Social Security (Reduced Rates of Class 1 Contributions, Rebates and Minimum Contributions) Order 2011

Lord Freud Excerpts

Wednesday 9th March 2011 Grand Committee

Moved By

[Lord Freud]

That the Grand Committee do report to the House that it has considered the Social Security (Reduced Rates of Class 1 Contributions, Rebates and Minimum Contributions) Order 2011.

Relevant document: 16th Report from the Joint Committee on Statutory Instruments.

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

My Lords, the draft order sets out the proposed contracted-out rebate rates that will apply from April 2012. Before I go into the detail of what those rates will be and why we have decided on our particular approach, I think it would assist the House if I were to explain what the rebates are and how the process to review them works.

Under the contracting-out arrangements, individuals may contract out through membership of a contracted-out salary related or money purchase occupational pension scheme or through an appropriate personal pension. Employees forego all or part of their state second pension entitlement and in return pay reduced rate national insurance contributions and/or receive an age-related rebate paid to their scheme after the end of the tax year. Employers with contracted-out occupational schemes also pay reduced national insurance. These reductions and payments are known as the contracting-out rebate.

The Pensions Act 1993 requires the Secretary of State to review the level of the contracted-out rebates at least every five years after giving due consideration to a report by the Government Actuary recommending what the level of the rebate rates should be. The legislation requires that there should be a full tax year between parliamentary approval of the rebate order and its coming into force. The last full review of the level of rebates was in 2006 for rebates from April 2007.

The present review began last year. The Government Actuary issued a consultation paper in August 2010 on the actuarial assumptions that he proposed to adopt for his report to the Secretary of State. The Government Actuary gave the responses to that consultation careful consideration before drawing up his final report. His advice to the Secretary of State has been taken into account in the proposals before the Committee. The proposals in the Government Actuary’s report reflect his view of the factors affecting the cost of providing benefits of equivalent actuarial value to the state pension foregone as a result of contracting out. These include, for example, increasing longevity; rates of investment returns; increases in earnings and prices; the future change in the indexation of the state additional pension by the consumer prices index; and future changes to state pension age.

The Government Actuary’s report and the report by the Secretary of State were laid before the House, together with the order, on 3 February. In this order, rebate percentages have been provided for members of both salary-related and defined contribution schemes. This is in spite of the Government’s plans to abolish contracting out on a defined contribution basis on 6 April 2012. This is because the requirement to review defined contribution rebate rates under Sections 42B and 45A of the Pension Schemes Act 1993 will not be repealed until the enabling legislation for abolition—primarily Section 15(1) of the Pensions Act 2007—comes into force. So, rebate rates for members of defined contribution schemes have been provided but, because these figures are not expected to be used, they have been provided for only one tax year.

Therefore the focus of today’s speech will be on the reduction in national insurance contributions which should apply to those contracted out on a defined benefit or salary-related basis. Unlike his previous reports, the Government Actuary has, with this report, provided three alternative approaches for valuing the costs of the benefits foregone by contracted-out workers in salary-related schemes: a best estimate basis; a typical funding basis; and a gilts basis. In deciding which of these alternative approaches should be adopted, we have considered that the reduction in national insurance contributions is provided at considerable cost to the taxpayer and that, therefore, the Government have a duty to ensure that the rebate is set at a level which is fair to all. Taking this into account, we believe that adopting the Government Actuary’s best estimate basis is the correct approach.

Furthermore, we believe that the assumptions upon which the Government Actuary has based his best estimate basis are justifiable. That basis provides for two different rates which may be adopted by the Secretary of State: one which takes into account the existing arrangements for state pension age; and one which takes into account the proposed changes the Government will legislate for, which will see the state pension age rise to 66 from April 2020. We have decided that the proposed rise in state pension age to 66 needs to be reflected in the revised rebate rate. This will mean a reduction in the rate of national insurance contributions from April 2012 from 5.3 per cent to 4.8 per cent of relevant earnings. If, however, it becomes apparent that the proposed state pension age changes will not take place, we will consider conducting a further review of rebate rates before the end of a further five-year period, the time by which we must review rebate rates again.

We propose broadly to maintain the division of the reduction in the level of employee and employer contributions. This will mean that the level in the reduction of employee contributions will be reduced from 1.6 percentage points to 1.4 percentage points, and the reduction in employer contributions will be reduced from 3.6 percentage points to 3.4 percentage points. For personal pensions and money purchase occupational schemes, we have again accepted the Government Actuary’s proposed rates of reduction in national insurance contributions and age-related payments which should apply but for the plans to abolish contracting out for defined contribution schemes in April 2012. This will mean that the flat rate element for contracted-out money purchase schemes will decrease to 2.4 per cent of relevant earnings for members of contracted-out money purchase schemes. This will be split between employees at 1.4 per cent and employers at 1 per cent. We have also decided to maintain the level of the age-related rebate cap. This will stay at 7.4 per cent.

As I mentioned earlier, these rates have been provided simply to meet an ongoing statutory requirement that will not lapse until contracting out for defined contribution schemes is abolished. I am satisfied that the order is compatible with the European Convention on Human Rights. I commend it to the Committee. I beg to move.

