§ 4.36 p.m.
§ The Parliamentary Under-Secretary of State, Department of Social Security (Baroness Hollis of Heigham)
rose to move, That the draft order laid before the House on 1st March be approved [10th Report from the Joint Committee].
The noble Baroness said: My Lords, I wonder whether I am going to keep a full House. Perhaps not! I beg to move that the draft Social Security (Reduced Rate of Class 1 Contributions) (Salary Related Contracted-out Schemes) Order 2001, which was laid before this House on 1st March, be approved. I shall also speak to the draft Social Security (Reduced Rates of Class 1 Contributions, and Rebates) (Money Purchase Contracted-out Schemes) Order 2001 and the Social Security (Minimum Contributions to Appropriate Personal Pension Schemes) Order 2001, which were also laid before this House on 1st March.
My right honourable friend the Secretary of State has a statutory duty to review the contracting-out terms at least every five years. The last full review was in 1996, with the rebates proposed then taking effect from April 1997. There was, however, an interim review of the contracting-out terms for money purchase schemes in 1998, which changed the level of rebate for the last three years of the current quinquennium.
The present review began last August when the independent Government Actuary issued a consultation paper. He took account of the responses that he received in preparing his report to the Secretary of State, who has accepted the Government Actuary's advice in his own proposals. They were laid before the House together with the three draft orders and the Government Actuary's report on 1st March.
A great deal has changed in the pensions landscape since that last full review in 1996. I remind noble Lords that the Government inherited a situation in 1997 where many people were heading for poverty in retirement even when they had been in work for most of their lives. Our pensions reforms seek to turn that situation around by helping those who can save for their retirement to do so in funded schemes and by concentrating state help on those who are least able to provide for themselves.
We are committed to supporting occupational schemes, which are one of this country's great pension success stories. However, not everyone has access to an occupational pension scheme. We are therefore 631 introducing stakeholder pension schemes from this April to provide a low-cost flexible means of saving in a private funded scheme for moderate and higher earners who do not have access to an occupational scheme.
In addition, we are reforming SERPS through the introduction of the state second pension, which will give more help to low and moderate earners (those earning between the annual lower earning limit and £21,600 in 1999 earnings terms). The state second pension is to come in from April 2002, which is the same time that the orders would take effect. The proposed level of rebate is based on the benefit that will he given up by contracting out of the state second pension and into a private scheme.
For low and moderate earners, the amount given up will vary according to whether someone is in an occupational or a personal pension scheme. That variation is taken into account in the orders. That different approach is what the pensions industry told us it would prefer when we consulted on the proposals for the arrangements for contracting out of the state second pension. It may make our calculations more complicated. However, noble Lords will know that computers can handle that.
What individuals need to know is that all the extra help in the state second pension for low and moderate earners will be available to those who contract out into a private pension through a combination of enhanced rebates and/or state scheme top-ups. This means that there should be no hard or difficult choices for people about whether to stay in or join a private pension scheme, in line with our long-term aim of increasing funded pension provision.
Turning to the level of rebates proposed in the orders, I should emphasise that they represent a significant increase in the level of rebate for all forms of contracting out. The Government Actuary advised increasing the rebate to take account, principally, of a reduction in the yield on both pre- and post-retirement investments and increased life expectancy. Other factors he has taken into account are related to the changing nature of the membership in contracted-out salary-related schemes; for instance, the increased average age of members and more female members. We accepted the Government Actuary's advice on all those matters.
In addition, we decided to raise the cap on the age-related rebate to money purchase schemes. The cap was agreed in 1996 and introduced in 1997 by the last government to restrain the cost on public finances and to discourage those who may not have sufficient time to benefit from a funded pension arrangement. Those reasons remain valid.
The cap is currently set at 9 per cent. Keeping it at that level would mean that those who will be around age 50 when these orders come into effect and who are currently contracted out, would have had to weigh up whether they would be better off contracting back into the state scheme. So we are proposing to increase the cap to 10.5 per cent. This means that all those currently contracted out can continue to be so.
