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Occupational Pension Schemes (Levy Ceiling) Order 2011

Volume 725: debated on Wednesday 9 March 2011

Considered in Grand Committee

Moved By

That the Grand Committee do report to the House that it has considered the Occupational Pension Schemes (Levy Ceiling) Order 2011.

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

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.

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?

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.

There is another aspect of difference which is the much lower level of housing costs in the CPI than in the RPI. In the last years, mortgage interest’s effect on the RPI has caused it to fluctuate wildly. It has ranged from being dragged down by 2.76 percentage points to being pushed up by 1.51 percentage points. It is clearly a significant factor. But as noble Lords are aware, only 7 per cent of pensioners have a mortgage and many of those—the poorer ones in particular—are supported in their housing through the support for mortgage interest. So the exclusion of mortgage interest and the impact it can have on inflation seems the right course to take.

That is the current position between CPI and RPI, but noble Lords will welcome the Office for National Statistics’ work on the exclusion of owner-occupied housing costs from the CPI. This may address some of the housing costs issues in years to come. The DWP and the Government as a whole will monitor this development very closely. Unless there is a whole range of questions on this, I shall not go on about it here and now. I shall close this section by saying that irrespective of whether the RPI would result in higher increases, if it does so, that may simply be—and we would argue that it is—because it is overstating inflation as people actually experience it. That means that the CPI is the right measure of inflation.

Let us turn to the draft regulations before us. The regulations specifically change the inflation measure specified in the FAS regulations from the RPI to the general level of prices so that accrued pensions will be valued by reference to the RPI for periods before 31 March this year, subject to the cap, and can be revalued by reference to the CPI after that date, again subject to the cap. Indexation on rights accrued after 1997 applied on 31 January 2012 can be based on increases in the CPI, subject to the 2.5 per cent cap. The CPI can be used for the annual increase to the FAS cap that will be made in April 2011.

Noble Lords may be wondering why the draft regulations specify the general level of prices instead of the CPI. There are a number of different indices used to measure inflation, and we do not want to have to amend these regulations if the CPI index changes its name, for instance, with a change in how it treats housing, or if there is a more appropriate index at a future date. Therefore, we have adopted the more general term used for occupational pension legislation. I hope that noble Lords will agree that this is a sensible precaution. However, I can confirm that it is our present intention to use the CPI. Should a more appropriate index be identified in the future then we will, of course, consult on any planned changes.

In conclusion, these draft FAS regulations will ensure that FAS payments are protected against inflation in a reasonable way and in a more appropriate manner. In my view, all of the regulations before the Committee are compatible with the European Convention on Human Rights. I commend them to the Committee.

My Lords, I thank the Minister for his eloquence in introducing these orders. If I am not mistaken, the first two will no longer be subject to the affirmative procedure as a result of provisions in the Pensions Bill, so perhaps we must make the most of this occasion. Together with the levy ceiling earning percentage increase order, they set the compensation cap, as we have heard, limiting the amount of compensation payable by the PPF and the levy ceiling which controls the maximum amount of levy the PPF can charge pension schemes. As we heard, the levy ceiling for the year commencing 1 April 2011 is £892 million, which is comfortably above the proposed levy for that year, which the Minister told us is £600 million. In respect of that levy, I do not know whether the Minister is able to give us a split between the risk-based and scheme-based components. Could he take the opportunity to say something about collection rates and how we are doing in terms of collecting what we think is due?

The increase in the general level of earnings for the period 1 August 2009 to 31 July 2010 is 2.4 per cent. On the current compensation cap, the maximum level of compensation which is payable before applying the 90 per cent requirement is increased by 0.5 per cent to £33,219. In this case, the uprating is still by earnings but by reference to a different period.

We have no problem with these two orders, although, not surprisingly, they prompt wider questions. First, it is right to reflect on the importance of the PPF and how, alongside the Pensions Regulator, it has played an important role in ensuring some stability in a turbulent period for defined benefit schemes. It has ensured that something like 55,000 individuals already receive, or can expect to receive, a decent income in retirement which, because of the insolvency of their employers, they might otherwise not have achieved. From my experience, it is a highly professional organisation. According to the website, some 212 schemes are in the PPF at the moment and, as at January 2011, almost £236 million has been paid in compensation, with the oldest recipient being 105 and the youngest four.

Things seem to be in a far from steady state, with 10 schemes just transferred into the PPF and 409 schemes and 200,000 members in the assessment stage. Perhaps I can ask the Minister about the time taken for assessment. Clearly in some cases the assessment has not been completed within two years, although in the Pensions Bill we are considering removing the requirement for the assessment period to last for a minimum of 12 months. I accept that there is no inherent inconsistency between those two positions—we support that—but what are the barriers to speeding up the assessment process?

Given the levy ceiling we are discussing, perhaps we could get an update on the PPF’s exposure to the universe of eligible schemes. It would appear that before taking account of the RPI/CPI changes, the number of schemes in deficit and the aggregate deficit has declined over the past year. It is presumed, therefore, that the headway created by the levy ceiling is something with which the Minister is wholly content. In the past, the ability of the PPF to fund the consequences of a big influx of schemes was often called into question. I think that we responded robustly then and I imagine that the Minister is in a position to do at least that this afternoon, given the change in the background to those schemes. Can he say how many compensation payments are currently limited by the cap? I tried to get my mind round this issue—I am not sure that I have completely—but, going forward, what will be the relationship between the level of the cap and what would have been provided for by underlying schemes and the PPF arrangement? If the cap gets uprated by earnings, but compensation amounts going forward are uprated generally by earnings, because that is the nature of defined benefit schemes, and partly by reference to the CPI, is there potentially a divergence of the cap from underlying compensation which thereby would weaken its purpose?

