Balancing Intergenerational Demands

March 2018
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Politicians have criticised the management of some companies for paying dividends at a time when pension funding deficits are growing. The Pensions White Paper, published by the Government, will introduce a much tougher list of sanctions for directors who are considered not to be acting responsibly in fulfilling defined benefit pension promises. Tougher sanctions may be welcome against those who seek to ignore their obligations to pension scheme members but a balance between the needs of all stakeholders needs to be struck.

While companies, like any organisation with limited funds, have to prioritise competing demands, cutting or banning dividend distributions is not the answer to meeting pension deficits. Such a policy could ultimately threaten the viability of the company, leaving current and future pensioners worse off. Investors in business invest in order to secure future income streams and potential capital gains. Curtailing or banning dividends would deter private investment and leave companies having to pay more for capital.

Any restriction on dividends would impact unfairly on younger generations. A lack of investment capital could endanger their jobs. They also stand to lose from dividend cuts as dividends are paid into their defined contribution pension schemes, so cutting dividends would slow the growth on their pensions, which are already less generous than earlier generations. ONS statistics show that the median employer contribution to defined benefit schemes is 14.1% of payroll, compared to 4.1% for defined contribution schemes. *Seeking to meet pension deficits by curtailing dividends would represent an intergenerational subsidy from the young to their elders.

Intergenerational fairness was at the heart of recent recommendations made by Lord Willetts, former Government minister and head of the Resolution Foundation; he has proposed higher taxes on the baby boomer generation to pay for social care.

This proposal has not been welcomed by baby boomers who have pointed out that they have already paid in more tax over their working lives than younger generations, have seen interest on their savings shrink over the last decade and are often subsidising the care provided to their parents and the education costs of their children. While baby boomers have seen the value of their homes, in some parts of Britain quadruple, they rightly point out that they were the generation who experienced negative equity and paid mortgage interest at 15% in the 1990s.

Meanwhile the Welsh Finance Secretary is considering whether national insurance contributions in Wales should be increased to pay for social care. This proposal, which could see younger workers paying for the care costs of their parents and grandparents, has met vocal opposition from younger voters who complain that they are already shouldering the burden of student debt and higher housing costs. To soften the blow, it is proposed that the increased contributions should increase with age. The UK Government is watching with interest. There are rumours that the age at which NI is paid by employees may be extended beyond state pension age for those still working, to fund adult social care.

Addressing intergenerational fairness will be high on the Government’s agenda over the summer with a consultation on funding social care and a review of student tuition fees.

One small way in which intergenerational harmony might be restored is to look at the measure of inflation used to increase State and private pensions on the one hand, and student debt on the other. Currently both are linked to the RPI (retail prices index). There is a case to link them to the CPI (consumer price index) instead.

These two measures of inflation are similar but differ in the contents of the items included in their measure and also in the mathematical basis of their calculation. Over the long term RPI has tended to be around 1.2% higher than CPI. RPI includes the cost of housing, rent, mortgage and council tax, whereas CPI does not.

When 80% of over 65s own their own homes and so do not pay rent or mortgage interest, should RPI be the measure by which pensions increase? It could be argued that RPI increases to pensions in payment are over compensating the majority of pensioners, compared to the actual increase in their cost of living, more accurately reflected by CPI.

Conversely those paying back graduate debt, incurred after 2012, face a double whammy, when increases in rent and mortgages impact both their actual cost of living and increase their outstanding debt which is RPI linked.

Would a first step to achieving intergenerational fairness therefore be to replace the RPI linking of pensions in payment and student debt interest with CPI linking? The White Paper ducked the opportunity to make this reform on pension increases.

This may not go the whole way to balancing the interests of each generation but it could be the compromise acceptable to all, which could kick start the Government’s consultations on these two important issues and a way for underfunded pension schemes to balance the needs of pensioners, workers and investors.

Kay Ingram
Director of Public Policy, LEBC

LEBC Group Ltd is not responsible for accuracy and may not share the author’s views.

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