NIESR Conference:
The Evolution of Pensions:
Reforms and their Consequences
December 11, 2015
Pension reform in the United
Kingdom: An economic perspective
Richard Disney
Institute for Fiscal Studies: richard_d@ifs.org.uk
University of Sussex:
R.F.Disney@sussex.ac.uk
University College, London: r.disney@ucl.ac.uk
This talk + some background
Topics in my talk:
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What rationale for pension provision, especially for public
intervention in provision?
The four phases of public pension provision in UK since 1946
Private pension provision in UK – employer-provided plans +
voluntary (i.e. individual) purchase of annuities
General comments
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Semantics: ‘Social insurance’, ‘pensions’, ‘social security’,
‘welfare’ – multiple policies impinge on pension regime.
Multiple pension targets
multiple pension instruments?
(analogy – Tinbergen, 1952). (e.g. World Bank, 1994, ‘multipillar’ approach). Instruments not independent e.g public
pensions affect private retirement saving.
A framework for analysing pension reform
‘Pensions’ primarily insurance against uncertain length of life.
Development of pension arrangements in UK required calculation of ‘life
tables’ (Gilbert, 1966; Creedy & Disney, 1985).
For various reasons, voluntary risk-pooling arrangements could not
provide comprehensive coverage.
So why public intervention in pensions?
Standard framework e.g. Diamond (1977) lists five rationales:
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Market failure
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Paternalism
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Redistribution
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Revenue-raising
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Administrative cost
Market failure
Long life is a ‘good risk’, which is understood. Hard to
see a moral hazard rationale for intervention.
(though generous pensions may increase longevity)
Hence the rationale for intervention might be:
adverse selection in annuity markets.
Some (conflicting) evidence on adverse selection in UK annuity
market: e.g. Cannon and Tonks, 2004; Einav, Finkelstein and
Schrimpf, 2010; and Finkelstein and Poterba, 2002, 2004.
But this surely a rationale for compulsion, not for
public provision of pensions as such.
Paternalism
Two rationales:
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People don’t understand longevity risk (e.g. myopia), or
People do understand risk but social planner has different
preferences over e.g. level of saving that is optimal.
This issue mostly hinges around: is level of retirement saving by
individuals ‘optimal’?
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How is ‘optimality’ defined? An arbitrary replacement rate (e.g.
Pensions Commission, 2004) or by a life-cycle model (Banks et al,
2005; Crawford and O’Dea, 2014)?
Need a counterfactual – with no public pension what would saving
have been?
 ‘Crowding out’ most likely where public pension replicates private
saving (Disney, 2006)
 ‘Rational’ response by UK savers to retirement incentives? See e.g.
Chung et al, 2008; Disney, Emmerson and Wakefield, 2010 )
Redistribution
Issue is often confused by vague definitions of ‘redistribution’
(e.g. ‘from young to old’).
‘Intergenerational’ (between DOB cohorts) and
‘intragenerational’ (within DOB cohorts)
Intergenerational:
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Gainers have been early cohorts in NI programme + ‘large’ cohorts
(baby boomers). Future IRRS look negative in UK (Disney, 2004;
Disney and Emmerson, 2005)
Intragenerational
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Formula progressivity v differential mortality (Creedy, Disney &
Whitehouse, 1993)
Treatment of spouses, crediting in non-participation etc (Crawford,
Keynes and Tetlow, 2014).
Revenue-raising
General idea is that people are more likely to contribute to a
pension if they believe the contribution ‘pays’ for their own
pension.
This not true in practice even in private DB plan where pension
rights are ‘backloaded’ (Ippolito, 1997).
But especially not true in unfunded (PAYG) public programmes
where current contributions ‘pay’ current pensions.
But the ‘contributory principle’ is still defended as ‘core’ of UK
programme despite redistribution?
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Scrap separate NI system? (Dilnot, Kay and Morris, 1984) Unlikely to
happen due to ‘revenue-raising’ feature.
Integrate NI & personal taxes better (Mirrless, 2011)
Administrative costs
A mundane reason for public intervention?
But much of Beveridge’s famous report (1942) hinged on lower
costs of publicly-provided ‘social insurance’ v. (then) private
pension contracts.
And issue of admin costs resurfaced in late-1980s with
development of ‘Personal Pensions’ (e.g. , Murthi, Orszag and
Orszag, 1999).
The trade-off?
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low cost ‘one size fits all’ pensions (e.g. ‘Workplace
Pensions’) v. individually-tailored pension contracts (+
adverse selection?)
Public pensions in the United Kingdom:
The four stages of evolution
Comprehensive public provision introduced in UK in
1946 National Insurance Act. Many changes since!
I distinguish four phases:
 Social insurance
 Earnings replacement
 Tax credits
 A Citizen’s Pension?
Social insurance
The introduction of ‘National Insurance’ in 1946
Contribution-based eligibility; flat benefits and flat contributions
A residual means-tested sector
Object: to alleviate old-age poverty; ‘earnings replacement’ to
be left to private sector.
Problem 1: paying benefits immediately to newly retired
(without contribution histories) exhausted National Insurance
Fund.
Need to raise additional finance – partial shift to earningsrelated contributions.
Problem 2: Basic state pension so low that many pensioners still
on means-tested benefits.
