LONDON - A U.K. panel has proposed an overhaul of the British pension system, including mandatory participation in a second-tier pension system.
The second-tier system would include creation of a National Pension Scheme, a potentially giant defined contribution plan covering workers not participating in an employer-sponsored plan or a personal pension.
The plan would be governed by state-appointed trustees, who would set investment policy and would be free to contract investment management from the private sector.
The recommendations by the Retirement Income Inquiry, an independent panel sponsored by the National Association of Pension Funds, may set the stage for debate for the future of retirement income provision in Britain.
Observers believe the proposals will not go anywhere fast under the ruling Conservative Party, which opposes compulsory pension coverage.
But national elections, expected this year or next, probably will propel the Labour Party into power. The Labour Party is expected to be far more favorable to the recommendations, even though they essentially shift more of the responsibility for providing pensions to the private sector.
"These are issues that we as a country need to tackle. But it's unlikely this type of fundamental change will take place for a number of years," said Richard Malone, European policy director at Sedgwick Noble Lowndes Ltd., Croydon, and president of the Pensions Management Institute, an association for setting standards and training pension professionals.
The panel's recommendations reflect two growing global pension trends: a shift toward defined contribution plans to meet the needs of an increasingly mobile and flexible work force, and a move toward mandatory coverage to ensure workers have enough income to live on in their old age.
The shrinking basic pension
The problem, the inquiry's report said, is the basic state pension is dwindling in real terms. Following a 1979 reduction in inflation adjustments, the basic state pension has slipped to 15% from 20% of average gross male earnings.
If trends continue, the report said, the basic pension will decline to 9% by 2030. The cost of restoring the basic pension to its original level is prohibitive: it would cost an additional 6.6 billion immediately and nearly 50 billion by 2030.
While employer-provided pensions are improving retirement conditions for the elderly, only half of the working population is covered by these plans. What's more, total retirement income is skewed increasingly toward upper income earners. The upshot is a growing gap in retirement comfort between the poor and the well-to-do.
Thus, a growing consensus of U.K. pension experts says the only way to ensure a reasonable level of retirement income for all workers is to mandate participation in a secondary system.
To do this, the Retirement Income Inquiry would first revamp the existing basic state pension. Under the new first-tier system, retirees would receive a government-backed minimum pension, incorporating the current basic pension but providing an additional benefit for lower-paid retirees.
Higher-income retirees would see their benefits reduced on a sliding scale, still encouraging individual savings but ultimately redistributing income among lower-income employees.
For second-tier benefits, the commission recommended phasing out the State Earnings Related Pensions Scheme, replacing it with a mandatory supplementary system.
Introduced in 1978, SERPS was designed to provide supplemental retirement based on average earnings. But the Thatcher government cut benefits sharply and encouraged workers to opt out of the system (implementing personal pensions instead). Further benefit cuts were imposed by last year's Pension Act.
As a result of myriad changes, the system is hard to understand and is used by only 17% of British workers - 70% of whom earn less than 10,000 a year and 65% of whom are women. These low-income earners will earn at most a pension of 10% of average male earnings.
To restore SERPS benefits to their originally envisioned level would drive costs to 35 billion to 40 billion a year by 2050 - from a currently projected 10 billion.
Instead, the panel proposed requiring a minimum combined contribution from employers and employees - initially set at 4.8% of includable salary. That's the level of rebate employees receive for contracting out of SERPS.
Individuals would be free to choose to participate in an employer-provided plan, a personal pension or the new National Pension Scheme. The new defined contribution scheme would be administered by trustees, who would set investment policy and could hire external money managers and administrators.
Sir John Anson, the inquiry's chairman, had little idea of how much money would accumulate in the national scheme, and he dismissed its potential impact on capital markets and corporate governance.
Tom Ross, chairman of the National Association of Pension Funds, said in a statement that he welcomed replacing SERPS with a compulsory funded system, but he felt the new state scheme "would be best run by competing private organizations with individuals having personalized accounts."
Some observers said the proposal would merely roll the clock back 20 years. A similar national defined contribution scheme was scrapped in 1973, before the plan ever became operational, out of fears the state would gain control of a massive pool of capital.
Inadequate benefit levels
There's another issue the panel sidestepped. While it would set the contribution rate at 4.8% initially, Mr. Anson declined to say what level would be needed to provide an adequate retirement benefit. His view was to get the proposal adopted and then determine the necessary contribution rate.
The committee's own background report acknowledges 4.8% is far too low.
"The effect on incomes of merely insisting that an amount equivalent to the contracted-out rebate should be put into a funded scheme is, not surprisingly, small, because the rebate itself is rather low," wrote Paul Johnson, Richard Disney and Gary Stears of the Institute for Fiscal Studies, a London-based think tank.
"By the same token, it would provide woefully inadequate levels of pension, especially for the lowest earners for whom most of the extra would be lost in charges."