632 The overall effect of these changes on the cost of the rebate—in terms of revenue foregone—is an increase of £1.4 billion in the first year, rising to an extra £2.2 billion_by the end of the five-year period; in other words, approximately £10 billion. Those are sizeable increases. By comparison I invite noble Lords to consider the rebate for contracted-out salary-related pension schemes. The current total flat-rate reduction in national insurance contributions is 4.6 per cent of earnings between the lower and upper earnings limits. The proposed increased rate is 5.1 per cent. At first sight that is an increase of 0.5 per cent. but in fact it is much more than that.
The rebate is based on the value of the state benefit given up. For occupational schemes that continues to be assessed against what SERPS would have been if it had continued, with all the extra help for low and moderate earners being delivered through state scheme top-ups. Now, as noble Lords will know, the previous government progressively reduced the value of SERPS for everyone reaching state pension age in the current decade and beyond. So, had there been no change in the Government Actuary's assumptions (and no increase in the cap on age-related rebates) the level of the flat-rate rebates would have fallen—from 4.6 per cent to 4 per cent—because the value of the SERPS benefit given up would also have fallen for those reaching state pension age some time in the future.
Therefore, the real increase is from 4 per cent—that is, the real value of what that would have meant—to 5.1 per cent, or an increase of more than a quarter in the level of the rebate for salary-related schemes. We have decided that all of the increase in the flat-rate rebate for occupational schemes is to go to employers in recognition of the benefits provided by those schemes. Those increases take the total cost of rebates to £10.3 billion in the first year and £12.8 billion at the end of the five-year period in terms of revenue forgone.
We are aware that there may be those who wish the Government Actuary had gone further. There are those who take a pessimistic view of future yield on investments, and those who use only the time period and figures which support their own arguments. But the rebates, and the sizeable increase proposed, are a substantial current cost on public funds. Of course, they reduce future liability of the state to pay unfunded pensions, and we want to encourage more people to move into funded pensions, but it is still the case that they must be paid for now.
We have a duty to balance the needs of current and future pensioners. In the course of this Parliament we have committed a further £8.5 billion to helping today's pensioners. Now we are proposing to increase the amount going into building up funds for future pensioners by an extra £9.9 billion over the five years from 2002. We remain committed to encouraging private pension provision. We have fully accepted the Government Actuary's recommendations on increasing the level of rebates for those who contract out of the state scheme from April 2002 (when the state second pension is introduced). The orders are a fair reflection of the value of the state scheme benefits given 633 up. They also strike a balance between public finance considerations and the interests of contracted-out schemes and their members.
In the light of that explanation, I commend the orders to the House and hope for their approval.
Moved, That the draft order laid before the House on 1st March be approved [10th Report from the Joint Committee].—(Baroness Hollis of Heigham.)
§ 4.45 p.m.
§ Lord Higgins
My Lords, I must first declare an interest as the chairman of an occupational pension scheme which is to some extent affected by these orders. Secondly, I agree with the Minister that it would be helpful to speak to the three orders together although there are some variations between them and some aspects do not apply to all three.
I note with interest the way in which the Minister said that there is no need to worry about the complexity; the computer will cope with it. She managed to say that with a straight face which, after the past four years of listening to the noble Baroness on many occasions, I find intriguing.
At all events, these are important orders and reflect the fact that the private sector's funded schemes are important. Throughout, the Government stressed that they believe they are a great success story and should be encouraged. Indeed, I was surprised by a statement by Mr Jeff Rooker, whom we shall all miss in his ministerial role, in speaking perhaps for the last time on these matters in the House of Commons on these orders on 20th March, when he said,We remain committed to encouraging private pension provision. Our big picture plan is to shift from 60 per cent./40 per cent. ratio to 40 per cent./60 per cent. ratio in public and private provision".—[Official Report, Commons, 20/3/01; First Standing Committee on Delegated Legislation, col. 7.]Given that statement, which is important, are we to understand that the Government's intention is that the structure of rebates shall encourage people to contract out of the national scheme rather than contract in?
As the noble Baroness rightly pointed out, this is part of the five-year review. There was an interim review but that related to provisions in the Budget rather than the usual five-year review. So the matters we are now considering are a review since April 1997 and will come into effect, as she rightly says, in April 2002. That being so, it spans the period between when rebates are related to SERPS and when they are related to the second state pension.
There is therefore a large structural change underlying these affairs during the period under consideration. I notice that the noble Baroness continues to refer to the change as being a "reform" of SERPS. As the noble Baroness, Lady Castle, is not here, she will not be contradicted in that respect, nor reminded by her, though she will be by me, that this clearly involves a broken election pledge. The Government said that they would maintain SERPS, whereas quite clearly the state second pension is somewhat different.
