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Eroding social contract at stake

First published on City AM, 22 May 2017

The importance of the social contract has been pointed out by philosophers as far back as Socrates. Edmund Burke, explains: “it is a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born.”

The principle of the social contract underpins the entire tax and spending and welfare system.

But as society ages it leans more heavily on the working age population to fund age related spending, creating  friction between net contributors and net beneficiaries in the social bond. 

The challenges of an ageing demographic are evident already in policy discussions around pay, housing, healthcare and a myriad of other issues

Now the upcoming general election has created a flash point around the state pension and its role in intergenerational (in)equality. An official government report published by John Cridland CBE in March advised scrapping the triple lock that sees the state pension increase by the higher of earnings, inflation or 2.5%. It also suggested raising the age at which we become eligible to receive a state pension.

We surveyed 1,000 voters aged 55 and over and asked if the threat to the state pension triple lock would change their voting habits. Over one-third said they were less likely to vote Conservative if the triple lock was at risk.

Jeremy Corbyn’s Labour has already nailed its colours to the mast and insisted it will keep the triple lock till at least 2025. Now the Conservatives have announced they would replace the triple lock with a double lock. This was a bold step, however, it will not fix the social contract, despite that being one of the party’s main goals.  

This is because the debate about the state pension is a question of who pays and how much. The more generous the terms, the more money shifts from the working age population to older citizens. We operate a ‘pay as you go’ system. Instead of saving for your own state pension, you pay your parents and hope your children will pay yours.

This means the system is hard-wired around the principles of the social contract. It requires a show of faith from all parties that they will get a fair deal over their lifetime. While our private savings give the opportunity of a prosperous retirement, state provision gives everyone a minimum foundation.

Despite this emphasis on intergenerational dependence in the state pension system, our recent research shows almost two thirds (59%) of those aged 30-45* are concerned they won’t be able to afford a decent standard of living in retirement, illustrating a lack of confidence that the social equation will deliver them a fair deal.

In his review of the State Pension, John Cridland dedicated an entire section to the issue of intergenerational fairness. He recommended the triple lock should be scrapped in the next parliament “if additional savings are needed”.

However, while the double lock will remove the 2.5% rise no matter what, it still mans the state pension will rise faster than both earnings and prices in the long run, because of inflation, according to projections from the Office for Budget Responsibility.

The Conservatives should have heeded the recommendation of a ‘smoothed earnings link’ from the Work and Pensions Select Committee. This means growth in pensions continues, but when earnings fall behind price inflation, an above earnings increase could kick in until either earnings growth resumes or for as long as the pension remains above a previously established limit compared to average earnings. When this happens it would revert to earnings.

This would ensure that the state pension rises in line with earnings rather than faster than earnings, but also protects pensioners when earnings fall.

Removing the triple lock is politically challenging. While curbing the generosity of the state pension creates future savings it is likely to rile older voters that by age-proximity are more likely to resist state pension reform.  While the Conservatives have taken a bold step, they have not solved the problem.

There are no simple answers but given the country’s major political parties have taken opposing views on the state pension. The scene is set for a debate about around the role of the welfare state in an ageing society and the strength of the social contract in an era when, for the first time, younger generations are at risk of being worse off than their parents.

Jon Greer is retirement policy expert at Old Mutual Wealth

For financial advisers only. Not to be relied on by consumers.

This article is for information purposes only. The views expressed in this document are those of our sister company, Quilter Cheviot and not of Old Mutual Isle of Man or Old Mutual International Ireland, and are subject to change without notice.

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