8 December 2005
Ageing and the 'pensions crisis'
Never mind the Pensions Commission: we can afford the future without saving our pennies and keeping pensioners in poverty.

The UK's pensions debate reveals our overblown fears about ageing, and our low expectations of the future. This is summed up in the long-awaited report by the Pensions Commission, and the reaction to the report by government and commentators.
 

Adair Turner's long tussle with the arcane British pensions system invites comparison with undertaking an arduous military campaign. However, rather than 'coming, seeing and conquering', in Julius Caesar fashion, Turner, came, saw, and... failed to follow through with the fight.
 

Turner showed no reticence in coming to the issue. He accepted the government mandate to undertake a pensions savings enquiry three years ago and, along with the other two members of the Pensions Commission, engaged with a huge amount of material during that time. His commission has produced two reports totalling 1,300 pages, providing a comprehensive reference work on the ins and outs of the most complex pensions system in the world.
 

Through this long period of review and assimilation, Turner saw some very crucial truths about this pension system. The commission highlighted a number of specific deficiencies of the system as it is, and which successive governments have failed to acknowledge or do anything about. In spelling out these thoughts, Turner tantalisingly set up the prospect of his commission dismissing many of the false assumptions that handicap most Western discussions about ageing and pensions, and also addressing some of the real defects of the current system.
 

But having come to the fight and seen what was needed, Turner and his fellow commissioners squandered the potential to conquer, by failing to turn valid assessments into correspondingly robust and radical practical suggestions. Quite simply, when it came to policy suggestions the commission backtracked. Why?

To have a proper discussion of whether the current pensions system is working well and, if not, what changes are required, means questioning the conservative and mean-minded notion of the 'unaffordability' of ageing, which runs through all Western discussions of pensions. The pensions problems currently facing countries like the UK can only be resolved by focusing on the benefits of economic growth and wealth creation: essentially understanding that we can afford to grow old.

Rather than embracing such positive arguments, however, the Pensions Commission accepted the constraints of the 'affordability' argument put forward by the likes of UK chancellor Gordon Brown: namely, that all the UK economy can afford in relation to pensions is a limited, penny-pinching set of changes. This reveals the low horizons of the pensions debate, and indicates the broader miserablism that surrounds discussions about our' ageing society'.

What pensions crisis?

In essence, what we got from the Pensions Commission was no different to the formulation from its interim report in October 2004, projecting the necessity of higher taxes, working longer, and saving more. Following indirectly, the main proposals in the final report are for raising taxes to pay for an earnings-linked Basic State Pension (BSP); raising the State Pension Age (SPA) to 68, or possibly 69, by 2050; and introducing a national savings scheme for people in employment.

As in the first report, this package remained couched in the familiar language of 'tough choices' that is characteristic of contemporary discussions about ageing. The commission therefore failed to take up the key challenge: to dispel the ubiquitous negativity about ageing. The commission has missed its opportunity to move the discussion decisively forward, because so long as ageing is perceived through the prism of financial problems and pending crisis, society will be severely hindered in embracing the positive social opportunities resulting from improved life expectancy.

For example, at the report's press launch on 30 November 2005, Turner emphasised that 'There is not a general current crisis in pensioner income' and warned against 'unnecessary scaremongering' (1). This could have been an excellent starting point. In today's anxious times, when any slight aberration or perceived difficulty is turned into a huge 'crisis' that demands serious concern, anyone should get at least two cheers for injecting into the discussion about ageing and pensions the rational point that there is 'no crisis, and no need to panic'.

But having formally rejected the idea of a general pensions 'crisis', Turner immediately let it back into the discussion by asserting that 'There are significant problems in our pension system, there is a major demographic challenge' (2). According to the commission, the real problems for pensions are in the future, reintroducing the image of a demographic time bomb. This is illustrated, by the very first chart in the report's Executive Summary, by that staple of every over-anxious discussion about ageing - the old-age dependency ratio. This ratio measures the relationship between people of different ages, and is defined as the number of elderly dependants for each person of working age, with 'working age' usually taken as everyone aged between 16 and 64, and 'elderly dependants' as anyone above this age (3).

Yet as I have discussed before on spiked, this ratio, which is projected to peak in about 2035, tells us nothing about the social and economic impact of ageing populations - a point spelt out in several submissions to the commission (See Ageing: the future is affordable, by Phil Mullan). This is because this ratio only measures a crude relationship between the numbers of people of 65 and above and of working age. But by no means all people of working age work, and even fewer contribute to wealth creation; there are about 9 million people between 16 and 65 who do not work - of which some are more appropriately classified on the other side of the ratio, within the dependent category - while many others are in unproductive jobs that do not create new wealth.
 

