The Costs of the State Earnings Related Pension Scheme

Abstract

In her introduction to the White Paper (Better Pensions) describing the new state pension scheme which came into effect in Britain in I978, the then Secretary of State for Social Services wrote: 'The cost of the commitments in this White Paper has been very carefully considered in relation to the capacity of the country to support it' (HMSO, I974). We can find little to indicate that this is a true statement. The memorandum on the financial implications of the scheme provided in that paper by the Government Actuary contained estimates of the costs of the whole national insurance scheme until 2008-9. It did not measure, and did not claim to measure, the cost of the additional pension commitments which the White Paper proposed, and which were, with minor amendments, subsequently implemented. It is that cost which we attempt to measure in this paper. We find that these costs are very substantial. Their magnitude was masked, in the Government Actuary's calculations, by favourable demographic trends which reduce the costs of the existing commitments of the national insurance scheme. In the early 2ISt century, however, these trends are dramatically reversed and the full cost of the I978 scheme will emerge. It is by no means fanciful to speculate that when the scheme is approaching maturity the burden of state pensions on the working population will be twice what it is todayif, indeed, future generations prove willing to honour the promises which have been so casually made on their behalf. The approach we adopt in this paper is to treat the new provision for earningsrelated pensions as a self-contained pension scheme in its own right (The State Earnings Related Pension Scheme SERPS). In Section I we describe the central elements of that scheme and our analysis of it, while Section II considers the implications of contracting out. We discuss how costs are affected by demographic factors in Section III and in Section IV relate our projections to those of the Government Actuary.