Published by Policy Exchange (London), 2 March 2008 (PDF)
By Nicholas Hillman, edited by Oliver Marc Hartwich
Defined benefit pensions
Defined benefit pensions are more secure and more generous than ever before. But well-intentioned reforms and other changes have increased their costs. Most defined benefit schemes in the private sector are now closed to new members.
To date, policymakers have failed to respond effectively. If defined benefit provision is to survive, it needs to become more affordable. In particular, there should be:
– more flexibility for schemes wishing to respond to changes such as rising longevity;
– a new regulatory regime for risk-sharing schemes; and
– closer alignment of the benefits available from public sector and private sector schemes.
Defined contribution pensions
The collapse of defined benefit pensions would not have been catastrophic if the slack had been taken up by other private pensions. This has not happened, at least not to the degree necessary to stop the overall decline. The proportion of the workforce whose principal second-tier pension was a private scheme fell from 55% to 42% between 1991/92 and 2003/04.
Defined contribution schemes tend to have lower contribution rates and lower take up than defined benefit schemes. The result has been a significant reduction in employer-sponsored pension provision. This has particularly hit younger people. Ministers have responded by saying employees will be automatically enrolled into employer-sponsored pensions or a new system of centrally-administered personal accounts from 2012. This will extend coverage. But untested and inflexible statecontrolled personal accounts are not the only possible solution.
Given the UK’s starting point, it would be better to use existing expertise by automatically enrolling all employees into tried-and-tested products, such as stakeholder pensions, instead.
The state pension system has faced grave problems in recent years. It is failing in its two main objectives of relieving poverty and providing a base for private saving.
The forthcoming state pension reforms offer some improvement. They will provide more equal outcomes, less means testing than if current policies continued and a higher State Pension Age. But, even after the reforms, the system will be flawed. It will continue to be excessively complicated: there will still be two state pensions with different contributory conditions, accrual rates and indexation rules.
A Single-Tier State Pension would be more progressive and simpler, and it would provide a better base for private saving. In short, all three elements of the UK pension system – defined benefit schemes, defined contribution schemes and the state pension – need further reform if future generations of pensioners are to be as well off as they could be.