End of the line?

Lord Turner’s solution to the pensions crisis will not work, says Liam Halligan. The UK government needs to accept that compulsory pension saving is the only answer

There is a widely held view among our political and media classes that this country has solved its pension problem. It’s often said that Lord Turner’s gargantuan review – published in late 2005 after almost three years of deliberation – has created a “workable pensions consensus”. All that needs to happen now, the argument goes, is for Turner’s grand vision to be implemented. And then, demographic time bomb defused, we can stop fretting. Job done. So powerful is the impression of universal agreement that those questioning Turner are dismissed as troublemakers. So precious is the ‘consensus’ that to raise issues is almost akin to treason – a ludicrous state of affairs.

I accept that politicians have agonised over pension reform for years. Since 1997, for instance, Labour has launched no fewer than nine separate pension enquiries. Nearly all have sunk without a trace  having served their purpose of allowing ministers to dodge difficult questions by answering: “I don’t want to pre-judge the review”. But Turner – ‘the mother of all reviews’ – was different. It spawned two hefty pension bills – one of which is already law, with the other still grinding its way through Parliament. Yet it’s precisely because the need for pension reform is so pressing and the sums involved so vast that objections must still be raised.

Out of public earshot, economists and other pension wonks are muttering that the ‘workable’ policy package now being implemented will at best be ineffective and could even make matters worse. But this extremely valid debate isn’t being heard – so it isn’t influencing the political process and, in turn, policy outcomes. And that’s a major problem. Turner’s reforms were billed as “a pension system fit for the 21st century”. Their impact will be felt over many decades, and by practically all British citizens as both pensioners and taxpayers. So, forgive me for admitting, despite the ‘consensus’, that I have serious concerns. And I’m far from alone. Like many who follow this fiendishly technical debate, I would question not only the policy detail of Turner’s reforms, but much of their intellectual thrust. Let me say at the outset that the analytical work in the Turner Review is world class – providing a crystal clear description of “the world’s most complex pension system”. Turner doesn’t pull his punches, either, on the demographic pressures we face. Across the OECD countries, average life expectancy is now 77 years – having gone up by no less than 10 years since 1970. And longevity will continue rising. By 2050, the share of over-80s in the OECD will increase from about 2 percent today, to 10 percent. At the same time, falling western fertility guarantees that just as there are many more pensioners, there will be far fewer tax-paying workers to support them.

The demographic time bomb

In the UK, the maths is particularly scary. By 2050, the number of British citizens aged 65 and over will be 50 percent higher than now. But we’ll have only two people working (and paying tax) for each pensioner, compared with four today. Our ‘dependency ratio’ – the extent to which the working-age population supports those not working – will double over the next 40 years. And, as the great wave of post-war baby boomers starts to retire, much of that increase happens between now and 2020. Longevity gains are great news for humanity, but terrible for taxpayers in the fast-greying western world. According to recent research by the ratings agency Standard  & Poor’s: “The message is unambiguous...without strong and sustained reform, high credit ratings in countries like the UK and France will be lost due to demographic spending pressures starting in the 2010s.”

The impending agequake is so serious, then, and the resulting public liabilities so great, that the sovereign debt rating of some of the world’s most advanced economies, including ours, could soon be sub-investment grade – or ‘junk’. And even if it was politically possible to sharply raise taxes in response, that would slow future economic growth, making our age-related spending crunch even worse. Lord Turner knows all this. That’s why he proposed raising the age at which we start receiving publicly funded pensions – which, of course, saves money. The law has now been changed so the basic state pension age goes up incrementally, reaching 68 by 2046.

But Turner rightly insisted that higher state pension ages aren’t nearly enough. We also urgently need to expand our private pension system, to contain the future burden on taxpayers. The trouble is that, just when we need it most, the UK’s strong tradition of private pension saving has gone into “significant underlying decline” – to use Turner’s phrase. In 1997, we saved about 11 percent of our income (including pension saving). That share is now less than 6 percent – a historic low. The grim reality is that a staggering 12 million of us (about half the workforce) are putting nothing aside for old age. At the epicentre of the pension-saving collapse are final-salary schemes, once the gold standard of UK pension provision. Just a decade ago, about half our workforce – including many skilled and semi-skilled manual workers – contributed to employer-based schemes that would eventually pay annual pensions of up to two-thirds of final salary. But the demographic squeeze and Labour’s disastrous 1997 pension tax raid have recently combined with competitive pressures on firms to close the vast majority of such schemes. Fewer than 10 percent of private sector workers now pay in to final-salary pensions. And, of those schemes still operating, two-thirds are closed to new members – so many existing contributors will eventually be short-changed. The demise of our private final-salary schemes will have a serious impact on the economic stability of this country, to say nothing of the quality of life and dignity of millions of future UK pensioners. It reflects badly on our trivia-obsessed media that this meltdown hasn’t attracted more attention. Protests by workers who have been “robbed” of final salary pensions they’ve contributed to for decades – despite being told by successive governments such schemes were “guaranteed” – have generated some coverage. But the broader implications of this collapse, in terms of future pensioner welfare, and pressure on public funds, are rarely mentioned. But, to his credit, Turner still wielded influence in the corridors of power. Before his report, ministers routinely denied there was a pension crisis. Post-Turner, they were forced to admit that demographic pressures, combined with risible private saving, meant there soon would be major problems unless “something was done”.