The numbers on the other side of the ratio also are a deceptive measure of dependency: not all old people are 'dependent', financially or otherwise. Around a fifth of pensioners pay more in taxes than they receive in state benefits, measured both in cash and in kind, for example healthcare. There're also many more genuine dependants under the age of 65 than above. These include children, the unemployed and the 'economically inactive', and workers who are at least partially dependent on public spending. This includes those whose jobs may rely on public spending contracts, as well as approaching five million people in work who receive Working Tax Credit and/or Child Tax Credit.

What happens to the numbers of all these other 'dependent' groups can swamp changes in the number of genuinely dependent old people, rendering the old-age dependency ratio both meaningless and misleading.

By endorsing once again the credibility of the old-age dependency ratio, the commission revealed its initial rejection of a pensions 'crisis' as little more than rhetoric. Turner went on to emphasise that 'we recognise quite explicitly throughout the report' that 'there are difficult issues of affordability'. These, he stressed, will necessitate trade-offs between different objectives and determine the timing of feasible reform (4). For all the huffing and puffing around the time of the report's publication about differences between the chancellor, 10 Downing Street, the Department of Work and Pensions and the independent Pensions Commission, none has budged an inch from their essential common position that the British pensions system must be 'affordable'. As John Hutton made quite clear in giving the official government response to the report in the Commons, 'affordability' would be central to the government's judgement on it.

'Affordable' - or cheap?

The 'affordability' issue is certainly 'central' to the way forward. It has become one of those official buzzwords that has broader connotations than its simple dictionary definition of 'something that can be paid for'. For a start it implies 'cheapness' and a lack of any pretensions to generosity. We are already familiar with the cheapness implication from the arena of housing: 'affordable housing' means skimpy housing designed for the poorest sections of the population.

This sense of the term 'affordability' is certainly close to chancellor Gordon Brown's heart, as he presides over a national budget that he is finding increasingly impossible to keep within the self-imposed fiscal rules.
 

Doubtless on a personal level Brown would like to see pensioners receiving better deal - but the first instinct of his Treasury is that any additional spending can only compound the mounting pressures on their budget. From the Treasury's point of view, this has to be avoided, not least as it would bring forward the prospect of an embarrassing unravelling of Brown's reputation as a competent economic manager, not helping his credibility as the next prime minister.

Hence 'affordable' to Brown means 'not a penny more'. Brown and his Treasury have been insisting for some time on the credibility of spending projections showing only a marginal increase in state pension spending as percentage of GDP between now and 2050, despite the number of pensioners growing by almost half over this timescale. This is why the Treasury is flagging up not only that it will oppose any re-indexing of the BSP to earnings, but also that the pension credit level might be de-indexed from earnings after 2008.

Simple arithmetic shows that under this notion of 'affordability', pensioners relying mainly on state support will see a further steady decline in living standards relative to the rest of the population. For all Brown's claims do be targeting funds to help the poorest pensioner, his stated position today is that it is fair and reasonable to retain a public pension system that will continuously see more pensioners moving into relative poverty every year.

To others less intimately concerned with the public purse, the adherence to' affordability' as the standard is no less pernicious. In this wider sense the term has similarities to that more widely used buzzword, 'sustainable': in fact, John Hutton, and chancellor Gordon Brown, have both made the link explicit when stating that any pension reforms would need to be 'fair, sustainable and affordable'. In this context 'affordable', like 'sustainable', is often a euphemism for restraint and caution, and for not doing anything too radical that could upset things. 'Affordability', like 'sustainability', has become a badge of contemporary conservatism.

By adhering to 'affordability', one effectively rules out the prospect for genuinely ambitious or wholesale change. It becomes a cop-out from real debate and therefore a substitute for taking bold political decisions and fighting for their adoption. It is therefore quite consistent that, having retained its own commitment to affordability, the commission's proposed changes are themselves so modest and cautious.
Rejecting the minimalism and evasions of 'affordability' requires going far beyond the present to-and-fro dispute over whether the Turner reforms will cost ?2billion or ?7billion or ?14billion by 2020. As Turner himself stated, the highest of these amounts is not that big in the overall context of public spending. As he noted in the overall discussion of the cost of his proposals, such an amount is less than the budgeted increases in health expenditure over the past five years, and spread over a longer period.
 

But this comparison still does not get us far out of the quagmire of affordability. Instead we need to turn the issue on its head. Genuine financial affordability is about the available resources as much as the demands upon them. Logically this is where the discussion should start. As Alan Pickering, a former chairman of the National Association of Pension Funds (NAPF) and author of a previous government review on pension savings, explains: 'The pensions debate is all too often focused on wealth distribution and not on wealth creation. If our economy does not create enough wealth there is not enough to go round for the workers, let alone for pensioners.' (5) The consequence of this approach is that if the political will were there, the resources could be found and justified from new wealth creation.

