The case for pre-funded social care

27 Jun 17

Bold and radical reforms are needed to address the problem of an ageing population. Pre-funded care is an attractive solution

England’s ageing population will put an enormous strain on social care services in years to come. UK spending is set to rise from £19.1bn today, to £30.5bn in 20 years’ time. To deal with similar issues in their pension systems, governments around the world started to turn to ‘pre-funded’ systems as early as the end of the 1990s. A similar approach could be the long-term solution for social care in England.

In a report published today, Reform explores how prefunding care could work. Working-age people would save into a government-mandated Later Life Care Fund (LLCF) each month. Instead of using these funds to pay for today’s social care needs, contributions would be invested, left to mature until participants retire, and eventually realised to cover their care costs.

This approach offers two advantages over the current pay-as-you-go system – it would be more cost-effective and fairer to young generations.

A prefunded system would be cheaper due to the high returns that an LLCF could generate if invested in financial markets. To ensure that the effects of compounded interest rate are maximized, Reform proposes that individuals pay contributions for no less than 25 years. Over such a prolonged period, the effects of compounded interest will result in substantial savings: Reform estimates that to deliver current levels of support, prefunding would require 18% lower contributions than current payments through general taxation.

To achieve this, returns on LLCF assets would have to be substantially higher than GDP growth. Some countries have shown that big national funds can indeed meet this target, but only if the right governance structures are in place. In Ireland and Sweden, the management of pension assets is outsourced to the private sector, and return maximisation is explicitly stated as the funds’ principal goal. Practices along these lines could put the LLCF in the best place to generate strong returns, and savings for the taxpayer.

The second benefit of prefunding is that it would stop the transfers of wealth between generations. This is an important issue because taxes are currently levied on the young to pay for care of the old. As there are more and more older people in the future, the tax burden on the young would have to increase. Reform finds that those born in 1991 will pay 34% more towards social care through tax than those born in 1981 due these dynamics. By prefunding care, each generation would save for its own support, avoiding the risk of having to pay for a disproportionately large cohort.

Before the old mechanism is phased out, however, the young generation will have to fund not only its own care through the LLCF, but also that of the current old-aged population. In the short run, this goes against the main problem that pre-funding is meant to solve.

Steps can be taken to ensure that the current young are not disproportionately taxed. Ways to achieve this include paring down pensioner benefits like the winter fuel allowance, and diverting those means to the social care system. Larger savings would be secured by removing the triple lock on the state pension, or tapping into the housing wealth of older people through some form of taxation or the extension of government equity release programmes.

At a time when working-age people have seen their wages stagnate, introducing an extra tax to fund an LLCF would not be easy. The alternative, however, would be even higher taxation in the near future. Prefunding pensions in a similar manner has been successful in other countries and policymakers should take advantage of this experience. Bold, radical reform such as this can ensure better social care for generations to come.