forms of private saving. Means-testing is also administratively costly, wasting many millions of pounds while, due to the continued reluctance of many pensioners to take up such benefits, leaving too many still in poverty.

  4.  Equity between men and women: The State scheme should address the problems of all those working people, predominately but not exclusively women, who have interrupted or shortened working lives, This should be achieved by giving adequate credits for periods of unpaid but socially important work, such as the care of children or disabled and elderly people. While S2P already includes some such provision, it is neither as adequate not as comprehensive as it should be.

  5.  Equity for disabled people: People who are disabled and, as a result, are otherwise unable to build up an adequate pension, must still accrue an entitlement to a full basic State pension. In addition an earnings related supplement should be reintroduced both in retirement and as an addition to incapacity benefit.

  6.  Pension age: We support the Government's view that at present there is no reason to increase the State pension age beyond 65. Simply raising pension age to 70 will neither increase opportunities of paid work for those over age 60, nor address the many problems of informal care that are faced by men and women.

  7.  Affordability: We consider that a pension system along the lines we propose is both essential and affordable. The present system produces pensions that for far too many people are below those provided by other OECD countries. This is despite the UK being both prosperous and faced by less acute demographic changes than other countries. A proper sharing between the economically active and pensioners of the long-term growth in national prosperity, as presently projected, is entirely feasible and will finance both an adequate State basic pension that is linked to average earnings and an earnings related supplement.

  8.  Accountability: A National Insurance Commission should be established to provide proper accountability of State-funded pensions. This body would directly represent the interests of both present pensioners and those of the future, of all age groups. Its role would be to both scrutinise and compare State and private pension sectors in terms of administration, management and transparency, within a robust legal framework. In addition the State scheme should be made more transparent by the issuing, at regular intervals, of detailed benefit statements to all members.

  9.  Short-term action: The State basic pension should be increased as soon as possible to the level of the Minimum Income Guarantee and guaranteed to increase thereafter by at least as much as National Average Earnings. We would like to see it increased thereafter, in stages, so that it ultimately achieved a target of 25% of national average earnings. In addition, the Government should indicate its commitment to develop a modernised State earnings related pension, complementing the basic pension and building on the existing S2P, by 2005 at the latest.

23 January 2003

21   Article 22 of the Universal Declaration of Human Rights reads: "Everyone, as a member of society, has a right to social security and is entitled to realisation, through national effort and international cooperation and in accordance with the organisation and resources of each State, of the economic, social and cultural rights indispensable for his dignity and the free development of his personality." Back

22   For example, Castle B., Davies B., Land H., Lynes T., Macintyre K. and Townsend P. (1998), Fair Shares for Pensioners: Evidence to the Pensions Review Body, London, Security in Retirement for Everyone. Back

23   Townsend P. and Walker A. (1995), New directions for Pensions: How to Revitalise National Insurance, European Labour Forum, No. 2, Nottingham. Back

24   For example, Lynes T. (1996), Our Pensions: A Policy for a Labour Government, London, Eunomia; Townsend P. (1999), New Pensions for Old: The Key to Welfare Reform, London, pamphlet published by Tribune. Back

25   One of the best examples is Blackburn R. (2002) Banking on Death, London, Verso; Dore R. (2000). Back

26   A new contract for welfare: partnership in pensions, Department of Social Security, December 1998 (Cmnd 4179). Back

27   Medium and Long-Term Retail Savings in the UK, H M Treasury, 2002. Back

28   We all need pensions-the prospects for pension provision, The Pension Provision Group, 1998. Back

29   The Pickering Report ("A Better Way To Simpler Pensions"), DWP, 2002, p 69. Back

30   Ibid. Back

31   Quoted in Sue Ward, Resolving The Pensions Dilemma, The Work Foundation, 2002, p 2. Back

32   Occupational Pensions Regulatory Authority (OPRA) Annual Report 2002, p 47. Back

33   Answer to Parliamentary Question (Steve Webb) 21.6.02, quoted by Jay Ginn, "Can Women Escape the pensions poverty trap?", paper presented at Northern Pensions Conference, Newcastle-upon-Tyne, July 12-14, 2002. Back

34   IDS bulletin July/August 2000, quoted in IPRG/NPRG evidence to the Pickering Simplification Review, December 2001. Back

35   "Pension funds pay dear for playing the market", Guardian, 6 August 2002. Back

36   John Shuttleworth, PWC, talk to the Northern Pensions Conference, Newcastle upon Tyne, 14 July 2002. Back

37   Substantial personal fortunes have been made. Nicola Horlick, chief executive of Societe Generale is reputed to be worth over £30 million. Back

38   Better Pensions, Proposals for a New Pensions Scheme, September 1974 (Cmnd. 5713). Back

39   Worth £18.75 billion to employers in the period 1987-2000, Inland Revenue statistics, quoted in Prospects for Pensions, TUC, 2002, p7. Back

40   Women and Equality Unit, Key Indicators of Women's Position in Britain, Department of Trade and Industry, 2003, p 100. Back

41   op.cit. p 95. Back

42   Idem. p 101. Back

43   Labour Market Trends, August 2002, p 388. Back

44   Rake, 2000, p 4. Back

45   Ibid. p 5. Back

46   DWP, 2002, p 77. Back

47   TUC, 2002, p 5. Back

48   Ibid, p 2. Back

49   Evandrou and Falkingham, 2000. Back

50   Fleming Investment Trust Services. Back

51   DWP, 2002, pg 77. Back

52   EOC, 1995, p 60. Back

53   DSS, 1996, p 62. Back

54   DSS, 1996, pg 81. Back

55   The Guardian,16 January 2003-Jobs and Money, p 10. Back

56   Hill, 1995, chapter 7. Back

57   DSS, 1996. Back

58   Sinfield, 2000, p 141. Back

59   Official Report, House of Commons, 1 July 2002, 120W. Back

60   There has been extensive research into the issue. A good recent example is van Oorschot W. (2002), "Targeting Welfare : On the functions and dysfunctions of means testing in social policy," in Townsend P. and Gordon D. (eds.) op. cit. pp. 171-194. Back

61   Tackling pensioner poverty: Encouraging take-up of entitlements (HC 37 Session 2002-03). Back

62   HM Treasury (2002), Simplifying the taxation of pensions: Increasing choice and flexibility for all, London, TSO. Back

63   Summerskill B. and Reilly T. (2003), Fat Cat Pensions on the Rise," The Observer. Back

64   The Observer, 2 February, 2003. Back

65   The Economist (21 December, 2002), "Poor Old Britain," p 27. Back

66   "New Pensions for the Old", Brian Abel-Smith and Peter Townsend, Fabian Research Series No 171. Back

67   National Superannuation, The Labour Party, 1957. Back

68   Cmnd 5713. Back

69   Cmnd 3883. Back

70   Government reports on statistical trends have continued to illustrate the serious growth of inequality among the population of pensionable age. See for example, DSS (2000), p 25. Back