The role of private sector pensions in the welfare state

“The malaise in European economies presages the end of the social welfare state as we know it and this will offer huge opportunities to the financial services sector.”

The remark was made under the Chatham House rule so I cannot identify the speaker – but suffice to say that it was a distinguished and prominent member of the financial services community. The position has a strong resonance to anyone involved with pensions at the moment - for it is in the world of pensions that some of the most dramatic shifts are underway.

The debate about the welfare state is partly about the allocation of resources between the public and private sectors and tradition and ideology play a big part. It is no surprise that it was an American who made the statement quoted above. Neo-liberalism, which is what this is, predicates as small a state as possible and free markets throughout the economy and its natural home is, of course, in the US - compared with Europe the US spends a much lower percentage of its GDP on welfare. If the larger economies in Western Europe were to move down towards American levels of public welfare spending then the gap would have to be filled from the private sector – or a radical change to our assumptions about our collective duty of care as citizens would have to take place.

The most obvious shifts under way in pensions in the UK are in the public sector, where there is to be a reduced retirement benefits package on offer, and in the private sector with the move from defined benefit to defined contribution schemes. The changes to pensions for government employees is primarily driven by a perceived need to reduce the burden on public expenditure – the presumption being that instituting tax rises to fund future benefit provision would be politically unacceptable or economically counter-productive. It may seem odd to include private sector pensions as part of the welfare state but arguably that is what they are. In the past these pensions always received favourable tax advantages, although these have diminished in recent years. According to the Treasury the axing of dividend tax credit system by the Labour government in 1997 caused “…a shortfall in existing assets of up to £75 billion” and that “employers would have to contribute about an extra £10 billion a year for the next 10 to 15 years to get pension scheme funding back on track”. The point about this is not the numbers, large though they are, but the attitudinal change it helped engender. Over the past decade the attitude of employers has radically changed from one where they accepted the need to continue to offer a good defined benefit scheme to new recruits to now where virtually no major employer still does this. I am not saying that the removal of dividend tax credits did this (indeed I think that the impact was exaggerated). But I am saying that it contributed to a mood change among employers. Successive governments have done little if anything to encourage employers to keep or offer DB schemes. A pragmatic option for the government would have been to recognise that if good pensions are provided to retirees from private sector schemes it is less likely that these pensioners will be an unplanned burden on the state.

Private sector defined benefit pension schemes, with their tax advantages and their umbrella of legislative protection, are a one-step-removed part of the welfare state – and a very handy one for future government finances. Defined contribution schemes, on the other hand, are far more in keeping with a neo-liberal world in which individuals take their own decisions on whether to save for their retirement - and the extent of that saving. Despite auto-enrolment there will still be all too many who will opt out completely, or make inadequate provisions preferring current consumption to savings.

In future it seems citizens cannot expect governments will provide such a sufficiently fiscally beneficial framework for private sector pension funds that employers will be prepared to fund such schemes as generously as they did in the past. Companies’ pension costs will decrease and the financial services sector will gratefully move into the gap – for those employees who can afford to make adequate personal contributions. For government in the short and medium term the finances will benefit from lower outgoings and higher tax revenues. But in the long term a failure to properly support the private sector pensions element of the welfare state, while public sector retirement benefits are substantially reduced, could prove to be highly damaging socially and economically.

Paddy Briggs is a Member Nominated Trustee Director of the Shell Contributory Pension Fund. He writes in a personal capacity and the views he expresses are his own

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