Test 27 June, 2017

What can pre-funding offer for social care?

Social care has become one of the most high-profile public policy issues in the past few months. To alleviate short-term pressures, the Chancellor announced a £2 billion cash injection at the Spring Budget. But this move will not put the funding of care and support onto a “fair and more sustainable” footing. What is needed is a long-term solution that recognises the root cause of the sector’s problems – England’s ageing population.

Social care is currently funded on a ‘pay-as-you-go’ (PAYG) basis. Under this arrangement, taxes are raised to pay for people with care needs today. As the population ages, however, the proportion of people needing support will increase, raising the financial burden on a shrinking working-age population. To continue paying for social care in this way will not only pose a challenge for fiscal sustainability. It will also create a sizeable transfer of wealth from young to old.

In a report published today, Reform sets out the case for paying for later-life care on a ‘prefunded’ basis. Under the proposed scheme, workers would be obliged to pay into a Later Life Care Fund. These pooled contributions would then be invested with the sole purpose of maximizing returns. Once the contributors are past the State Pension age, their care costs will be partly covered by realising the fund’s assets.

To get an idea of the benefits and coverage this scheme would offer, a comparison with Germany can be made. There, contributions are 2.55 per cent of wages, split evenly between employee and employer. This level of payment ensures all people with care needs receive support equal to roughly 50 per cent of their costs. But a prefunded arrangement can deliver two benefits not present in the German PAYG system.

First, prefunding would offer better value for money. By saving in advance for care, contributions can be invested in a mixture of equity and debt. If the Later Life Care Fund matched the performance of UK pension funds, reform could see the cost of paying for social care fall by 18 per cent.

Second, prefunding would be fairer to younger generations. Reform’s paper notes that under the current system, people born in the mid-nineties will pay 34 per cent more towards social care than those born in the eighties. If each cohort were obliged to contribute into a fund earmarked for their care needs, younger generations would not be burdened by financing the care of a disproportionately large older generation.

Transitioning to Later Life Care Fund would, however, create significant challenges. During the phasing-in period, a generation of people would be asked to pay not only for their own care, but also the care of those that haven’t had the opportunity to pay into the fund. This ‘double burden’ raises concerns regarding intergenerational equity – the very issue prefunding was designed to resolve.

To ensure working-age people are not solely responsible for carrying this burden, Reform argues the state pension triple lock and winter fuel allowance could be scrapped and resources shifted to the care sector where they will bring more value.

Prefunding would be novel for social care – no country currently adopts this approach. Across the world, however, there has been a tendency to address intergenerational equity issues in pension systems precisely through this mechanism. There is no reason why the success of these reforms cannot be emulated in the social care field to deliver more efficiency and fairness.