UK ANNOUNCES MAJOR REVAMP OF PENSION SYSTEM

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SUBJECT: UK ANNOUNCES MAJOR REVAMP OF PENSION SYSTEM

REF: 04 STATE 0247

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1. SUMMARY: The British government announced on May 25 what
Secretary of State for Work and Pensions John Hutton

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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

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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

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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
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