Age-old argument

Years of austerity measures have pushed the issue of inter-generational fairness up the political agenda. With pensions at the centre of the debate, John Lappin looks at how pension policy will treat young and old 

Inter-generational unfairness certainly appears to be on the rise. Soaring house prices, the death of free university education and the demise of final salary pensions have all conspired to make it seem to young people as if the old are having it all. And with older people far more likely to vote, things are likely to get worse before they get better.

The issue achieved a new prominence in 2010 when the then Tory MP David ‘Two Brains’ Willetts published his book, ‘The Pinch: How The Baby Boomers Stole Their Children’s Future’, in which he accused the boomers – born between 1945 and the 1960s – of taking out 118 per cent of what they had contributed to the state.

Ironically, Willetts went on to foist the cost of university education directly onto 18-year-olds with £9,000-a-year tuition fees, rather than splitting the burden with those who had got it for free through taxation.

Pensioners, meanwhile, have been bought off with the triple lock and, more recently, George Osborne’s pensions freedom and choice.

Michael Johnson, the influential policy analyst at the Centre for Policy Studies, has just published a report – entitled  ‘Who will care for Generation Y?’ – in which he is highly critical of the debt burden being left for young members of the workforce born between 1980 and 2000.

He contends that the gap between the nation’s assets and liabilities
grew by an unsustainable 51 per cent in the five years to the end of March 2014, to £1.85tn. He suggests that the net liability of public sector pensions, at 111 per cent of GDP, is equivalent to £70,000 per household.

The report adds: “Generation Y is faced with unaffordable housing, college debts, fragmented careers, earnings and productivity stagnation, zero-hours contracts, relatively thin occupational pension provision including a defined benefit desert for the private sector, a rapidly retreating state pension age and, perhaps most challenging of all, having to support an ageing population.” 

Contentious subject

Fidelity Worldwide Investment retirement director Alan Higham thinks the issue cuts to the heart of fairness.

He says: “It is a contentious subject and creates significant emotion. The generation retiring now will have greater income security on average but there will be a big distribution. Many people who relied on the state pension before the earnings link was restored had a tough time.

“It is difficult to generalise because there are so many different groups of pensioners. DB is working its way through and, as time passes, will have a smaller impact. It promised a level of pension that isn’t affordable in the current economic climate.”

He continues: “But with promises that exist today in the public sector, the accrual rate for a civil servant is 2.3 per cent. That is each year and it is inflation linked. To provide a similar level of inflation-linked income in the private sector, you would have to contribute around 70 or 75 per cent of salary.

“Yet we would all recognise a DC pension that paid 15 per cent as being well above average. It is barely one fifth of what is promised to some workers.

“As we continue to over-pension a significant minority, what balances it out is the self-employed, who may have no pension, or those with small DC pensions.

“The big challenge is whether those inequalities can be sustained. If they can’t, how can they be equalised? Until they are, inter-generational fairness will be a very difficult point to argue.”

Political influence

Others are concerned about the recent election campaign and the promises made.

Financial Inclusion Centre director Mick McAteer says: “We have a mismatch between the pension and political cycles, compounded by political expediency, which ensures that the interests of older people, who are more likely to vote, are elevated over those of younger generations, who are less likely to vote.

“Interestingly, the proposed new law mandating a budget surplus could exacerbate the problem for younger generations. Refusing to raise taxes and limiting the ability of the state to borrow at very low cost to fund critical infrastructure means that the UK will probably turn to pension funds and insurers to provide infrastructure funding. This is economically illogical and transfers huge risks and costs to younger generations.” 

Johnson also makes reference to the state pension in his recommendations. He calculates that, if the state pension is included, the liability per household is an eye-watering £221,000 rather than £70,000.

However, some experts believe that society can cope with this. For example, Aviva head of policy John Lawson says: “State pensions are broadly fair. The cost as a percentage of GDP remains relatively constant, in the 5.5 to 6.5 per cent range over the long term, meaning that no single generation of taxpayers is paying significantly more or less than the previous or future generations of taxpayers.

“Adjusting the state pension age is one mechanism that ensures level cost and ongoing fairness.”

Levels of coverage

Lawson is worried about levels of private sector coverage. He says: “The current generation who are aged in their early 50s are the last to have a substantial portion of their retirement income from DB schemes. But even in their heyday, DB schemes covered only half of the working population.

“Nevertheless, this generation is quite well saved even if there are large pockets of people in this age group who have nil to modest savings.

“Generation X – currently aged early 30s to early 50s – are the generation we need to worry about most. They don’t have a lot of DB provision and, like the baby boomers, pensions covered only half of the population. The pensions they do have are DC, into which they and their employers paid much less in contributions than they did into DB schemes.

