Pensions reform? The reality is another raw deal for the poor old Brits

In the Queen’s speech at the opening of Parliament, we learnt that pension reform is proposed for the current session. A bill will be printed very shortly. The Prime Minister hopes that a new, sustainable pension settlement will prove a lasting legacy. He is going to be disappointed.

Last May, the white paper on pensions (on which the new bill is based) promised to make them fair, simple, affordable and sustainable. Just who is kidding whom? Outside the public sector, how many British people know what their post-retirement income will be? The vagaries of financial markets, the current vulnerability of occupational pension schemes and constant changes in official regulations governing state pensions and private pension saving — all combine to make this an impossible call. British pensions may not cost the taxpayer much, but in comparison to pensions on offer in other countries, they are unfair, complex and politically (if not financially) unsustainable.

Not so across the Channel. Pension restructuring in continental Europe has certainly been politically contentious, but settlements reached in Germany and Sweden following recent cuts offer substantially higher state pensions than we are promised in Britain. In Germany, phased-in reforms will reduce future state pension income from c. 70 per cent to c. 58.5 per cent of earnings by 2030. In France, the guaranteed pension will be cut by 5 per cent p.a. for every year short of a new 42-year working life, generating roughly the same results. Even in the USA, state social security still provides a pension at around 40 per cent median income.

In Britain, the new legislation will combine the basic state pension with the earnings-related second pension (S2P) and extend the coverage of the latter. Taken that the promised link to earnings is restored in 2012, these changes will offer a state pension at around 30 per cent of average earnings by 2030 to the majority of private-sector workers. This is better than the current situation: the basic state pension today is worth about 17.5 per cent and is the lowest in the developed world. However, the government’s proposed reforms will not lift Britain off the bottom rung of guaranteed pension provision.

Why are British state pensions so appallingly low?

While recognising the need for pension restructuring in the face of demographic challenges, European and Scandinavian systems differ from the British on three key points. First, questions of equity and security are addressed. Pension reforms pioneered in Sweden and Latvia (recently adopted by Italy and exciting interest elsewhere) have created notional defined contribution (NDC) systems to replace earlier pay-as-you-go defined benefit schemes. These NDC systems still structure pension benefits in accordance with the individual contributory record, but provide pensions standardised to reflect the size and life expectancy of the retiring cohort and overall fund performance. This mediates risks posed by provider failure, fund mismanagement and market fluctuation — and the higher costs of multiple providers. In the UK, these risks will continue to be borne by the contributor alone. Faced with chronic uncertainty, many low paid avoid contributing altogether, as means-tested supplements will make good future pension deficits.

This ties in with the second major difference. Unlike Britain, other European governments have retained a basic commitment to keep state pensions above the level of means-tested assistance. Further, in France, Germany and elsewhere, the state subsidises pension contributions for the unemployed, as well as for those caring for children and the incapacitated (who are also covered in the UK). All this sustains public support — and fierce opposition to political meddling with pension rights. Higher basic pensions also create incentives to save, which have proved such a problem for the current British government. In Germany, contributions to private occupational plans have boomed after the first pension cuts were introduced. Numbers covered exploded from 167,000 in December 2001 to 1.127 million in March 2003: an increase of 573 per cent in 15 months.

Finally, the government of pension systems in Europe has long involved representatives of the insured. Any alteration in pension rights has to be a negotiated process, necessarily entailing public involvement and debate. Dialogue and negotiation can create conflict, but also broaden understanding: this produces at least public acceptance, at best public understanding and trust. In Britain, economists and associated interests at the Treasury create pension policy behind closed doors. Policy is founded not on principles of democratic participation, but on models of rational choice. The result is confusion, as a public cut off from decision making greets with bewilderment the unending stream of regulations and incentives pouring from Whitehall.

Will the new pension bill alter this?

The short answer is no. The new bill will not raise state pensions above means-tested assistance before 2030 — and this more generous pension will not actually be paid to anyone for many years after that. The government has no intention of changing methods of pension policy making. This legislation imposes yet another layer of complexity onto an already Machiavellian system. We stumble on as before.

When contrasted with continental pension systems, the weaknesses of Britain’s proposed pension settlement are clear. New Labour implies that a consensus for reform was created by Lord Turner’s Pension Commission, that the government is carrying these proposals forward, and that we will all live happily ever after. Such optimism is misplaced. British pension policy has long been made with short-term electoral horizons in mind. Since 1945, policy has been highly unstable, changing tack as governments come and go. British governments believe that consensus is imposed from above, not by processes of negotiation. Hence the new legislation ignores Turner’s recommendation to establish an independent standing commission that would mediate between interests and between generations, to build and support a lasting consensus on pensions. This new bill opens up another hall of mirrors, an illusion of improvement that does not bear close inspection. The settlement on offer will not last.

Noel Whiteside is professor of comparative public policy at Warwick University. Britain’s Pensions Crisis, co-edited with Hugh Pemberton and Pat Thane, was published by the British Academy in October 2006.