Thinking the unthinkable is only way to defuse pensions timebomb

When Tony Blair asked Frank Field to "think the unthinkable" as Minister for Welfare Reform, one of his ideas was for compulsory pension contributions by people not in company or personal schemes.

The idea was too hot to handle and disappeared with Mr Field when he was sacked in 1998. Now, it seems, Mr Blair is ready to think the unthinkable himself by considering the same proposal.

Much has changed in the pensions world since Mr Field's brief ministerial career. People are saving less and living longer. The falling stock market has cut the value of funds. Company schemes, seen as the most successful piece of the jigsaw, have run into problems as firms replace final salary schemes with those based on "defined contributions", cutting the retirement income of workers by about an average of a third.

Some funds blame Gordon Brown's £5bn a year raid on their divided income. Only 800,000 people have taken out the new stakeholder pensions promoted by the Government, which are targeted at 2.5 million people earning between £10,000 and £20,000 a year.

Taken together, these problems amount to what some in the industry call a "pensions meltdown". The Association of British Insurers has calculated that people are £27bn short of the savings they need to finance their retirement.

Ministers insist that such apocalyptic visions are exaggerated. Alistair Darling, the Secretary for Work and Pensions, says the basic structure is sound and argues that people want a period of stability. He wants the stakeholder scheme, launched in April last year, to be given a chance. However, the kaleidoscope will be shaken again in July when three inquiries are due to report.

Alan Pickering, the former chairman of the National Association of Pension Funds, will report to Mr Darling on the pensions system and will call for the state retirement age to be raised from 65 to 70 by 2030. Ron Sandler, a former chairman of Lloyd's of London, who is studying long-term savings, will report to the Treasury, while the Inland Revenue will conclude a review of pension scheme taxation.

The flurry of activity will give the Government a chance to produce a new "joined up" pensions strategy. Although Mr Blair and Mr Brown will not make up their minds until they have studied the inquiries' findings, the first smoke signals from Whitehall suggest they are willing to consider compulsion.

Employers could be forced to contribute to a scheme for each worker; at present, 350,000 companies must administer a stakeholder scheme if they do not have their own, but few volunteer to contribute to it.

The Trades' Union Congress, which estimates that the number of employees in final salary schemes has fallen from 5.6 million to 3.8 million since 1991, has launched a campaign calling for compulsory contributions by firms.

However, Mr Blair and Mr Brown may regard this as a step too far. They will be very nervous about piling more costs on to business when it is already squealing about the national insurance rises announced in the Budget and the cost of administering other schemes. Although supporters of compulsion argue that it would not raise overall labour costs because wages would be cut, it could undermine the drive to make British industry more competitive.

A more likely route, according to Whitehall sources, is to force workers to pay into a fund if they do not have a company or personal pension. Again, the move would be controversial. It would be widely seen as a new tax, and the timing would be explosive after the national insurance rises, which take effect next April.

Some ministers believe the Government will eventually "bite the bullet" because its decision to top up the basic state pension for the poorest pensioners will become impossibly expensive in the long run if today's workers do not make more provision for their old age.

There is a growing fear at Downing Street that the Government will pay a heavy price if it fails to defuse the pensions timebomb. "Doing nothing is not an option," said a source.

Safety net - retirement schemes worldwide

Germany: A relatively generous state pension but no compulsory scheme, although there is now a plan in operation to top up the state payment. Employees can force employers to make a small contribution to an approved scheme from their salary, similar to the UK stakeholder pension.

France: A generous state scheme which can produce up to 50 per cent of covered earnings for a full career. Supplemented by compulsory pay-as-you-go schemes. Further occupational pension provisional is limited to the affluent.

United States: State pension provision is relatively limited and private schemes far more widespread. The state retirement age is about to be raised from 65 to 67.

Australia: A means-tested basic state pension is supplemented by compulsory employer contributions of 9 per cent on earnings up to a specified limit, paid in to a pension fund.

Singapore: A compulsory state pension aimed not only at catering for retirement but also at providing for home ownership and health care needs. The individual is expected to foot most of the bill. Supplementary occupational pension provision is rare.