The order concerning the financial assistance scheme puts into effect, as we have heard, the RPI/CPI switch for revaluation, indexation and annual increases in the maximum cap. The Minister will be aware that we have concerns about the switch to CPI, certainly as currently constructed, as an appropriate measure of inflation. Doubtless we will have a substantive debate on that in Committee next week and on subsequent occasions.

I share the Minister’s view that no index is perfect and I was interested in his example about the formula effect and switching. When he referred to it in the Chamber he spoke about moving from one kind of biscuit to another. I am comforted to know that we can go from one jammy dodger to another and we will be okay. It was good to hear about the work going on in the ONS.

As we have heard, FAS, unlike PPF, is funded by government—net of assets taken in, of course—and a reduction in costs can make a contribution to deficit reduction. We could, in principle, support this for a period, but there is a dearth of information about how much is involved and no impact assessment has been provided. Perhaps the Minister can help on that

I am aware that the final settlement for FAS arose from a tortuous process involving, among other things, legal action in the UK and in Europe. I presume that there is nothing in the CPI/RPI switch which could be said to negate that settlement. Perhaps the Minister can confirm that. I welcome the proposals dealt with in the Explanatory Notes to consolidate the FAS regulations.

For both FAS and PPF, before entry into the appropriate scheme there would have been a judgment of what an individual could have obtained in the market and whether FAS and PPF would provide a better outcome. This judgment, presumably, would have been made on the basis that FAS and PPF payments would be uprated by RPI. If this is not the case, is there the prospect that individuals will be worse off in retrospect because of the decisions made? What analysis have the Government made of this situation? If it is not to hand, perhaps the Minister will write to me.

Let me make one further point on the PPF levy. It appears that there is to be a new levy framework introduced in 2013. What can the Minister tell the Committee about this and what are the ramifications, if any, for the levy ceiling? I look forward to his responses in due course.

I support these regulations and I have only limited points to make on them. The role of the Pension Protection Fund is very important—all credit to the previous Government for introducing it—and we want to make sure that it is maintained and sustained. Obviously in the current environment the investment levels on the stock market have helped some of these schemes, but can the Minister give the Committee his view on how the economic situation is impinging on companies, particularly those on the borders of insolvency, and the pressures that that is likely to place on the fund over the next couple of years as we move, we hope, towards economic recovery?

I accept that we will be discussing the CPI issue in the coming week but I make the point that none of these indices is perfect; they measure inflation for all consumers on different bases. The Minister will perhaps answer this point more fully next week, but is any further research being done on the CPI to ensure that, as we are now moving towards using it more fully across a number of measures which affect pensioners particularly, we can make the index more representative of pensioners’ expenditure and fairer in the long term? I support the regulations.

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?

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.

My question was slightly broader. It was not just on the EU judgments but on whether, given any of the negotiations—there were quite complex and tortuous discussions with various lobby groups—the switch is true to that position as well.

I think that I hesitate to answer that on the Floor. Is that sensible? Yes, my team is nodding, not vigorously, but gently. We should write the noble Lord a letter on that matter.

The last real question was on the impact assessment on FAS costs. The overall change to CPI for FAS purposes is estimated to deliver around a 10 per cent reduction in assistance costs over the lifetime of the FAS, which has been projected at about 90 years. Clearly, the impact on individuals will depend on the characteristics of the member, such as age and period of service.

On the economic situation, I think I have some data on what has been happening to the overall level of surplus in the PPF. I was asked about that and I know that I have those figures. It would be easier for me to tell the Committee than to write, but if I do not have them in a microsecond I will write. I cannot put my hand on them but the question raised was: where is the overall level of surplus, by schemes, and how many of them are in deficit and how many in surplus? I wanted to look at the overall risk levels but I cannot put my hand straight on that. If we could deal with that issue of economic conditions and the place that the market got to, that would also address the question from the noble Lord, Lord Stoneham. I am irritated with myself for not having it absolutely to hand.

As your Lordships know, the Government recognise the difficulties experienced by those who lost their pensions through no fault of their own.

I am grateful for the full reply that the Minister has given us on a range of questions but I wanted to make sure that we had covered this point or that he was going to respond to it. Looking at the PPF before a judgment is made, for example, as I understand it before somebody enters the PPF you look and see what the market would have produced. If the market would have produced something which was at or above the PPF levels, that is what would happen. Presumably when those judgments were made, they were made on the assumption that PPF levels would be uprated by RPI—obviously, that is not going to happen, at least for a period—with the expectation that indexation would be lower than RPI. Is there the prospect that that means—at least with the benefit of hindsight, and it may not matter that it is hindsight—that judgments were made that might have been made differently? In some instances, the market would have been able to do better than the PPF on a CPI basis.

The answer is that currently CPI is the same as RPI in terms of current annuity pricing. Clearly that may or may not be the case in the future. At the current time, that does not make a difference. The Pension Protection Fund and the Financial Assistance Scheme will continue to provide help to people whose pension schemes fail them. These regulations will enable the continued delivery of that help in a manner that is fair and equitable to both scheme members and the taxpayer. I commend these draft regulations to the Committee.

Motion agreed.