634 The noble Baroness referred to stakeholder pensions, as did Mr Rooker in the debate to which I referred. It is right that stakeholders should not be treated differently from similar non-stakeholder pensions. It is right that the rebate should be the same, whether or not it is a stakeholder system. When we were discussing the underlying Bills which introduced the stakeholder pension and the state second pension, we referred to "decision trees". I gather that decision trees have been produced to enable people to consider the question whether they should take out a SERPS or some other pension arrangements.
Two points arise in that regard. I understand that the Financial Services Authority has had problems in building into the decision tree the initial decision as to whether or not someone should contract out. Perhaps the noble Baroness can tell me whether that is so. It seems to me that any such decision tree ought to begin by saying whether one should contract out.
I have seen a great deal about stakeholder pensions in the press recently. The Government are engaged in promoting them in a big way. To what extent is there a warning, so that we avoid mis-selling again, in that people might contribute to a stakeholder pension and then find that the minimum income guarantee is uprated in line with earnings rather than prices and, having contributed to a stakeholder pension, they would find at the end of the day that they receive no benefit? The noble Baroness shakes her head. Perhaps she can tell me whether that is being made clear to people who might be considering stakeholder pensions.
I turn now to the specific question of the size of the rebate. What I am not really clear about is the extent to which the orders we have before us today are the result of the Government Actuary's report or the result of the Secretary of State's decision. Both the Government Actuary's report and the Secretary of State's commentary have been published. As a result of the publication of those two documents a number of expert commentators have come to the conclusion that, despite what is obviously in absolute terms an increase in the amount of the rebates, the overall effect of these orders will either be neutral in the sense that they do not encourage people to contract out, which would seem to be contrary to the policy statement made earlier by the noble Baroness or alternatively, they will encourage people in certain age groups and circumstances, having contracted out, to contract back into SERPS. I understand that that is not what the Government intend.
Perhaps I may give another example. A member of William Mercer, which is well respected in this field, said that the effect of the new rates means that a 25-year-old man earning £30,000 a year would be £300 a year worse off in retirement by opting out of SERPS until the next review of rebates. I believe that Scottish Equitable has also gone on record to say that the effect of the figures in these orders will be either to discourage people from contracting out or even to encourage them to contract back in. The National Association of Pension Funds has expressed a similar view. I am genuinely puzzled. I do not know whether 635 what they are saying is correct or not and whether the proposals in the orders will have the effect which is said by those outside experts to be the result of the Government's figures. It would be very helpful if the noble Baroness could clarify that particular point.
The other point she mentioned is the cap. I am not sure whether that also has a perverse effect in relation to government policies. I said at the beginning that the orders are not precisely the same in each case. As I understand it, the cap applies only in the case of the money purchase contracted-out schemes and will be raised as a result of these orders. Overall, the rebates need to be preserved. I certainly share the view, which is declared government policy, that we ought to encourage private schemes rather than use the rebate mechanism in such a way that it becomes counterproductive and, instead of encouraging contracting out and the move towards funded schemes, has the reverse effect. I shall be grateful if the noble Baroness can, from the detailed analysis, clarify the situation as far as that point is concerned.
§ Lord Goodhart
My Lords, actuaries practise an arcane science, which largely involves looking into crystal balls. The results are incomprehensible to the rest of us and for that reason, if for no other, I would not want to dispute or disagree with anything in the Government Actuary's report. I also have no objection to the first of these orders relating to salary-related contracted-out schemes. However, the other two orders raise the issue of the cap about which I have serious concerns.
As I understand it, the effect of age-related rebates is to pay on behalf of employees in each year an amount which, when topped up with reinvested income from the rebate, will produce at retirement an amount of income equal to the SERPS or SSP entitlement, which would have been earned by the contributor for the year in respect of which the rebate was paid. Owing to the longer period in respect of which income can be reinvested, the amount of the rebate needed to achieve that objective is therefore much smaller for younger earners than for older ones. The Government Actuary's tables show that for a 16 year-old the amount of rebate needed in 2002–03 as regards a money purchase or stakeholder scheme, or an appropriate personal pension, would be 2.6 per cent of relevant earnings whereas for a 58 year-old the amount needed is 19.1 per cent.
