Sunday, September 19, 2004
An empty pot of pension gold
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

For me, the interesting thing about the pro-hunt protesters who burst into the House of Commons last week was what one said to Alun Michael, the rural affairs minister. He was confronted with the words: “You’ve mucked up pensions. You’ve mucked up everything.”

That may be a cleaned-up version of what was said, but the inference was clear. Even in the heat of the chase, and facing the loss of their ancient right to hunt foxes, they could not resist a swipe at pensions.

Even more than fox-hunting, this is an issue that threatens to undermine the government. Andrew Smith was the quiet man of the cabinet but his departure has produced more debate than he was ever able to generate while in charge of the Department for Work and Pensions.

The causes of the pensions crisis are well known. The bear market in equities produced a reappraisal of future stock-market returns so that trustees realised they had been living in a fool’s paradise of inflated expectations.

Actuaries, normally slow-moving folk, appear to have woken up suddenly to the implications of greater longevity. People reaching 65 can now expect to live three to four years longer than a generation ago, with the increase particularly marked among men.

Companies, their attention focused by the FRS17 rules that require them to account for pension-fund assets and liabilities on balance sheets, have been searching for ways to reduce risk. Martin Temple, director-general of the Engineering Employers’ Federation, recalls that just a few years ago pensions rarely featured in any discussion of business risk. Now they are near the top of the list; hence companies’ stampede out of final-salary schemes.

How much is Gordon Brown to blame for the sad decline of Britain’s pensions? When Labour took office in 1997, it was acknowledged that our state pensions were lousy, but our occupational pensions were the envy of Europe. Seven years on, state pensions are still lousy but company pensions are also badly tarnished.

The chancellor’s interventions have either been highly damaging, such as the £5 billion annual raid on pension funds through the abolition of the dividend tax credit, or ineffective, for example, stakeholder pensions and the low take-up for the pension credit.

Brown believes firmly in self- reliance, but he has presided over a period in which, in the case of pensions, self-reliance has been dangerously eroded. People are not saving enough for retirement, either because they have lost trust in pensions or because the government’s interventions have introduced perverse incentives not to save.

All eyes are on Adair Turner, the government-appointed chairman of the Pension Commission, and his interim report, due on October 12. He will address the two key issues of the retirement age and compulsion, although he will not necessarily make recommendations on these.

On the first, Turner is in favour of retirement beyond 65 becoming the norm, as is anybody else who looks at the problem logically. When today’s pension arrangements were put in place, the average working man barely made it to retirement age. That has changed dramatically. Making it the norm to work until, say, 70 looks eminently sensible.

Except that, as the National Audit Office (NAO) reported last week, and as was confirmed in the latest official figures for economic inactivity, people are already being underemployed in the years before they get to 65, with a particularly sharp decline among men. Thirty years ago more than 70% of men aged 60 to 64 were in work; now the figure is only 40%.

There is an argument that raising the retirement age would have a cascade effect on younger workers. Those in their early sixties, with nearly a decade to go until 70, might be more likely to stay in work. That, however, is by no means guaranteed, and the NAO says we already waste up to £31 billion a year in lost output and taxes by not employing the 2.7m people aged between 50 and the current retirement age of 65 (60 for women) who are outside the job market.

So raising the retirement age is not the straightforward solution it appears to be. But nor is compulsion. In the mid-1980s Australia responded to its pensions problem by introducing compulsory contributions by employers, initially of 3% of salary, rising to 9% a couple of years ago. The intention was that these compulsory contributions would add to existing savings, ensuring adequate provision.

But compulsion in Australia has produced an unexpected side-effect: the collapse of other forms of saving. This is either an extraordinary coincidence or — more likely — because people decided that their employers’ compulsory contributions would take care of everything.

There is a parallel in the debate in Britain. Some advisers believe a third-term Blair government should boost National Insurance contributions to pay for improved state pensions. Apart from the fact that, given the starting-point, the state will probably never be able to fund adequate pensions, the unintended consequence could be to make people even less willing to contribute to private schemes. Compulsion is a potentially dangerous route.

What’s the solution? We need to restore confidence in occupational schemes, and introduce genuine incentives to save and — without being compelled — to work longer.

The Institute for Fiscal Studies points out that by 2021 half the people of voting age in Britain will be over 50 and, given that they are more likely to vote, they will constitute a majority of the electorate. They will have pensions on their mind. The world is getting older — interestingly, by the middle of the century China will have the same age composition as Britain. The pensions issue will not go away.

PS: It is not just over pensions that the feelgood factor is lacking. Contrary to the way governments usually try to arrange these things, a pre-election squeeze is going on. Figures last week showed that average earnings are rising by 3.8%, unexpectedly down because of lower private-sector bonuses this summer.

There is, on the face of it, a healthy gap between this rise in pay and inflation, running at just 1.3% on the government’s consumer prices index (CPI) measure. Nobody outside Treasury and Bank of England circles (and quite a few within those circles) believes this is a fair measure of inflation, however. If we take the old retail prices index (RPI), the headline rate is running at 3.2%, its highest since September 2000. The tax and price index, which measures the amount by which pay needs to go up to keep pace with both tax changes and price rises, is running at 3.1%.

The gap between pay and inflation on these measures is under 1%, implying weak growth in real incomes. The big effect on the RPI comes from mortgage-interest payments, up by 30% in the past year.

The latest figures have encouraged the markets to believe that the base rate may have peaked at 4.75%. Low CPI inflation and a drop in earnings growth imply the Bank of England does not need to apply the brakes any more.

There is, however, a little way to go on this. The Office for National Statistics seemed embarrassed by its new retail-sales figures, which appeared to be totally at odds with the evidence from the high streets. But the fact is that they were up on the month (helped by heavy discounting) and up 6.5% on a year earlier.

Not only that, but the August inflation projections from the Bank had short-term weakness in the target measure of inflation, based on the CPI, before a steady rise through next year. Only if next year’s inflation rise appears no longer on the cards will it be safe to rule out further rate hikes. We are not there yet.

From The Sunday Times, September 19 2004