A pension solution?

That something is the National Pension Saving Scheme, the centrepiece of Turner’s vision. The NPSS is designed to ensure that more British workers, particularly those on modest incomes, directly finance their own retirement. Under NPSS, employees will have Personal Accounts to which they’ll contribute regularly throughout their working lives. The new pensions bill states that employees aged 22 and above and earning £5,000–£33,000 a year will, from 2012, automatically be enrolled into NPSS (or an equivalent scheme). They’ll pay in 4 percent of their salary, with employers contributing another 3 percent and the state chipping in 1 percent. The idea is that millions more workers should have funded pensions (backed by investments) instead of relying on state pay-as-you-go schemes (financed by present-day taxes). Given how fast our dependency ratio is rising, that makes a lot of sense. There is much else to commend Turner’s plan. Contributions to Personal Accounts will be channelled into ‘pooled’ index-tracker funds, allowing millions of lower income earners to benefit from compounded returns. Economies of scale should also bring low administrative and asset management costs, resulting in higher pensions. So compelling is Turner’s vision, in fact, that Paul Myners, the businessman ministers have asked to oversee the new Personal Accounts, calls it “the shining light” of pension reform. Why, then, do I think this raft of measures about to hit the statute book, while designed to boost private pension saving, will in fact crush it even more?

Why Turner’s plan will not work

My first concern is Turner’s 3 percent employer contribution rate. There is a very real danger the NPSS will encourage firms with good pension schemes – often paying in 15 percent of salary and more – to see 3 percent as an officially endorsed benchmark. Worries that Turner will provoke such ‘levelling-down’ of company contributions have been voiced to me privately by senior pension professionals over several years. A recent survey by the Association of Consulting Actuaries of 330 company schemes, with assets of £127bn, is perhaps instructive. Under the cloak of anonymity, a worrying 70 percent of companies said the NPSS will cause ‘levelling-down’, with no less than 76 percent predicting it will speed up the closure of existing occupational schemes.

An even bigger problem with Turner’s proposals, in my view, is that workers automatically enrolled into NPSS can opt out. And if they do, their employers won’t have to pay in either. I predict that millions of workers on modest incomes – the group that so desperately need to save – will be tacitly ‘advised’ by their employers to un-enrol themselves from Turner’s scheme. This disastrous outcome seems to be as obvious as it is impossible to police. I hope I’m wrong – but, again, a lot of pension experts agree with me. And if that happens, for all the fanfare, the NPSS would end up on the scrap-heap of policy history, just like stakeholder pensions. Remember them? The main obstacle to the success of the NPSS, though, has nothing to do with Turner’s proposals. For the reality is that the Personal Accounts are likely to be stillborn due to the government’s own policies and its ongoing refusal to change them.

Practically every actuary I know thinks that a major reason pension saving has collapsed is the government’s Pension Credit and the associated mass expansion of means-testing.

The current means-testing mania means a huge number of potential NPSS savers will conclude it makes little sense to put money in a Personal Account – because it will simply replace old-age benefits they would have anyway got from the state.

This is a highly technical area, but there is a near cast-iron consensus, at least outside the Treasury, that Pension Credit and other old-age means-tested benefits will kill the NPSS stone dead.

That’s because those automatically enrolled into the NPSS stand to lose a large part of the value of their pension savings if they’re one of the four in ten people working today who, under current rules, will be means-tested when they retire. And those four-in-ten will, of course, comprise a much higher proportion – perhaps six or seven in ten – of Turner’s low- to middle-income target group.

My view is that Turner should have recommended, and ministers should have adopted, ‘compulsion’ – forcing us to save for old age. It’s already been introduced in places as diverse as Singapore, Sweden, Australia and Switzerland. Given the grave demographic dangers we face, UK citizens should also be compelled to invest in their future retirement.

Ministers shy away from compulsion because they worry they’d be accused of imposing a tax. But with voters paying into their own individual accounts, watching their money grow and with the government contributing too, compulsion has proved popular in those countries with the guts (and good sense) to adopt it.

Turner’s proposals amount to ‘soft compulsion’. And I suspect many – if not most – of the millions of people the government says are set to benefit from NPSS will, in fact, opt out. Even if they aren’t tempted to spend all their wages, or pressured by their employees, our current means-testing regime makes it completely rational for workers to turn their backs on Turner’s new scheme.

The UK economy faces enormous demographic challenges. Enormous financial pressures are just a few years away. We must now grasp the nettle and rein in means-testing, so paving the way for compulsory pension saving. Nothing less radical will do. 

Liam Halligan is chief economist at Prosperity Capital Management.