UK ANNOUNCES MAJOR REVAMP OF PENSION SYSTEM

UNCLAS SECTION 01 OF 03 LONDON 003853 SIPDIS SIPDIS DEPT FOR EUR/UBI, DRL/IL DOL FOR ILAB/WBRUMFIELD TREASURY FOR A/S WARSHAWSKY E.O. 12958: N/A TAGS: ELAB ECON PGOV SUBJECT: UK ANNOUNCES MAJOR REVAMP OF PENSION SYSTEM REF: 04 STATE 0247 LONDON 00003853 001.2 OF 003 ¶1. SUMMARY: The British government announced on May 25 what Secretary of State for Work and Pensions John Hutton SIPDIS described as "the greatest renewal of our pensions system since the post-war reforms implemented by Clement Attlee's government." The changes include an increase in the retirement age to 68 by 2050, more generous state pensions with indexing linked to earnings rather than prices, and creation of a voluntary national savings plan that would require individuals to "opt-out" rather than "opt-in." The changes are intended to address several problems, the greatest being that the UK's basic state pension is lower than those of other western countries. Also, the current system is too complex, and a declining percentage of the workforce is covered by secondary pension plans. The government has built an impressive level of consensus around its reform proposals and response to the announcement from all major political parties, business, unions, and pensions advocacy groups was generally supportive. The first implementing legislation will be introduced in September ¶2006. END SUMMARY. The Turner Commission Recommends Change -------------- ¶2. On May 25, the UK government published a so-called white paper, a precursor to detailed legislation, outlining plans for a complete overhaul of the British pension system. The paper adopts virtually all of the recommendations made by a special commission, set up at the end of 2003 to review the pension system. While the Turner commission initially had a mandate to look only at the public sector, the Prime Minister favored a broader approach and it quickly became evident that the prevalence of contracting-out -- equivalent to carve-outs in the U.S. system whereby some of the money workers pay into the public pension system is diverted into individually-owned accounts -- made it desirable to look at the private sector as well. ¶3. The commission was made up of three experts: Lord Adair Turner, Vice Chairman of Merrill Lynch Europe and former head of the Confederation of British Industry; Jeannie Drake, Deputy General Secretary of the Communications Workers Union; and John Hills, Professor of Social Policy at the London School of Economics. Turner described the Commission's work as "a fact-driven process," and its first paper, issued in October 2003, was a basic status report. A key finding was that the assumptions made by the government in its previous policy study (1998) were off target, i.e. that the then-current division of the average person's pension payments as 60 percent state and 40 percent private would gradually shift to 40 percent state and 60 percent private. In fact, Turner found that private pension plans were becoming less available and, where available, less generous, while the state too was planning to do less. The Present State of British Pensions -------------- ¶4. The present British system combines features of the U.S. social security and welfare systems. British pensioners receive a basic pension of 80 pounds per week. The national poverty line is set currently at 109 pounds and the gap (29 pounds) is given to retirees as an additional pension credit. However, this additional payment is means-tested, i.e. for every pound of private income received, 40 pence is deducted from the pension credit. The poverty line is set through a mechanism that is linked to earnings, while the basic state pension has been linked to prices since the earnings link was severed under the Thatcher government in the 1980s. Therefore, if current trends in earnings and prices continued, the Turner Commission concluded, the present pension system would not only discourage private savings by individuals, but would lead to a gradual increase of the gap between the basic state pension and the poverty line, subjecting more and more of the payment to this means testing. ¶5. As in other western economies, there has been a move away from defined-benefits plans to defined-contributions plans that offer no guaranteed pay out. In addition, pension plans offered by private companies presently operate under an "opt-in" system where workers must specifically declare their desire to participate in the private plan. The Commission's conclusions regarding the impact of "opt-in" and means-testing on savings were reinforced by the latest LONDON 00003853 002.2 OF 003 official data showing that almost 60 percent of private sector workers did not contribute to a non-state pension plan in 2005, up from just over 40 percent in 2003. The latest Employer's Pension Provision survey indicates that the percentage of employers making pension provision for their employees declined from 52 percent in 2003 to 44 percent in ¶2005. The Way Forward -------------- ¶6. The government has proposed an ambitious combination of remedies designed to simplify the system and improve benefits for most people. However, average earners will no longer qualify for the additional secondary pension credit payment and their improved benefits will come from a new national savings scheme. -- The retirement age will rise gradually, starting in 2010-2020, over which period women's eligibility will increase from 60 to 65. (Retirement age for men currently is 65.) The retirement age for both