Poor pensioners

The main defect of the Pensions Commission report is its failure to refocus attention on wealth creation as the fundamental driver of prosperity for people of all ages, working or non-working. Even if the total financial impact of population ageing over the next half century, adding the costs of decent pensions, healthcare and other long-term care, were as much as 5 percent of GDP - about the highest estimates anyone comes up with - this is only the equivalent of a 0.1 - 0.15 per cent reduction in annual productivity growth over the next 45 years. This is the difference between, say, 1.75 and 1.9 per cent average annual productivity growth.

By the power of compound arithmetic this means the difference by 2050 between everyone - including pensioners - being able to share an economic cake that is on average 118 per cent or 133 per cent bigger than today's. Not a big difference over such a timescale. On any conceivable increase in the ratio of economic dependants to economic producers, this is still a considerable rise, roughly double, in living standards for everyone compared to today.

This means two things. First, the assumed challenge of the affordability of ageing lacks any financial or economic substance. Second, if society devoted as much energy to combating barriers to innovation and productivity growth as it has done to pensions reform based only on wealth redistribution, then the small relative reduction in average living standards due to the costs of ageing could probably be more than offset by boosting the average pace of productivity growth.

But the Turner report does not venture far into the terrain of productivity growth and wealth creation, and all its pulled punches derive from this basic defect. In practice, the acceptance of affordability within a narrow paradigm of wealth distribution condemns the commission to making quite limited suggestions, some of which by being so modest would compound existing problems of inadequate retirement income.
 

Turner and his colleagues refused to sign up to the main consensus view that has emerged in recent years and which dominated the submissions made during the commission consultation process: that the essential starting point for UK pensions reform is a higher Basic State Pension at close to the present Guarantee Credit level of about ?110 a week, thereafter indexed to earnings, and available on a more universal basis. Despite the hopes raised by pre-publication leaks about an 'enhanced' and more 'generous 'BSP, the commission is not proposing any immediate rise in real terms, nor even a gradual improvement relative to national living standards.
 

'Generosity', for the commission, has been redefined to mean merely that from 2010 the pension should become earnings-linked and not fall further behind average living standards thereafter. The omission of any real extra uplift to the BSP was missed by a lot of post-publication commentary, which still reported a more generous BSP.
 

This puts a fresh light on the commission's statement that there is no 'current pensions crisis'; it becomes an endorsement that the current BSP of about 15 per cent of average earnings (which will be even less by 2010) is adequate and not a big problem for many existing pensioners. Unsurprisingly the National Pensioners Convention decried this view that current incomes are adequate, reminding the commission that one in five old people lives below the official poverty line. NPC president Joe Harris quipped: 'Lord Turner may talk about not wanting to engage in fairytale economics, but his recommendations for today's pensioners look like they have been written by the Brothers Grimm' (6).

The commission report recognised that women are especially disadvantaged by the contributory element of the BSP and that there has been insufficient compensation for many people taking work breaks in order to bring up children or care for others. As a result, about half of women pensioners, as well as one in 10 men, do not qualify for the full BSP today. To address this, the commission claimed to accept the merits of a universal, residency-based BSP.

But in practice this viewpoint is watered down considerably by proposing only to move future BSP accruals on to this basis, doing nothing in this respect for today's pensioners, and doing nothing or little for many of today's working-age population who are close to retirement who have lost out under past rules. In similar meek mode, even the relatively low-cost and surely uncontroversial suggestion to give all older pensioners of over 75 a full BSP (rather than one reduced by contribution gaps) is only an 'ideal' suggestion from the commission that is 'subject to affordability'.

The commission also saw that the spread of means-testing is problematic for an effective and adequate pensions system, a criticism which has gained much ground in recent years, at least outside the government. Means-testing both limits the state's foundation level for retirement income and also distorts people's own arrangements and preparations for their later years - not least in the disincentive that means-testing creates for saving and for building up other assets for monetising and use when people are no longer working at their desired level of income.

However the commission's objective of 'making the system as non-means-tested as possible' immediately fell foul of the low horizons imposed by their assimilation of affordability. Far from seeking the elimination of means-testing as quickly as possible, the commission suggests putting a cap on the peak impact in the middle of the next decade, when it could affect about 42 per cent of pensioner households, and thereafter very gradually reducing the impact to about 32 per cent in 2050, only a few percentage points below today's level (7).

