REVIEW OF RELATED LITERATURE
CHAPTER 2
The traditional aim of someone seeking work, full-time employment, is the status of 16.1 million British people–not much more than a third of the total potential work-force (Champion, 1996). Even so, the only other category of the over-15s to constitute such a major share of the total is the retired group (14.1 million) (Champion, 1996). The full basic state pension rates for 2003/4 are : a single person’s basic state pension of £ 77.45 per week and; an adult dependency addition of £ 46.35 per week (Understanding the state pension scheme, 2003). While these may not fully cover the expenses of a person, a pension would always be a relief from future financial burdens. The bottom line is that investing for retirement has become more uncertain and that everybody has to put more money aside to sustain any given standard of living.
The UK pensions system is broadly made up of two basic components: the state pensions system and private sector pensions. The state pension system is made up of: the basic state pension, paid at a flat weekly rate determined by the individual’s national insurance contribution record and; the state second pension which is an earnings-related pension paid to “contracted-in” employees only (Fiscal Studies, Vol. 21, No. 1.)
Retirement had been a lot harder for UK citizens in the last decade. The deliberate reduction in state pension scheme benefits and the shifting of the bonus for self-sufficiency in retirement from the state towards the individual had caused this problem. The current state pension system includes: the falling investment returns and stealth taxes on pension funds such as the removal of advance corporation tax (ACT) relief on dividends; low interest rates as a by-product of falling inflation; improving life expectancy, which implies that capital has to last longer and; the flight from final-salary occupational pension schemes paying guaranteed benefits as a result of falling investment returns, lower interest rates, increasing longevity and the impact of bureaucratic measures like the 1995 Pensions Act, the minimum funding requirement and the recent FRS 17 accounting standard (Fiscal Studies, Vol. 21, No. 1.).
Private-sector pensions may be approved or unapproved. Approved schemes qualify for a host of tax relief. Approved private-sector schemes fall into two categories: occupational schemes (also known as company and employer schemes) that are available to employees only and; personal pensions which are available to just about everyone resident in the UK whether in employment or not, save for members of occupational schemes who earn more than £30,000 per annum and/or who are controlling directors of their companies.
The case for membership of an approved pension scheme rests on the generous tax reliefs available, without which we would surely not be persuaded to lock capital away until retirement. There are, however, alternative vehicles that confer a net tax advantage on the investor (Fiscal Studies, Vol. 21, No. 1.). These are not necessarily as tax-efficient as approved pension schemes but they offer greater flexibility and superior access to capital.
The state pension scheme has two tiers : flat-rate basic state pension and; an additional pension available to employees only, of which there are three generations:
The basic state pension is a universal benefit, which means that everyone gets it subject to payment of minimum national insurance contributions (NIC). The basic state pension is paid at a flat weekly rate and is taxable (Understanding the state pension scheme, 2003).
The late 1980s saw a major shift in pension provision in the United Kingdom, when for the first time individuals were permitted to opt out of part of the social security programme into individual retirement savings accounts (personal pensions) (Disney, Emmerson, and Smith, 2003.). At the same time, membership of company-provided schemes (occupational pensions) was made voluntary. IFS work has explored the possible impact of these and other pension-related changes in the 1980s and 1990s, on household saving rates, on the current and future public finances, on retirement, and on the job mobility of individuals covered by company pension schemes (Disney, Emmerson, and Smith, 2003.).
The UK government is planning to introduce stakeholder pensions from April 2001 as a ‘low cost, flexible and secure’ alternative to existing personal pensions (Fiscal Studies, Vol. 21, No. 1.). But stakeholder pensions are only one way to save for retirement; the new tax-free Individual Savings Account (ISA) is another (Fiscal Studies, Vol. 21, No. 1.).
Over the last three decades, there have been major changes to the direct tax and benefit system (Goodman, Johnson, and Webb, 1997). The overall burden of income tax has risen over the period as a whole, despite the cuts of the 1980s, but the structure remains highly progressive (Goodman, Johnson, and Webb, 1997). National Insurance contributions began the period as a relatively regressive tax, but successive structural reforms have removed most of the regressive elements. Means-tested benefits began the period as a relatively modest part of the incomes even of the poorest households, but have grown dramatically in importance for many poorer households, particularly in the 1980s. National Insurance benefits remain an important part of the benefit system, particularly for pensioners, although they are now less central to the incomes of the very poorest households and are no longer the exclusive province of the poor (Goodman, Johnson, and Webb, 1997).
Whereas three decades ago pensioners were heavily concentrated among the poorest group, they are now far more likely to be found in the second and third deciles, with the unemployed and the self-employed below them (Goodman, Johnson, and Webb, 1997).
Goodman, Johnson, and Webb, (1997) discussed the patterns of the benefit and the pension system in the UK through the Labor movement. According to their analysis, the prevalence of poorest pensioners has been reinforced by a growth in entitlements to benefits under the State Earnings-Related Pension Scheme (SERPS), which has been in place since 1977. SERPS pensions are based on earnings since 1977 for those not in company or private pension schemes, and as the scheme matures, growing numbers of pensioners are receiving increasing amounts of SERPS pensions. The planned growth in SERPS pensions has, however, been significantly reined back by government legislation in 1988 and again in 1995 (Goodman, Johnson, and Webb, 1997).