“The older part of this group, the early 40s to early 50s, are the biggest worry as they have the least time left to catch up. So my guess is that they are going to have to work on a lot longer than the baby boomers.

“However, due to auto-enrolment, coverage of the working population will increase from under 50 per cent to around 70 per cent. The younger members of Generation Y – early 30s to early 40s – also have enough time to catch up and can still aspire to a comfortable retirement.”

Lawson says Generation Y members need to acknowledge that they should save 12 per cent to 15 per cent, as opposed to 8 per cent.

“Although some employers offer good contribution rates, this is not the norm. Generation Ys therefore need to learn how to negotiate good pension contributions as part of their pay package,” he adds.  

JLT employee benefits director Mark Pemberthy says: “The long-term nature of pensions poses inevitable direct and indirect inter-generational fairness challenges. The current framework for managing investment, yield and longevity risks across generations through DB has proved unsustainable for most private sector sponsors.

“Proposals for new frameworks such as CDC address some of the issues. However, there appears to be limited appetite in the private sector for pension scheme structures that genuinely share the long-term risks.

“The biggest factor leading to variable pension outcomes across generations is the level of saving. This is not inter-generational unfairness per se, although it could be argued that legacy DB funding has depressed DC funding, therefore creating an indirect inter-generational fairness.”

Some suggest there may be an uplift in DC contributions when DB works through the system.

Towers Watson’s David Bird, who is proposition development leader at its LifeSight master trust, says: “We are in a transition from DB to DC pensions; the story starts way back when. When employers bought into DB, they thought it was going to cost a certain amount of money, say 10 per cent of payroll or even less. But broadly speaking a third is now going into accrual for members, a third into paying down the underfunding through recovery contributions and a third to DC.

“The third for DC is covering as much as 80 per cent of the workforce, and what you get out of a pension is inextricably linked to what you put in. It can’t happen now but, as employers pay down past liabilities, there will be an opportunity to increase what employers are spending on DC.

“Generally, the current level is not what they would have spent had they not had the problems of DB schemes.

“Yet it is hard for employees to differentiate types of pension because they are not that interested.

“If you ask if fairness between the generations is an employer’s problem, it is really employees’ problem and society’s problem but employers have an important role to play. 

“And if it is a problem for us all, you have to think who is best placed to address this. If we don’t want Government to mandate things like this, the next-best person is the employer.”

PTL managing director Richard Butcher says: “Final salary schemes are mostly closed to accrual yet it is companies trading that are paying for those benefits. So there is a generation of people working who are getting DC but their employers’ profits are being depressed because they are paying DB benefits for a previous generation.

“But what can be done about it? Not a lot.”

Bucking the trend

Butcher says within DC, younger generations may in fact be subsidised.

“On DC schemes, people with big pots of money subsidise people with small pots of money because, if you take away the big pots, the insurers can’t afford to provide the pensions, so that is a reverse inter-generational support. Older people in DC are cross-subsidising the new arrivals.”

Hargreaves Lansdown head of pensions research Tom McPhail says: “Those coming through in 10 years’ time increasingly will not have enough money and will not be able to retire when they want to.

“Because it is a problem for individuals, it will become a problem for employers. Employees are going to have to work later into retirement so employers are going to have to offer more flexibility.”

He adds: “And you have George Osborne’s seismic change in terms of how people relate to their retirement so perhaps people will look to employers to facilitate engagement. It could end up on the employer’s desk.

“There are older people with lots of tax breaks but we know tax reliefs and salary sacrifice are coming under pressure. So can they cut back on these without exacerbating inter-generational unfairness?”

In terms of Osborne’s freedom and choice, there are some worries. The International Longevity Centre – UK issued a report in March on the new policy and retirement in general for the over-55s. It suggested that more than half of those retiring soon would be unable to secure an adequate income unless they used non-pension assets or received additional benefits.

Aries Insight director Ian Neale is concerned about this issue. Speaking in a personal capacity, he says: “In the context of the steady atomisation of society in the past 40 years and the cult of the individual exemplified by the freedom and choice agenda, we have a situation where today’s pension savers are being encouraged to look after themselves, even arguably to the exclusion of their spouses and partners, such as with the proposed secondary market for annuities.

“One of the consequences is that more individuals later in life will find themselves with resources that are thoroughly inadequate. People who have had the capacity to save today and built up not insignificant savings may have liquidated those savings well before they reach old age.

“As a percentage of the voting population, this generation will be more and more dominant and they will have the voting power to require governments to increase state support. And that in turn will increase tax burdens on younger generations. Those generations will be increasingly resentful.”