Occupational Pension Schemes (Levy Ceiling) Order 2011

Lord Boswell of Aynho Excerpts

Wednesday 9th March 2011 Grand Committee

[The Parliamentary Under-Secretary of State, Department for Work and Pensions (Lord Freud)]

My Lords, I shall speak also to the Pension Protection Fund (Pension Compensation Cap) Order 2011 and the Financial Assistance Scheme (Revaluation and Indexation Amendments) Regulations 2011; and I shall first give a relatively short account of what the Occupational Pension Schemes (Levy Ceiling) Order 2011 and the Pension Protection Fund (Pension Compensation Cap) Order 2011 do. Many noble Lords will be familiar with these orders, which have appeared annually and been the subject of amicable debate in Grand Committee on a number of occasions.

I turn first to the Occupational Pension Schemes (Levy Ceiling) Order 2011. Your Lordships will be aware that the compensation provided by the Pension Protection Fund is in part funded by the pension protection levy, which is paid by those schemes eligible for the protection provided by that fund. The pension protection levy is the responsibility of the board of the Pension Protection Fund. However, the Pensions Act 2004 provides a levy ceiling that restricts the amount that the board may raise through the pension protection levy in any year.

The levy ceiling for the financial year beginning 1 April 2010 is £871,183,684. This order provides for an increase in the ceiling for the financial year beginning 1 April 2011. The Pensions Act 2004 requires that the increase must be in line with increases in the general level of earnings in Great Britain, in this case using the rate published by the Office for National Statistics for the 12-month period to 31 July 2010. The order therefore increases the levy ceiling by 2.4 per cent, bringing it to £892,092,092 for the financial year beginning 1 April 2011. This does not mean that the pension protection levy will increase to that figure. The board of the Pension Protection Fund has already determined that, for the period covered, it estimates it will collect a pension protection levy of £600 million.

I turn to the Pension Protection Fund (Pension Compensation Cap) Order 2011. The pension compensation paid to people who are below their normal pension age at the date their scheme is assessed for entry to the Pension Protection Fund is subject to a cap. The compensation cap for the financial year beginning 1 April 2010 is £33,054.09. However, people below their normal pension age are paid pension compensation at the 90 per cent rate. This means that the compensation payments for people below normal pension age shall not exceed £29,748.68, which is the 90 per cent figure.

The Pension Protection Fund order provides for an increase in the compensation cap for the financial year beginning next April. Again, the Pensions Act 2004 requires that the increase must be in line with increases in the general level of earnings in Great Britain, in this case using the rate published by the Office for National Statistics for the financial year ending March 2010. The order therefore increases the compensation cap by 0.5 per cent to £33,219.36 for the next financial year, which means that, with the cap in operation, the compensation payment for people below normal pension age shall not exceed £29,897.42. The new cap will apply to people who first become entitled to pension compensation on or before the coming 1 April.

I should point out that when the more sharp-eyed or sharp-eared of your Lordships spot the difference between the 2.4 per cent and the 0.5 per cent, that simply reflects what happened to the relevant earnings index in those three months. It just so happened, but clearly, over the period, there will be catch-ups and so on.

[Lord Boswell of Aynho]

On that specific point, perhaps it might be convenient to ask my noble friend whether he can confirm what I thought I heard him say—that both those figures, although they differ from each other, are derived from calculations made by the Office for National Statistics?

[Lord Freud]

Yes, they are Office for National Statistics figures. I think that it is the average weekly earnings figure, which is the new figure that is updated from the annual earnings index—no, it is the general level of earnings.

I turn now to the Financial Assistance Scheme (Revaluation and Indexation Amendments) Regulations 2011. Many noble Lords will be familiar with FAS; indeed, the noble Lord, Lord McKenzie of Luton, has in the past brought a number of sets of regulations on the scheme to this House and presented them most eloquently, despite the material. I hope that noble Lords will listen to me with the same patience that they extended to the noble Lord, Lord McKenzie.

The scheme provides financial help to members of qualified pension schemes who face significant losses because their schemes wind up underfunded. It is mainly funded by the taxpayer. It has never been intended that FAS should replicate what might have been provided to members had their schemes wound up fully funded. Payments made by FAS have their value protected against price inflation through revaluation before payment begins and indexation after payment begins on rights accrued after 1997. This reflects the broader legislative position. The changes being made to the FAS revaluation and indexation rules by these draft regulations are a consequence of a wider decision. Noble Lords will know that the Government intend to use the consumer prices index—the CPI—as their general measure of inflation for a range of payments. These include state pensions, statutory minimum increases for private sector occupational pensions and increases to pension compensation payments made by the Pension Protection Fund.

Much has been said about the move to the CPI since we announced our intentions. We are moving to using the CPI as we believe it is a more appropriate index, although we acknowledge that no index is perfect. Without going into the kind of elaborate detail that I think we may be going into in the next few days, let me summarise why it is the most appropriate index.

The key difference between the RPI and the CPI is what is known as the “formula effect”. Put simply, the CPI is calculated in such a way that it takes account effectively of consumers switching to substitute goods when prices rise. That consumers behave in this way is a cornerstone of economic theory, and it has been borne out by empirical research. Let me be clear that we are not talking about switching from rump steak to lamb shoulder, for example, but from rump steak that has seen a sharp increase in price to rump steak that has seen a lower one. The substitution effect is nothing more than that.

