Is The National Insurance Fund Running Out Of Money?

Talk of the National Insurance Fund (NIF) running out of cash is nothing new. On this occasion what seems to have prompted the doom-mongering is a blog from the Government Actuary’s Department (GAD) on the NIF’s future issued in December. This in turn was based on the Government Actuary’s Quinquennial Review of the National Insurance Fund as at April 2015, which emerged last October.

Let us begin by making clear what the NIF is not. It is not a fund designed to finance benefits over the long term from contributions and investment returns in the way that a typical final salary pension scheme fund operates. When it started life in 1948 it was such a real fund, but these days it is best described as an accounting element in the Treasury’s balance sheet.

The following formula broadly explains how the NIF changes throughout a financial year:

NIF at start of year
+ NICs received during year
– NIC allocation to NHS funding
+ Interest earned during year on NIF brought forward
+ Treasury Grant
– State pension and other benefit payments* during year

= NIF carried forward to next year

* The main benefits are: Incapacity Benefit/Employment and Support Allowance (contributory only), Bereavement Benefits, Jobseeker’s Allowance (contributory only) and Maternity Allowance,

In practice the cash inflows of NICs and outflows of benefit payments and NHS allocation mean the NIF is more a conduit for money in transit than an accumulating fund. HMRC data shows in 2016/17 for Great Britain there were inflows (after the NHS allocation) of £98.3bn and outflows of £99.5bn, producing a net reduction of £1.2bn in the NIF to £21.9bn. The NIF has been trending downwards for some while: at the beginning of 2010/11 it was £48.8bn.

The NIF’s decline in 2016/17 was somewhat illusory. In 2015/16 there was a Treasury Grant of £9.6bn paid into the NIF, but in the following year there was none. The Treasury Grant is a variable top-up payment from general taxation and is limited by the Social Security Act 1993 to 17% of total benefits payable. In parallel the GAD recommends that the minimum size of the NIF should be 1/6th (16.7%) of annual payments to provide a reserve for short term fluctuations, e.g. arising from a recession.

The decline in the Treasury Grant to nil in 2016/17 was down mainly to a jump in Class 1 National Insurance contributions following the end of defined contribution contracting out and the related NIC rebates. The phasing in of increased State Pension Age (SPA) for women also helped to lower the overall increase in pension payments (92% of all outflows in the year). The windfall from the demise of contracting out and increasing SPA (including the move to a common SPA of 66 by the end of 2020) mean that the GAD projects a rise in the NIF to over £45bn by 2024/25, assuming the Treasury Grant remains at zero. Thereafter a decline sets in which is only marginally slowed by the SPA increase to 67 between 2026 to 2028. On the GAD’s calculations, the NIF will be exhausted by 2032.

To keep the GAD’s 1/6th reserve will therefore need to Treasury Grant to be reinstated. However, even that will not be enough to keep the NIF in the black by 2040, once the next SPA rise to 68 (2037-2039) is over unless the 17% statutory ceiling on the Treasury Grant is changed. At this point the question of whether NICs should be raised enters the GAD considerations. Any increase is focussed on Class 1 NICs, which accounted for over 96% of all NIC income to the NIF in 2016/17.

The current Class 1 total rate is 25.8%, of which 3.95% is allocated to NHS Funding, leaving 21.85% to enter the NIF. The GAD calculates that “Assuming no other financing was provided, at the end of the projection period [2080], the Class 1 NIC rate that would be required to cover benefit expenditure is projected to be around 28%.” This was translated in the GAD blog to “around 5% higher than the current rates”.

As ever with long term projections, there are considerable uncertainties. The fact that the crunch is some years off may encourage political procrastination, particularly when the inter-related issue of NHS funding is more pressing. The ‘obvious’ solution of raising NICs would exacerbate intergenerational inequity. The time may be nearing (post-election, naturally) when NIC and income tax is combined and applied to all income, not just earnings.

Source: https://www.techlink.co.uk/user/knowledge/?df