Adair Turner speech to Congress 2005

Adair Turner speech to Congress 2005

Address by the Chair of the Pensions Commission, 14 September 2005

I ' m pleased to have this opportunity to talk to Congress today, but also very aware that I have a problem. Which is that anything I say may be quoted as evidence for assertions about what the Pensions Commission is going to recommend. The Pensions Commission has moved into our equivalent of pre-budget purdah ahead of the publication of our Second Report on November 30^th . Obviously we already know something about what we are going to say - though there are still quite a few details to be pinned down. But revealing those recommendations clearly has to wait till we have all the details pinned and until November 30.

But what I would like to do today is to highlight some of the difficult issues with which we have been wrestling, and which I suspect will be the subject of major public debate over the next three months and indeed after November 30 - whatever we then recommend.

The first relates to the demographic challenge and the state system. The second relates to compulsion.

We cannot avoid facing the demographic challenge. Life expectancy is increasing and will continue to do so. This, despite having spent a lot of the last two years talking to actuaries, I insist on calling thoroughly good news. But it clearly creates a challenge for all aspects of the pension system - for the state system, for private sector Defined Benefit schemes, for public sector schemes, and indeed for Defined Contribution schemes - though with the difference that in the DC environment all the risks are borne by individuals facing declining annuity rates, not by government or employers.

And the scale of that challenge appears to grow with every new estimate of future life expectancy. In 1980 decisions about public pension policy and about the affordability of Defined Benefit promises, were being made on the basis of estimates that male life expectancy from age 65 in 2005 would be about 14 years. But now that we' ve reached 2005 the estimate is 19 years. Looking forward, the current official base case forecast is 22 years of life expectancy for a man reaching 65 in 2050, but many experts believe that will be revised up significantly as new information becomes available. Figures in the high twenties are quite possible.

Take those life expectancy increases plus forecasts of fertility and immigration, and the ratio of people above 65 to people of working age, or at least what we used to define as 'working age' is going to go from about four today to about two in 2050.

When that happens only four things - or a mix of these four things - can happen:

• Either pensioners will get poorer relative to average earnings;
• Or taxes or national insurance contributions will have to rise to pay for more generous state pensions;
• Or savings flowing into private pension funds must rise, and regardless of whether the money is contributed by employers or employees, that in the long run will be at the expense of cash wages;
• Or average retirement ages and pension ages must rise.

In part the trade-off between those four options will be made and should be made by individuals. Increasingly in the world of Defined Contribution pensions, individuals will have to make their own trade-offs between how long to keep working and how much to save versus desired income in retirement. The challenge here is to make sure that those people who do want to work later are able to do so. That is why the Pension Commission strongly supports the anti-age discrimination legislation and would prefer there to be no maximum age of its application.

But - in the state pension system - the trade-off will have to be decided collectively, in the definition of state system policy. And the tradeoff in the state is a three way choice: less benefits relative to average earnings; higher taxes or higher pension ages.

Present policies, if continued indefinitely, will means substantially smaller pensions on average relative to average earnings. Public expenditure is planned to stay roughly constant as a percentage of GDP increasing only from 6.2% to 6.4%; the state pension age is assumed to stay constant at 65. But the proportion of the adult population over 65 will increase by around 45%. As night follows day that means that in by 2050 on average pensioners will receive about 30% less relative to average earnings than they do today.

The good news is that the government is committed to ensuring that that falling provision is not at the expense of the standard of living, relative to the rest of the society, of the poorest pensioners. To achieve that the Guarantee Credit is, quite rightly the Pensions Commission believes, linked to earnings. But that in turn means that the contributory state pension income enjoyed by the average earner - the person on about £22,000 per year - will have to fall even further than 27% in earnings terms, in fact by about a third relative to average earnings. And it means that the system will become steadily more means tested over time.

All of that defines the essential dilemma of pension policy.

• The Commission is told repeatedly that means testing is a big problem. Pensioner groups dislike it. And the private pension industry tells us that it is a disincentive for private pension saving, that the voluntary pension system cannot work if means testing spreads and that compulsory savings would be unacceptable if people , having been compelled to save, saw some of the benefit of their saving disappearing as a result of means-testing.

• The Pension Commission is also left in no doubt that there would be many people, and many business groups, who would oppose any significant increases in the level of tax or national income devoted to pensions.

• And we are also left in no doubt that there are many people and institutions who do not want an increase in state pension ages.

But the state pension system is either going to become more means tested, or it' s going to require higher taxes or NI contributions, or there are going to be higher state pension ages, or some mix of all three. There is nobody clever enough to design a state pension policy in the face of the demographic challenge, which doesn't involves one of those three things or some mix.

But whatever choices we make on the state system, it is clear that increased pension saving into funded pensions will also have to be part of the response to the demographic challenge if people are to achieve what that they are likely to consider adequate pensions. Both the present government and previous Conservative governments have certainly believed that and the overt aim of British pension policy for several decades has been that the percentage of pension income coming from non-state sources should rise.

It is however clear that we are not on target for a sustained rise in private pension income - whether from occupational pensions or from personal pensions. Rather the opposite. Participation rates in private sector pension schemes - occupational or personal - are in slight decline. And average contribution rates will fall over the long term as the shift from Defined Benefit to Defined Contribution works through the system. The state is planning to do less for the average earner, but neither the average earner herself nor her employer are doing more to fill the gap .

And the Pensions Commission has become increasingly aware of three inherent barriers to that gap being filled by a voluntary system:

• The fact that many employers do not see it as their role to provide pensions simply for reasons of social responsibility, focusing only on what advantages they get in the labour market. Many are also convinced that pension promises - deferred pay - don't bring them as much bang for their buck in recruitment and retention as cash wages.

• The fact that many individuals find it very difficult to make sensible decisions about long-term savings without encouragement and advice, particularly when the whole pension system is so complex and difficult to understand.

• And the fact that it is very difficult for the financial services industry to sell pensions to people of average earnings and below, working for small and medium size companies, or even to sell pension schemes to their employers, at annual management charges sufficiently high enough for them to make a profit but sufficiently low enough to represent good value for money for the person saving.

Some people and institutions, faced with those barriers, urge the Pensions Commission to recommend compulsion. And we know that many individuals say that they would like to be compelled to save: but we also know that many say very clearly that they do not want to be compelled. And we know that resolving that conflict by saying ' well let's just compel employers not employees' - is not an answer since there is a wealth of economic theory to suggest that in the long-term compulsory employer contributions will be at the expense of cash wages . Indeed in the major developed country which has introduced compulsory pension savings in the last two decades - Australia - that tradeoff - pension contributions instead of cash wage increases was a deliberate aim of the policy, recognized by government ,employers and unions alike. Finally, we know that simply compelling people to save doesn't necessarily fix the cost efficiency problem - Australia again is a case in point . They have compulsory savings, but high annual management charges.

So on compulsion, quite as much on state pensions, taxation and pension ages, there are no easy answers. Indeed all the Pensions Commission can promise you, or government or business or individuals, is that there are going to be no easy choices among the recommendations we present on November 30^th.