--- Later in debate ---

[Lord Stoneham of Droxford]

I have very little to say on this. This is a shadow document in many respects because it is provisional on what we are doing on the current legislation. I think we are broadly supportive of it.

[Lord Freud]

My Lords, I thank, in particular, the noble Lord, Lord McKenzie, for his interest in this and the noble Lord, Lord Stoneham, for making that point. To summarise, this sets out the level of contracted-out rebate rates that will apply to employers and employees within defined benefit contracted-out occupational pension schemes from April 2012. As I said earlier, while we have provided rates for defined contribution schemes, that is purely to meet the statutory requirement. As I said before, we are looking at a reduction for contracted-out defined benefit schemes from 5.3 per cent to 4.8 per cent.

As I understand it, the central question that the noble Lord, Lord McKenzie, put was about why we have picked that one rather than the funding basis or the gilts basis. I shall go a little into the concepts behind the three different approaches. Each approach is designed to provide the employer with a different level of guarantee about it being sufficient to cover the cost of the additional state pension foregone. Taking into account the considerable cost to the taxpayer of providing the reduction in national insurance contributions, the Secretary of State decided that adopting the best estimate approach was the most reasonable. When you think about it, the point about it working half the time is really saying that we have reached the point of indifference between whether you provide a pension scheme or do not do so and rely on the state. There is a rationale there. The other approaches in practice provide a much more powerful bias towards contracting out.

The noble Lord’s supplementary question was about defined benefit schemes. The risk is now essentially being run by the schemes. Different schemes will, of course, have different contributions rates for employers and employees, so there is no simple answer. The core answer is that moving to the point where, on balance, there is a point of indifference between whether you go in or out means that it is a neutral decision.

On the question about public versus private, for public sector schemes there is no extra cost to the employer as the Government are the employer so there is a degree of funds being recycled. Both public and private sector employees will see a slight reduction in take-home pay as a result.

[Lord McKenzie of Luton]

Perhaps I can clarify that. The note to the order, which I cannot now put my hands on, refers just to the public sector in that regard. It puzzled me because I understand that these rebates operate between the LEL and the upper accrual point, which is fixed in cash terms, in order to move towards a flat-rating of the state second pension, so I would have thought that there would potentially be a loss to all contracted-out employees. Therefore, I do not understand the distinction that is made in the Explanatory Memorandum between public and private sector.

[Lord Freud]

I think the noble Lord is right in saying that the loss is shared by the public and private sectors. Clearly, there is something slightly confusing in that note that has led him in a different direction. There should be an equalised effect.

[Lord McKenzie of Luton]

I am looking at the Explanatory Memorandum to the Social Security (Reduced Rates of Class 1 Contributions, Rebates and Minimum Contributions) Order that we are discussing. The impact paragraph states:

“There is no new impact of the changes to the contracted-out rebate rate. However, the reduction in the rebate rate will lead to a small increase in the National Insurance contributions of public sector employers and employees. The value of the increase will depend on individual employee earnings”.

[Lord Freud]

Which note is that?

[Lord McKenzie of Luton]

That is paragraph 10.1. Paragraph 10.2 states:

“A full impact assessment has not been published for this instrument as it has no new impact on the private sector and civil society organisations”.

[Lord Freud]

The impact is common across both the public and private sectors. The noble Lord asks about the impact assessment. I imagine that that is a reference to where the obligation to have an impact assessment is, rather than to the differential impact. By definition, we are saying that it does not have a new impact on the private sector and civil society organisations. By reference, that would also apply to the public sector.

[Lord McKenzie of Luton]

I am happy for the noble Lord to write to me on that. It is confusing. It specifically identifies public sector employees and employers as taking a hit. Paragraph 10.2 suggests no new impact on the private sector. That did not make sense to me.

[Lord Freud]

It is easy to see that confusion. I shall write to the noble Lord, but I am comfortable in stating that it is a reference to where the obligation to have an impact assessment is, not to who is getting the impact. That is the reason for the difference. However, I shall write to the noble Lord to lay that out very clearly. I am very impressed that anyone has got to note 10.2. I think I have dealt with all the outstanding issues.

[Lord McKenzie of Luton]

I am sorry to press the noble Lord but this may be part of the discussion we have just had. Is the £600 million saving by government just replicated as an extra £600 million of costs on employers and employees?

[Lord Freud]

Yes, I can confirm that, obviously. There is an argument there: it is a rather complicated sum, not just the sum of what has gone in and out in terms of all of the factors. To the extent that there is an extra cost, it is partly because it has become more expensive to get pensions for one reason or another. Some of that reflects the marketplace and what it costs to purchase annuities outside the Government’s scheme. Rather like me, the noble Lord will, I suspect, have gone through this understanding some, but not all, of the bits in it. However, that is the process, so the saving becomes a cost for employers and employees, given how we have split it.

I have one main item on which to write formally to noble Lords but, with that, I hope that I have dealt satisfactorily with the issues. As everyone in this Room will realise, they are highly technical. I commend the draft order to the Committee.

Motion agreed.