Clark and Emmerson (2000) analyses the thrust of the UK Government’s pension reforms in the context of the system they inherited. The reforms represent continuity with what went before in seeking to continue the privatization of pension provision, but herald a new emphasis on pensioner poverty reduction(Clark and Emmerson, 2000). In the long term, this strategy has advantages in terms of containing public sector liabilities, but involves further downgrading the contributory principle. It will also affect the incentive to save for many individuals. Individuals currently on means-tested benefits will be able to keep more of their savings as a result of the reform. But those currently outside the means-tested benefit regime who expect to be brought into it as a result of the reforms will face a diminished incentive to save.
The regulations around the UK pension system are complex and confusing, and the transfer process is often complicated, frustrating and time-consuming . The UK pension system dictates when and how you will receive your money, whereas retirement options are much more flexible in New Zealand . In Autumn 2001, the UK government finalized its proposals for the introduction of the Pension Credit in 2003 (The Institute for Fiscal Studies, 2003). Since the initial plans, the Government has significantly changed the way in which pensioners’ savings will be treated by the new benefit, and has also decided to couple the reform to significant increases in the generosity of housing benefit for pensioners (The Institute for Fiscal Studies, 2003).
In tandem with a reducing importance for those right at the bottom of the distribution, NI benefits spread through more of the distribution (Goodman, Johnson, and Webb, 1997). The period between 1971 and 1981 was one where NI benefits extended their influence even up to the eighth docile group (Goodman, Johnson, and Webb, 1997). One factor behind this increase was a rise in NI benefits to the long-term sick through Invalidity Benefit (IVB), which was introduced in the early 1970s. The numbers receiving IVB rose steadily, and then dramatically particularly during the 1980s. However, this in turn prompted a series of cuts in the level of IVB, and presaged its eventual replacement by the less generous Incapacity Benefit in 1995 (Goodman, Johnson, and Webb, 1997). Again, the movement of pensioners up the distribution has been important in explaining this trend.
National Insurance benefits, which had been designed by Beveridge and the post-war Labor government to target people in periods of their greatest need–when their incomes from work were lost because of unemployment, sickness, widowhood, or old age–became progressively less well targeted on the poorest over the 1970s1980s (Goodman, Johnson, and Webb, 1997). This reflected increased benefits which drove some recipients into higher deciles, the increased private incomes of some groups, notably pensioners, with rights to NI benefits, and increased incomes from other family members. This last effect would include the impact on household income of having a spouse in work whilst claiming Invalidity Benefit or Unemployment Benefit, for example (Goodman, Johnson, and Webb, 1997).
The Pensions Act 1995 gives to the trustees of UK occupational pension schemes wide powers to delegate the investment-management task (Stapledon, 1996). In practice, the responsibility for day-to-day investment management is almost invariably delegated to either one or more external managers, an in-house manager, or a mixture of the two. Any external fund managers employed by a pension fund to manage assets in the UK are required to be authorized (or exempted) persons under the Financial Services Act 1986. Any in-house pension-fund managers who do not fall within the Act’s definition of carrying on investment business are nevertheless deemed to be doing so, 18 and are thus required to be authorized or exempted (Stapledon, 1996).
It was stated earlier that, as at 1993, 78% of directly invested UK pension funds employed external fund managers to undertake the investment of their funds, and that a further 8% used both external and internal managers (Stapledon, 1996). It is not the case, however, that external firms managed over 78% of the total assets of directly invested UK pension funds at that time (Stapledon, 1996).
Given this leaning of the largest pension funds towards internal management, it is not surprising that, whilst only 14% of directly invested UK pension schemes were managed wholly internally in early 1993, some 38% of the assets of directly invested pension funds were then managed in-house (Stapledon, 1996). About 62% of assets were managed externally, compared to the figure of 78% for the proportion of schemes managed extremely (Stapledon, 1996).
Pension funds, which can be defined as financial intermediaries, usually sponsored by non-financial companies, which collect and invest funds on a pooled basis for eventual payment to members in the form of pensions, are among the most important institutions in certain national financial markets (Davis, 1995).
Pension funds are of two main types–namely, defined benefit and defined contribution–which differ in the distribution of risk between the member and the sponsor (typically a non-financial company) (Davis, 1995). In the former, the sponsor undertakes to pay members a pension related to career earnings, such as a predetermined percentage of final or average salary, subject to years of service, or a flat benefit per year of service. Hence members trade wages for pensions at the long-term average rate of return in the capital market, while employers bear the investment risk, paying benefits even if the fund proves inadequate. In practice, this usually entails an undertaking to top up the fund when assets decline in value or liabilities increase, to keep it in actuarial balance (note that liabilities may increase not merely because of higher pension claims but also because of a fall in the long-term interest rate at which liabilities are discounted (Davis, 1995). In the case of a stock-market crash just prior to retirement, such risks for defined-contribution plans may be severe–pensioners in the UK who retired earlier risks not receiving any pension at all (Davis, 1995).