This methodology is uncontroversial, and once we accept it as preferable to the RPI’s, which the Institute for Fiscal Studies and the Royal Statistical Society do, we have accounted for 60 per cent—two-thirds—of the historical gap between the CPI and the RPI and already the CPI becomes the more suitable index. We will have the opportunity to talk about this in great detail, although I will do so now if noble Lords want.

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[Lord Boswell of Aynho]

My Lords, I, too, am very pleased to support these regulations. The purpose of my intervention on my noble friend, for whose reply I was grateful, was to confirm that there was a principled basis for the slightly different, heterogeneous nature of the figures set, in that they all have their root in the ONS and are related to the principles of the particular component parts of these three orders or, to put it the other way round, that Ministers were not setting the rules in order to suit themselves or with the intention of saving money. Of course I accept that assurance.

I should make it clear to the Minister, if it is not already self-evident, that partly because it came in the lacuna between my Front Bench service and today, I would not claim to be very ready to sit an exam on the pension protection scheme and am less familiar with it. In relation to the cap, which if it is raised is relieving as a measure, is there an impact on a significant number of individuals or on just a handful? I would be interested in that. The Minister knows that I am now, for the first time, a pension trustee.

There is another point that he might like to say a bit about. There is concern, certainly debate, across the sector about the balance between the scheme levy and the risk-based levy and how that is to be conceived. That forms two categories. First, will he report to us on where we are on it? Secondly, given that he is, in a sense, setting limits under which the levy should be set rather than the level of the levy itself, which he said is the responsibility of the scheme, is it the case that he will stand back and allow that balance to be struck by the professionals? Does he have a view and what is the state of play on that?

[Lord Freud]

My Lords, again I thank noble Lords for taking such an active part in the debate and, as ever, looking at these issues in real detail. I will aim to answer as many of the questions as I can before I resort to the expedient of the letter.

The noble Lord, Lord McKenzie, is completely right about this being our last opportunity—last unforced opportunity, if you like—to do this under the affirmative procedure, so we should—and we are—taking advantage of that opportunity. He asked about the spilt between risk-based and scheme-based. Eighty per cent of the quantum is designed to be risk-based. That varies slightly, but the figures have held pretty firm over the years so, without going through endless figures, if we look at the £600 million for 2011-12, which I referred to at the outset, the risk-based element is estimated to be £480 million and the scheme-based element is £120 million.

The noble Lord, Lord McKenzie, and my noble friend Lord Boswell asked about the impact of raising the cap and about how many people are affected by it. As at January 2011, 92 scheme members receiving compensation were affected by the cap. The noble Lord, Lord McKenzie, asked about time in assessment. The real driver in that is legal action, which can take many years. As he saw, that is connected to the change in the Pension Bill. The problem we have is that resolving some of these issues can take a lot of time. On top of that, assessment is often delayed by poor scheme data and uncertainty about what the scheme rules are. It is not people being dilatory; there are genuine problems.

My team has just informed me that, in opening, I made a mistake. I said that the newer cap applies to people entitled to compensation before 2011 and I should have said after 2011. I am sure noble Lords knew what I meant. I apologise to the Committee.

The noble Lord, Lord McKenzie, asked whether the cap was overrated if it was linked to earnings. That is not the case because, to take an example, the comparator is the position of a 50 year-old at the insolvency of the employer. We want someone whose employer goes bust this year to be capped at the same relative level as someone whose employer went bust, for example, in 2005.

The calculation of the levy formula is something for the board of the Pension Protection Fund. The proposals concern the distribution of the levy between schemes and not the overall quantum. Will individuals be worse off due to the switch from RPI to CPI? The current market conditions mean that the cost of providing RPI or CPI are equal, but we have to recognise that there may be a divergence in future and we shall review that over the summer in the light of emerging evidence.

The noble Lord, Lord Stoneham, asked about indices. Without going into a full-blown techie analysis, the question was about whether we can make CPI a better fit with pensioner inflation. The ONS is working to include owner-occupied housing costs in its statistical programme. It is a very active programme. Rather than using mortgage costs, according to its research, the likely outcome—I may be jumping the odd hurdle to reach that conclusion, but bear with me—would be to take the cost of an average house and see how that moves up and down. I cannot see that happening much before two years, but an active process is taking place and the ONS will work very closely with European statistical organisations because it would need to be a general move.

One of the most interesting things is that the CPI has been adopted as the main measure, certainly for comparative purposes in Europe. The Americans took the decision to go down this route because of the geometric approach, which basically gets elasticities closer to one, which reflects substitution, as opposed to any elasticities closer to nought, which do not show much substitution, and that is seen in the arithmetic mean used mainly in the RPI. In the CPI, interestingly, about 70 per cent is done geometrically. The other 30 per cent of goods, which are hard to substitute—oil, for instance—are left at that low-elasticity arithmetic mean. We will have more of that next week.

The noble Lord, Lord McKenzie, asked whether the implications of this switch to CPI mean that some FAS members would find that the total value of their protection from the UK Government is reduced to a level that the European Court of Justice indicated would be below the minimum lawful percentage for protection. Perhaps I slightly overinterpret the question, but we have looked at that closely and we believe that the Government continue to meet their obligations under Article 8 of the European insolvency directive.