Earnings replacement
Critics of ‘social insurance’ pointed to low level of income of those
without additional private pensions.
Left-wing solution: comprehensive publicly-provided earnings
replacement?
Right-wing solution: compulsory private insurance above BSP?
The solution (?) the 1975 Act:
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A second tier earnings-related pension (SERPS)
Earnings-related contributions (to a ceiling)
Additional provisions of credits for e.g. child care and generous
spouses’ pensions
‘Approved’ employer-provided pensions (DB plans) could opt-out
of second tier (and paying lower NI contribution)
The problem: It all cost too much! (Hemming & Kay, 1981, 1982)
Tax credits
The problem: cost, especially with rising numbers of pensions
Solution 1: cut back generosity of SERPS and introduce new
private pensions (see later)
Solution 2: move towards a tax credit programme (Gordon
Brown’s preferred option for redistribution)
The Labour reforms 1999 onwards:
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Uprate basic state pension more slowly (prices not earnings)
Focus on means-tested sector, but supplement ‘Minimum Income
Guarantee’ (then called Pension Credit Guarantee) by a tapered
benefit (at 40% withdrawal) ‘Pension Credit Saving Credit’. Hence a
two-tier NIT-type structure.
Issues: Effective MTR lower but more people means-tested
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‘Taper’ subsequently steepened
worsened incentives
Co-existence of medium-term 2-tier NIT with long run 2-tier ‘social
insurance’?
A citizen’s pension?
Pensions Act 2014:
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Scraps earnings-related public provision, opting-out of tier 2 by
employer-provided plans
Combines two tiers into one flat pension.
Raise pensionable age to 67 in stages.
Appraisal
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‘Back to Beveridge’?? (the Minister responsible a Liberal (Democrat)
MP, as was Beveridge!).
But eligibility for higher flat pension not just contribution-based,
closer to a duration-of-residency eligibility requirement, as in New
Zealand than the ‘contributory principle’.
The ‘triple lock’ of uprating as best of prices or earnings growth or
+2.5% - no longer ‘lifting pensions out of poverty’ – they are doing
better than workers since 2008!
Evaluation
UK has tried every conceivable kind of public pension
provision since 1946!
Advantages:
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Multiple instruments can achieve multiple targets
Has (broadly) achieved aim of eliminating pensioner poverty
Has (broadly) responded to demographic ageing without
rapidly rising pension contributions.
Disadvantages:
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Constant tinkering with pensions by politicians hinders
rational retirement saving plans by individuals.
Different ‘models’ of provision cause over-complexity esp. in
late 1980s/early 1990s, and in 2000s.
Private pension provision in the
United Kingdom
I briefly investigate two models of private pension
delivery in UK:
Employer-provided pension plans
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Defined contribution (DC) where pension depends on value of
contributions by employee and employer, return on fund, annuity
rate and age of taking pension
Defined benefit (DB) where pension depends on years of service,
some measure of earnings (e.g. final or career average), and age
of taking pension
In DB plan, employer undertakes investment risk but employee
takes on tenure and earnings risk (Bodie, Marcus and Merton,
1988; Disney and Whitehouse, 1996)
Individually-purchased annuities (DC personal accounts)
Employer-provided pensions
Private DB has shrunk
since 1960s:
SERPS forced out
unapproved DC plans
Personal tax rates fell
so need for tax-relieved
‘fringes’ fell.
Raids on tax reliefs
since 1997
Change in labour
market from ‘lifetime’
jobs
Chart 1
Active members of employer-provided
pension schemes, UK: 1953-2003 (millions)
14
12
10
8
6
4
2
Public sector
Private sector
2013
2012
2011
2010
2009
2008
2007
2006
2004
2000
1995
1991
1987
1983
1979
1975
1971
1967
1963
1956
1953
0
Public DB share has, if
anything, increased:
Public sector more
‘white collar’?
But generosity of public
DB cut back.
The annuity market and individuallyprovided pensions
The ‘voluntary’ annuity market was relatively small:
Finkelstein & Poterba (2002) cite 1/6th of annuitants and 6% of new
annuitants were voluntary market v. compulsory market.
New data are useful on take-up characteristics e.g. Banks, Crawford
and Tetlow (2015).
The major expansion of individual accounts arose from
replacement of s226 plans by Personal Pensions after 1988
Employees could opt-out of SERPS (or employer plan) and have NI contributions
+ 2% bonus put in a PP account.
Returns initially v. attractive but subsequent rebate changes (+ lower returns &
annuity rates + high charges) eroded generosity (Disney & Whitehouse, 1992a,
1992b)
little net new saving?
Introduction of Stakeholder Pensions (low cost simplified version of PPs) had
little effect on take-up but tax relief changes did have an effect (Disney,
Emmerson and Wakefield, 2010)
New ‘Workplace Pensions’ will supersede these accounts?
Conclusion
I suggested a standard set of criteria for evaluating and
motivating UK pension policy.
The UK programme has been reformed constantly and has
been highly complex at times.
This has provided a ‘test-bed’ for various forms of
provision, and scope for (limited) evaluation!
At the present time, the UK programme has a degree of
clarity, irrespective of ‘optimality’ (or otherwise)
Better data (ELSA additional waves, ASHE, WAS etc) are
assisting current research.