Because we are interested in people’s living standards, we are interested in their net income–that is, their income after they have received any social security benefits and paid any taxes on their income (Goodman, Johnson, and Webb, 1997). On top of all the changes to original or market income that occur over time are the changes made by government to the tax and benefit system. The initial analyses, then, describe the impact of the tax and benefit system on household incomes in 1991-93, the latest three years for which micro-data are available, before moving on to look at changes in taxes and benefits since the early 1960s in the UK (Goodman, Johnson, and Webb, 1997).
Before the introduction of occupational pension schemes, the pensions paid by private employers were entirely ex gratia in nature.(Nobles, 1993). Old employees who were too sick to work would ask their employer to make some provision for their retirement. By the end of the nineteenth century, such ad hoc discretionary arrangements began to give way, especially within larger companies, to formal schemes (Nobles, 1993). Employers’ contributions and the benefits which they provided were not seen as part of the employee’s pay but, like the gratuities they replaced, were viewed as a reward for long service with one employer and something which the employer could legitimately control.
Occupational pension schemes were at first based upon private statute, or friendly societies’ legislation but, by the beginning of the twentieth century, increasingly took the form of a trust Before the introduction of occupational pension schemes, the pensions paid by private employers were entirely ex gratia in nature.(Nobles, 1993). Old employees who were too sick to work would ask their employer to make some provision for their retirement. By the end of the nineteenth century, such ad hoc discretionary arrangements began to give way, especially within larger companies, to formal schemes (Nobles, 1993).
Employers’ contributions and the benefits which they provided were not seen as part of the employee’s pay but, like the gratuities they replaced, were viewed as a reward for long service with one employer and something which the employer could legitimately control. A trust was inexpensive, and it allowed the employer to set up its pension scheme on whatever terms suited it. The use of a trust established a separate fund to meet the cost of pensions, which thereby increased the employees’ certainty that the pensions promised would in fact be paid, without the employer relinquishing control of the assets within that account Before the introduction of occupational pension schemes, the pensions paid by private employers were entirely ex gratia in nature.(Nobles, 1993). Old employees who were too sick to work would ask their employer to make some provision for their retirement. By the end of the nineteenth century, such ad hoc discretionary arrangements began to give way, especially within larger companies, to formal schemes (Nobles, 1993). Employers’ contributions and the benefits which they provided were not seen as part of the employee’s pay but, like the gratuities they replaced, were viewed as a reward for long service with one employer and something which the employer could legitimately control (Nobles, 1993).
After 1921, the trust form became the universal basis for private occupational pension schemes (Nobles, 1993). This was the result of the introduction, in that year, of tax reliefs which were conditional upon the schemes being trusts (Nobles, 1993). Tax reliefs were justified by the 1920 Royal Commission on the basis that pension schemes represented the savings of employees, the majority of whom would at that time not pay tax (Nobles, 1993).. However, before 1970, the Inland Revenue insisted that schemes contain a rule prohibiting refunds to the employer, and prohibiting amendments which could lead to them (Nobles, 1993). In 1970, the Inland Revenue introduced a requirement that all new schemes seeking tax reliefs should include a rule specifically providing that any surplus arising on winding up was to be returned to the employer. Whilst the reason for the 1970 change is unclear, it has had the effect of exposing schemes to the threat of being wound up for the purposes of asset stripping (Nobles, 1993).
The expansion of occupational pensions led indirectly to increased government regulation through the need to integrate them with the state pension scheme (Nobles, 1993). The National Insurance Act 1959, which introduced graduated state benefits to supplement the basic flat-rate state pension.
Stapleton (1996) looked at the history and current level of institutional monitoring of the management of UK quoted companies. Of the various institutional and noninstitutional groups, the occupational pension funds collectively hold the largest proportion of the issued ordinary shares of listed UK companies It would be natural to assume, therefore, that an inquiry into the role of institutional shareholders in UK corporate governance would focus heavily upon the pension funds themselves (Stapledon, 1996).
The factor responsible primarily for the relatively insignificant role of pension funds in direct institutional monitoring also largely explains the relative prominence of the insurers in that area: in general it is fund managers that meet (regularly) with, talk (regularly) to, and engage (occasionally) with the management of companies (Stapledon, 1996). In contrast, the reason why pension funds have not often been involved in direct monitoring lies in the fact that most of them have for many years employed external fund-management firms to undertake the investment of their funds. As at 1993, 78% of directly invested UK occupational pension funds used solely external fund managers, whilst only 14% managed their investments wholly ‘in-house’, and 8% utilized both external and in-house managers (Stapledon, 1996).
Virtually every well-known UK company authorized to write life insurance has an investment-management subsidiary which manages the investment of the vast majority, if not all, of the group’s life and general insurance funds (Stapledon, 1996).
The review of social security systems concentrates on worker retirement benefits and does not attempt to examine disability insurance, unemployment programs, or medical insurance (Rappaport and Schieber, 1993). While these programs, especially medical insurance, are also affected by the changing age structure of the population, pace constraints of this paper do not permit an assessment of all aspects of aging (Rappaport and Schieber, 1993).
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Credit:ivythesis.typepad.com
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