As a result not only do the Turner proposals not help poorer pensioners today, but for many years better-off pensioners will benefit most from the changes - an odd outcome of reform for a system which is seen by many to be failing in giving a decent deal for lower earners. Research carried out for the Financial Times by the Organisation for Economic Cooperation and Development found that while lower earners will gain in today's money from the shift to a flat rate second state pension over the 'very long term', in the previous decades there are bigger gains for higher earners. The research spelled out that because of the continuation of means-testing, lower earners get nil benefit from the reforms for many years. It used illustrations where this applied to current pensioners after 10 years of the implementation of the Turner suggestions, and to 45-year-old people retiring in 2025 (8).

Another sign of unfulfilled promise came when Turner went on record to reject the notion that there is a 'quantifiable "savings gap"' (9). The idea of a savings gap has been strongly adopted in recent years both by the pensions investment industry - closing such a 'gap' would be good for business - and by the government, because it focuses attention on people saving more and upon their individual responsibility for retirement income, rather than on a good state element financed through taxes and national insurance contributions.
 

The 'savings gap' idea has gained so much backing that it has become one of the main received wisdoms distorting a reasoned approach to establishing a better way of organising pensions. However, the idea that more savings will solve the problem is a red herring. Savings do not automatically produce more productive investment and improved wealth creation (10). The commission stood back from endorsing such confusions in some of its analysis, but in the end it stuck to the conventional view that we all need to 'save more'.
 

Even if the commission's suggestions on savings were implemented, this is an area where people could be made even worse off than today.
 

In the foreword to its first report last autumn, the commission correctly highlighted that the problems of the pension system reflected the cumulative impact of decisions made 'often with unintended consequences, by governments over several decades' (11). This is striking with regard to the attempted privatisation of pensions through the increasingly prescriptive regulation of occupational pensions. For all the impact on private pension funds of stock market falls, lower interest rates and rising longevity, it is the history of intensified state regulation and intervention that has created liabilities which companies feel they can only escape from by closing down their defined benefit schemes. In these circumstances, the bold move would be to deregulate private pensions as far as possible.

 

In line with this approach, it should be argued that retirement income would (for the foreseeable future) rest on two simple elements: a foundation of a decent universal state welfare payment, topped up by personal provision, whether through savings, work or other sources of income. If companies want to offer their employees some deferred remuneration through a work-based pension that's up to them and should be left as something to be agreed between workers and their employers, not to be subject to extensive regulation and prescription by government.

This was broadly the conclusion of an earlier government-commissioned review of pensions carried out by former NAPF head Alan Pickering: A Simpler Way to Better Pensions (2002). This report argued for the significant simplification and de-regulation of private pensions but was largely ignored by government.
 

The Turner Commission has rejected anything so radical and instead proposes to develop yet another layer of state-organised private pensions in the form of the National Pension Savings System (NPSS), or 'Britsaver'. This mixes so-called 'soft compulsion' for workers - automatic enrolment with an opt-out provision - with full compulsion for employers who would have to contribute a minimum of 3 per cent of salary for participants - in effect an additional tax.

If implemented as part of the Turner package, the NPSS would likely make the pensions system more complex to future pensioners and damaging to many. One perverse consequence is that it might accelerate the winding down of existing, more generous occupational schemes where employers can pay up to 15 per cent of salary into defined benefit schemes and 6 to 7 per cent into money purchase schemes. Some of these may level down to the default contribution of 3 per cent. So far from boosting private pension provision, the unintended consequence could be to reduce it even faster than undercurrent trends.

As the NAPF warns, one possible consequence of the proposal for auto-enrolment in existing occupational pension schemes (which would be yet another new state requirement) is that 'many employers may cease offering an occupational scheme and opt for a lower quality NPSS instead. There is a very real danger that, in proposing new savings options to a wider constituency, the commission's proposals would throw the baby out with the bathwater.' (12)
 

This commission's reticence to follow through the criticism of means-testing also has perverse consequences for the impact of the NPSS, an inconsistency which many missed in the initial reactions to the commission's report. Since means-testing is envisaged under the commission's proposals to continue to affect about one third of pensioners by mid-century, why should lower earners be any better advised to contribute to the NPSS than to join or take out an existing private pension today? In fact, because of the element of compulsion - which will be both practical through auto-enrolment and then reinforced by social pressures (who wants to be branded these days as a feckless spendthrift by opting out?) - many lower-income people could well be worse off during their lives than today. They will have the same combined pension income in retirement as under today's system, but the forced savings will have reduced their disposable income during their working lives.

