IFS - Our pension and social care systems load too much risk onto individuals
Delivering a lecture to mark the centenary of the Government Actuary’s Department, IFS Director Paul Johnson will argue that we are not well prepared for the challenges of an ageing population.
“There is a degree of hubris around our pension arrangements. With current pensioners on average better off than ever, the introduction of what will become a near universal single tier state pension, and auto-enrolment boosting workplace pension coverage to its highest ever rates, it easy to think that all is well. It is not.
A combination of bad design, bad policy, low interest rates and unanticipated increases in longevity have killed our defined benefit pension system in the private sector. What’s left is a system of individual saving pots. Inadequate contributions accompany very low interest rates; individuals face all the risk of low returns; and, with pension freedoms, very few buy annuities so there is no longevity insurance for most. A pension system without any risk sharing is unlikely to be stable in the long run.”
Talking about social care he will say:
“Our social care system continues to leave families to face the catastrophic risk of losing all their assets. There is an obvious case for some form of social insurance and we need urgently to break the policymaking logjam.”
On the future costs of ageing he will say:
“For decades spending on health and pensions has risen without state spending growing overall. That reflected, first, sharp falls in defence spending and, over the last decade, falls in spending on many other services. It seems unlikely that further substantial falls in other spending are possible to accommodate growing demands on the health and pension systems, implying either radical reform or higher taxes”.
Our current system of private pension provision is not the success many believe
Just 20 years ago more than a third of private sector employees were members of defined benefit occupational pension schemes. These schemes are almost gone with fewer than one in ten now continuing to accrue entitlement. This collapse can be traced directly to a series of design problems, unanticipated changing circumstances and policy errors.
Auto enrolment has been successful. Seven in ten private sector employees are now in employer sponsored pension schemes. But not only are contribution rates low, especially given the current very low interest rate environment, there are more fundamental design risks:
- The vast majority are defined contribution schemes which place all the risk with the individual. Low returns for any group of individuals translates directly into low resources in retirement;
- These “workplace pensions” look much less like traditional pensions and much more like individual savings pots. Following “pension freedoms” there is no requirement to annuitise and few now do. Individuals will face longevity risk as well as risks over investment returns: there is a real risk that some will find they reach older ages having exhausted their pension pots while others might be overly cautious and unnecessarily sacrifice their living standards in retirement;
- The high standards of living enjoyed by many of today’s pensioners are likely to be less widespread in the future. This reflects not only the collapse of generous occupational pensions but also less generous state pensions for many, low interest rates, and low rates of home ownership among younger generations.
We need urgently to move to some form of social insurance provision for social care
A small minority of us will face very high social care costs in later life. On current funding models this means that those with assets will have to use them up to pay those costs. There is no effective private insurance market available at the point of retirement. There is an obvious role for government to provide social insurance so that risks are better shared across families (the essential conclusion of the Dilnot Review).
- We have left individuals to bear all the risk. This a problem similar in nature to that which we have reached with pensions. The state steps in only where people have low levels of income and wealth.
- Even with the current system the pressures on social care spending are likely to make local government finances unsustainable unless more revenue sources are found.
- Growing spending pressures, especially from health, will likely mean tax rises
Health and pension spending has risen dramatically over the last 60 years without the overall tax burden rising by much. Over the long term this has been possible in large part because defence has fallen by three quarters as a share of government spending. More recently health spending has been protected and state pensions made more generous while spending on other many other services has been cut and working age benefits have been made less generous.
- In 2000 health spending accounted for less than a quarter of public service spending. By the early 2020s it will account for nearly 40% of public service spending.
- It is unlikely that future increased spending on health, pensions and social care can be paid for entirely by cutting other public spending. That is likely to result in tax rising by several percentage points as a fraction of national income or truly radical reform to the way in which health, pensions or other services are delivered.
Increased longevity has been one of great the triumphs of the past century. Getting and keeping pensioner poverty down from the levels seen prior to the mid-1990s is another. We have the basics in place – a state pension that is simple to understand and will ensure most pensioners are not in poverty, increasing pension ages to limit the cost to the public finances of an ageing population and to encourage individuals to retire later, a National Health Service that meets the healthcare needs of most – to help ensure we manage and get the best from rising longevity over the next century. But that will mean brave decisions in the near future, to ensure that our health, pensions and social care systems are not just financially sustainable, but also share risks and costs appropriately across and between generations.
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