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

Lord McKenzie of Luton Excerpts

Wednesday 9th March 2011 Grand Committee

[Lord McKenzie of Luton]

My Lords, I again thank the Minister for his full explanation of this order, which sets out the revised national insurance rebates for contracted-out pension schemes. As we have heard, the figures are provided for contracted-out money purchase schemes and appropriate personal pensions, although the planned abolition of contracting out on a defined contribution basis from 6 April 2012 means that these will never come into effect.

Again, as we have heard, these changes are based on a report by the Government Actuary which, in contrast to previous reports, sets out three alternative valuation approaches. The Government, of course, have adopted the basis which provides the lowest level of rebate—4.8 per cent—and taken account of the changes in state pension age provided for in the Pensions Bill. I noted that the Minister hinted that should those changes not proceed, there would be a review of the 4.8 per cent figure. The rate is below the 5.3 per cent rate adopted for the five-year period to 2012.

The Explanatory Notes make it clear that the annual savings to the Exchequer from reducing the rebate is about £600 million. I am trying to understand what the other side of that saving is. Is it that the cost is greater on employers and employees; and/or is it that the cost of providing the relevant benefits is reduced? What is the other side of the saving that the Government make?

The note also states that a full impact assessment has not been published because it will have no new impact on the private sector. How does this differ from public sector employees and employers, where it is confirmed that there will be a small increase in national insurance contributions by each? I do not fully understand how it can have an impact on the public sector but not on the private sector.

More fundamentally, can the Minister expand on the rationale for adopting the best estimate approach? Paragraph 6.4 of the actuary’s report states that this basis of valuation means that the rebate,

“is expected to be sufficient, half the time, to cover the cost of providing benefits equivalent to the state second pension forgone”.

What about the other half? On what basis were the other valuation approaches rejected? To the extent that the best estimate falls short, where are the costs and risks being borne? It will be interesting to have data on what the difference will be for someone on median earnings and at or above the UAP.

The Government Actuary’s report is a complicated document and I am not sure that I have absorbed all of it. I hope the Minister and his team will be able to help us out on those particular inquiries.

--- Later in debate ---

[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.