 

Although charges could be lower under the NPSS than under most existing private pensions, this is of no help to the many low earning people who are still going to find their private pension income effectively taxed at up to 100 per cent as a result of means-testing. Building up a bigger pension pot through lower charges sounds great, but is irrelevant if you are going to continue to lose out on the pensions credit later.
 

The end result is that retirement incomes for the poorest third of pensioners will be pretty much the same as if the national savings scheme didn't exist; but less of their income will come from public funds, more from the NPSS. This will therefore be at the expense of living standards and consumption levels in the period when they are working and earning and remaining auto-enrolled and paying into the NPSS out of salary. So yet another negative 'unintended consequence' from extending state intervention in private pension provision.

 

The bold stance here is to say that savings decisions in pensions, property or any other asset should be left up to individuals. We should have more faith in people being able to make sensible judgements on the financial aspects of their current and future lives. We do not need the patronising attitude that informs the NPSS about 'the inherent behavioural barriers to people making rational long-term savings decisions without encouragement' (13). The only encouragement people could do with is the removal of as much as possible of the existing meddling by the state into their retirement income options.

 

The overall complexity of the present system introduces absurdities that interfere with rational decision-making and planning by individuals. Yet the result of the commission's timidity adds to, rather than reduces, complexity. As Christine Furnish, chief executive the National Association of Pension Funds, lamented, 'the commission is being too timid. By recommending a two-tier state pension system [effectively merging the State Second Pension with the BSP], the commission will perpetuate current complexity, delaying real simplification for some 25 years, and exposing reform to significant political risk. Far from simplifying the pensions landscape, these proposals could make things more complicated.' (14)

 

Longevity is not a problem
 

What about the other main long-term commission proposal to raise incrementally the State Pension Age to 67 between 2020 and 2040, and even higher thereafter? Leaving aside the exaggerated argument about the cost of decent state pensions that is being used to motivate this increase, many have commented that this proposal is rational as a gradual adjustment to longer life expectancy. It is believed to help address the paradox of the past 30 years - that we have been retiring earlier while our life expectancy, including our healthy life expectancy, has been rising. Fifty years ago the average retirement age for men was over 67 when their life expectancy at 65 was about 12 years; today the retirement age is a bit less than 64 while life expectancy at 65 is almost 20 years. It does seem odd that we've been living longer healthier lives but stopping work earlier.
 

But not only is there no pressing financial need to raise the state pension age, nor does this suggestion really address the paradox of earlier retirement. In another flash of good sense, the commission notes that there is no automatic connection between the SPA and the effective age of retirement. It correctly notes that the financial savings for the exchequer might be less than imagined: 'if pensionable ages rise and average retirement ages do not, even the reduction in pension expenditure may be offset by other non-pension benefit expenditure (such as Incapacity Benefit and Jobseeker's Allowance)' (15).
 

The real problem with stopping work earlier has nothing to do with either the effects of ageing, nor with the particular state pension age. Much of recent earlier retirement is not voluntary, but the result of insufficient job opportunities, and most of this is down to economic weakness. 'Early retirement' is often a euphemism for job losses and is too early for many people.
 

The fact that the effective age of retirement is lower in the more economically deprived regions of the country where economic activity rates are lower emphasises that this is primarily a labour market and economic problem, rather than one that has anything to do with age or ageing. A report two years ago from the Department for Work and Pensions noted that of the 2.7 million people aged between 50 and SPA not in work, possibly one million would like to work if they could find suitable jobs (16).
 

Increasing the SPA does not address this economic and labour market issue. Just as the commission has missed the opportunity to focus the pensions and ageing discussion on wealth creation, so it has missed a complementary opportunity to focus on the primacy of extending job availability in general, and for older people in particular.
 

Longer life expectancy should allow us to think afresh about what we want to do in our older yet fit and healthy years, establish greater flexibility about working and leisure, and, over time, retire the whole concept of fixed retirement. Simply raising the SPA is no substitute for contributing to such a new approach to old age that is appropriate to truly innovative thinking about the twenty-first century. On the contrary - legislation or regulation that remains age-specific only reinforces the social and cultural pressures that make employment opportunities even more difficult for older people.
 

In this spirit, the commission noted that it would be a positive to give people greater choice and flexibility as to when and how much of their SPA they can apply for or defer until later. Unfortunately even this bit of more radical thinking risks getting lost in the focus on the suitable increase in the benchmark SPA, as required by the premise of 'affordability'.
 

When the government responds to the final report next spring, it is highly unlikely that it will come anywhere near accepting the commission's best moments of analysis of the problems. And given the timid way the commission has approached making recommendations, it is even less likely that we will see any truly progressive reforms being promoted by government. The debate about pensions and ageing needs to become much sharper and bolder in the coming months.