However, there is a cap on rebates which the Government propose to retain although they are proposing to increase it from 9 per cent to 10.5 per cent. The Government explain that the reason for the cap is to limit the burden on public expenditure. However, the result of the cap is that most earners from the mid-50s to the age of 65 will receive a rebate which is insufficient to provide a pension for that year and is equal to the SERPS entitlement.
At present there is a solution of a kind to that problem. The earner can opt back in to SERPS when he or she reaches the age of 50-plus and give up the rebate. If someone does that, the effect on the public finances is only on cash flow in effect. The rebate is tax 636 revenue forgone now, but it is replaced by higher spending on SERPS or SSP later. But the need to opt back in to SERPS to maximise the pension adds to the complication of the pension scheme, and many earners will lose out by not opting back in at all or by doing it at the wrong time. Therefore, the cap is detrimental to earners even now when there is a possibility of opting back into SERPS. I wonder how much the cap now saves in revenue after taking into account the additional cost to SERPS or SSP in future.
I believe that there is a more serious problem which is that the situation will become significantly worse when we move on to the second stage of the state second pension and that becomes a fixed amount pension. It ceases to be an earnings-related pension because people who opt out of an SSP into a stakeholder pension will find that in later years their rebate is capped and, once we move on to the second stage of the SSP, they will not be able to escape the effect of the cap by opting back into the state second pension. At that stage the operation of the cap could become seriously unfair. Have the Government any plans in the long term to raise the cap further or preferably to phase it out altogether? I believe t hat it is a matter of real concern.
In theory, there is an alternative way of reducing the burden on public expenditure without causing hardship to anyone. That would be to pay lower rebates for men than for women to take into account the fact that the longer life expectancy of women makes their pensions more expensive. According to the actuary's report, the equality legislation makes that impossible. If so, that is an unfortunate and perhaps an unintended side-effect of the equality legislation.
§ 5 p.m.
§ Baroness Hollis of Heigham
My Lords, I thank noble Lords for their comments on these orders. I shall start with the points raised by the noble Lord, Lord Higgins. He pointed out that the first time he came across the 40 per cent/60 per cent shift was when he read the speech of my right honourable friend Mr Rooker. That surprised me because the move from 60 per cent/40 per cent to 40 per cent/60 per cent was part of the background of the discussion of last summer in relation to previous pensions Bills in your Lordships' House. On the one hand we were seeking to encourage greater provision into pension funds as a savings vehicle; on the other hand we were seeking to develop such matters as stakeholder pensions for people currently reliant on schemes like SERPS Those who are somewhat higher earners would turn to stakeholder pensions and, therefore, private funded schemes. The remarks of my right honourable friend were made in that context and in the context of the discussions on earlier issues. I had certainly thought that that was part of the general currency.
The noble Lord also asked whether, as a result, rebates would encourage contracting out. He referred to the Government's "big picture". It is fair to say that rebates are intended to be a reflection, as the noble Lord, Lord Goodhart, said, of the value of the state 637 pension that is forgone when a person contracts out. It is not meant to influence behaviour or to load it in one direction rather than another. It is meant to produce a fair playing field. Contracting out may not necessarily be the best option for everyone. However, we believe that rebates will not discourage contracting out or encourage contracting back in.
The noble Lord asked specific questions about how the decision may be made.
§ Baroness Hollis of Heigham
My Lords, I shall turn to that in due course. The noble Lord then asked about the FSA decision trees and so on. Whether contracting out makes good sense or not will depend on individual circumstances. At this point people may want to consult a financial adviser and take professional advice for which they have to pay.
Alternatively, they could ask a stakeholder scheme provider for a comparison with the state pension scheme that is to be given up and the possible replacement pension that they may receive in a private arrangement. Those illustrations will be on the basis of a projection approved by the FSA. I hope that answers the points in relation to stakeholder decision trees.
The noble Lord went on to say that he was concerned as to whether the schemes were viable in terms of the amount of rebate. That is what I would call the Mercer point: a 25 year-old man earning £30,000 a year will have £300 a year less pension. It is a matter of the actuarial assumptions and whether they are correct.