men and women then will increase from 65 to 66 in 2024 and rise one year per decade thereafter to 68 in 2044. -- Individuals who leave the workforce for certain periods to care for children or other family members will find it easier to qualify for state benefits. The number of years required to pay into the system in order to receive benefits will drop from 39 to 30. -- Workers not already in a company pension plan will be enrolled automatically in the national savings scheme (NPSS) starting in 2012, although they can opt out. Companies will have to submit their plans for review to assure that they meet the same basic criteria as the NPSS. Workers who opt out will be offered further chances to opt back in. Employees will pay in five percent of income, employers will match 3 percent up to a maximum of 33,000 pounds per year, and the government will offer an additional one percent tax break. -- The hope is that two-thirds of the workforce will participate in the new NPSS; the highest estimate is 70 percent. -- Pensions will be linked to earnings, not prices, as of 2012, although Chancellor Gordon Brown insisted on a caveat, "subject to affordability." Over time, the government projects that the combination of the earnings link and the NPSS would mean no one would be on means-tested benefits by ¶2050. ¶7. The Turner Commission had left it to the government to decide how to pay for improvements in state benefits packages. The white paper confirmed the plan to reduce incentives currently paid on "contracting-out" schemes as one way of redirecting funds. Additional revenue will be generated by reintroducing the earnings link two years later than recommended by Turner, by the hikes in the pension age, and through curtailment of additional means-testing for benefits during the transition years. (The percentage of pensioners subject to means testing will be capped at the present 40 percent.) In a private meeting with USG officials, Hutton said he also intends to use several billion pounds he has saved in other cutbacks at his agency to "smooth the edges" of the transition between the current second state pension and the NPSS. Furthermore, he said, the change in the retirement age for women should "release resources" into the system. ¶8. One unanswered question is how the government plans to address a major anomaly in its grand plan, the deal it cut last October with public sector unions to retain the retirement age of 60 for current public sector employees. New public sector employees would be subject to the new rules, but there are already calls for the government to revisit the October 2005 decision as part of the larger reform plans. Strong Political Consensus -------------- ¶9. The lengthy study and reporting process has built a strong public and political consensus around the white paper proposals. A key point was the agreement on May 20 between LONDON 00003853 003.2 OF 003 PM Blair and Chancellor Brown on the reintroduction of the earnings link. Both Adair Turner and Tory Shadow spokesman David Willets emphasized in private conversations with USG officials the importance of the multiparty agreement that has formed around the basic elements of the reform. According to Turner, an even more critical element of the reform is the acceptance of the principle that the ratio of years paying into a pension scheme vs. years drawing out should remain the same, i.e. the British retirement age could go up further if life expectancy increases. ¶10. The implementing legislation is expected to move forward in two stages. The government will introduce the first bill in September 2006 to restore the earnings link. The second bill on the savings plan will be tabled in Fall 2007. Willets predicted smooth sailing for the reform legislation although he noted that there is a question as to whether the NPSS will be enough to move people off welfare. Business, he commented, actually has an incentive to discourage participation in the private accounts to avoid making matching payments. Other conservative commentators have suggested that the three percent contribution will place an unfair burden on small businesses; they suggest offsetting the pension contribution matching requirements with a cut in corporate tax rates to avoid squeezing small employers. ¶11. The UK government is optimistic that the reform plan will move ahead and resolve its most pressing issues. Key components in reducing current inequalities, such as the increase in female retirement age, are already on the books, i.e. no new legislation is needed. Although Hutton himself cautiously refused to say that he had nailed down the votes to pass the legislation, it seems clear that both the Conservatives and Liberal Democrats are ready to go along. Certainly the fact that the government has successfully built consensus on a package whose impact will be felt for generations to come shows that it is still very much in charge of the legislative agenda. There will be sniping and nibbling at the edges in the months ahead, but the bottom line is that most British workers will have better benefits under the new system than they are projected to have under the existing regime. It's not hard to generate political will to move forward when you can point to a more affluent future at the end of the road. ¶12. For the full text of the UK government's white paper, check the Department of Work and Pensions internet site: www.dwp.gov.uk/pensionsreform/whitepaper.asp. Visit London's Classified Website: http://www.state.sgov.gov/p/eur/london/index. cfm Tuttle