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What is a promise from the government worth?: measuring and assessing the implications of political risk in state and personal pension schemes in the United Kingdom

By David Blake

Abstract

There are three key types of political risk facing state and personal pension schemes: those induced by demographic, economic and pure political considerations. The state scheme in the UK has been susceptible to all three types of political risk with the result that the annual real internal rate of return (IRR) on the second-pillar state pension (SERPS) for the average male worker has fallen from 5% to 1.5% over the last quarter century. The New Labour government replaced SERPS with the Second State Pension (S2P) Scheme which was designed to benefit its natural supporters, low-paid workers, at the expense of middle- and higher-paid workers. S2P which assumes that all workers earn at least the Lower Earnings Threshold, regardless of their actual earnings, combined with the Minimum Income Guarantee and Pension Credit, has raised the prospective IRR to low-paid workers to 6.2%. Given the generosity of the MIG, which is uprated in line with earnings, most pensioners, including the well off, will become eligible for this means-tested benefit: we therefore question whether the MIG can survive in its present form. The flat-rate, first-pillar Basic State Pension has also experienced a fall in its IRR of 3 percentage points as a result of the indexation basis changing from earnings to prices. Personal pensions are not immune from political risk either, although to date they have been less susceptible than the state scheme: the abolition of the tax credit on UK dividends in 1997 lowered the IRR on personal pensions by 0.6 of a percentage point, for example. Given that company final-salary schemes in the UK have all but closed to new members, leaving state and personal (or company) defined contribution pension schemes as the only alternatives available for building up pension entitlements, it is hard to see where British workers can turn in future to guarantee their retirement income security

Topics: HG Finance, HB Economic Theory
Publisher: Financial Markets Group, London School of Economics and Political Science
Year: 2003
OAI identifier: oai:eprints.lse.ac.uk:24856
Provided by: LSE Research Online

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Citations

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