I am not surprised that the funds argue for an increased rebate over and beyond what we propose. The advice that I have taken suggests that in that respect a fairly pessimistic set of assumptions is being employed. I am not surprised by that, but the Government Actuary advises that to accept the pessimistic assumptions of the firm of William Mercer and others quoted by the noble Lord would be equivalent to the rebate being invested to earn only half a per cent a year more than the rate at which earnings increase and before applying the annual 1 per cent charge. If that were the case, there would be a negative state.
I do not believe that that is the case. I believe I am right in saying that there is something like a 2 per cent gap. Actuaries may disagree about what will happen to financial economic conditions in the future, but despite the advice given us by the Government Actuary, a more pessimistic outcome appears to develop in line with the situations suggested by the noble Lord as drawing on the advice of William Mercer. Although legislation requires the Secretary of State to report to Parliament on the level of rebates at least every five years, having taken advice from the Government Actuary, that does not preclude him from reviewing matters and reporting to Parliament at shorter intervals if circumstances require.
638 In 1998 there was an intermediate review of rebates and money purchase schemes that changed the level of rebates for those schemes for the last three years of account of the five-year period. That change was prompted by developments in the July 1997 Budget and the changing nature of occupational money purchase schemes.
There is plenty of opportunity to make correction, if we need to, should the Government Actuary's assumptions be wrong. Certainly the best advice I have received—for the purposes of this debate I checked this matter—is that the views quoted by William Mercer and other firms seem to be extraordinarily pessimistic because effectively they suggest a negative return on pension investment which seems to me improbable.
The noble Lord asked about stakeholders and MIG and whether we were giving advice that stakeholders could produce a sufficiently low return that would be overtaken by MIG and therefore it would not be worth doing. This was part of an earlier debate. I was trying to mouth to him that the whole point of the pension credit system—we are hoping to bring forward legislation as soon as appropriate—is that it will overcome the difficulty that over a period of nine years or 13 years, whatever your assumption, you could fall back on MIG despite modest savings.
So—if I may trespass on to an area that we have yet to explore in greater detail—for a single person on an income of up to £135 or a couple on up to £200, you would assume a MIG level of £100—an income of £100—and then people would keep 60 per cent of the private occupational pension that they had, including stakeholders, up to a figure of £135 for a single person and £200 for a couple. The pension credit is therefore an additional building block on top of the MIG sum, and the problem identified by the noble Lord should not arise.
During the passage of the Bill I was pressed hard on this issue. Pension credit is designed precisely so that those who are nearly poor—just above the MIG lines—and those who are penalised for having small savings will now find that they will enjoy a much enhanced pension.
I turn to the issue of the cap, which was the substance of the remarks of both noble Lords. First, I shall make some general points. The cap on age-related schemes was introduced to protect public funds. The noble Lord, Lord Goodhart, identified that without it rebates could be as high as 19.1 per cent, although I understood the figure to be 19.5 per cent, relevant earnings for someone aged 58 being some kind of notional value of state benefit given up. In turn, that could act as a perverse incentive for someone of that age to contract out into an inappropriate pension arrangement. The increase set out in these orders protects those who already have contracted out of a personal pension so that they are not faced with the dilemma of deciding whether they should contract back in to the state scheme.
We have then to decide whether to continue to increase the cap. We are dealing with quite a small number of people. My understanding is that the cap 639 affects about a quarter of a million people compared with about 4 million people receiving age-related rebates at the moment. That relates only to those already contracted out of personal pensions who are aged 50 to 55 during the five years beginning 2002; it is not an issue for younger workers because of the changes made by the previous government to the SERFS accrual scheme.
The noble Lord, Lord Goodhart, asked about the implication of moving to the flat rate at the stage of the state second pension. We have said that when SSP becomes a flat rate that will apply only to those with a significant part of their working life ahead of them—for instance. those aged 45 or below at the point of change. That group would not be affected by the cap because the value of the state scheme benefits given up would have been affected by the declining value of SERFS.
I hope that that is a satisfactory answer for the noble Lord, given our current information. I hope I have done my best to answer the questions. I shall be happy to follow up in correspondence any particular details that noble Lords may want to explore subsequently. With those explanations, I hope that noble Lords will feel able to agree the orders today.
§ Lord Goodhart
My Lords, before the Minister sits down, can she set out in a letter the saving to the public funds of the cap, given that it now affects only 250,000 people?
On Question, Motion agreed to.