Public sector pensions war hots up
The political heat surrounding public sector pensions is rising as a government-established public service pensions commission sets about producing proposals for cutting costs. We examine a string of reports published over the past six months that each claim to paint an accurate picture of the cost of public sector provision.
On this page:
CPI, not RPI for pension
uprating
National Audit Office report
Liabilities top £1 trillion, says CBI
Schemes
changed in 2007 and 2008
Pension rights bolster
private/public gap
Irish-style pension levy
"Pension envy"
True cost is 40% of pay, not
20%
TUC and union stance
Sustainability
of public sector provision
Our research
Independent Public Service Pensions Commission: terms of
reference.
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Key points
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Not a week seems to go by without the publication of new figures or analysis on the future sustainability of public sector pension provision. The new coalition Government has made the issue a priority, establishing an Independent Public Service Pensions Commission, chaired by former Labour minister John Hutton, within days of taking office.
The commission is undertaking a fundamental structural review of public service pension provision in time for the Budget in spring 2011, but is producing an interim report this September. This interim report is intended to consider the case for delivering immediate pensions savings ahead of this autumn's comprehensive spending review. In a letter to interested parties, John Hutton explains how his first task will be to assess current provision, including the identification of problems in current arrangements and objectives for any changes to be considered in the second phase of the commission's work later this year and early in 2011.
Those offering input have been invited to address the affordability, fairness and impact on staff mobility of the current provision.
CPI, not RPI for pension uprating
One decision has already been taken: the new Government announced in its emergency Budget that state benefits and public service pensions will be uprated in line with the consumer prices index (CPI) from April 2011, replacing the current system of uprating in line with the retail prices index (RPI). A later announcement makes it clear that this will apply to the revaluation of deferred pensions as well as pensions in payment.
The Government argues that the CPI provides a more appropriate measure of pensioners' inflation experience because it excludes the majority of housing costs faced by homeowners, which it assumes most public sector pensioners will no longer face having completed the purchase of their own homes. However, this argument falls down because the CPI will also be used to revalue deferred pensions prior to retirement.
The RPI has tended to increase at a faster rate than CPI in recent years, prompting the FDA, the union for senior civil servants, to comment: "This is clearly an unwelcome change as it is most likely to reduce the purchasing power of public sector pensions in future." Consulting actuaries Punter Southall estimates that this switch in uprating method will generate annual savings of about £0.5 billion from next April.
National Audit Office report
A report published in March 2010 (external website) by the National Audit Office (NAO) sets the scene for the current debate, and seeks to present a truly independent view of the public sector pension finances. A second report due later this year will draw conclusions on overall value for money, examine recent changes to public service pay-as-you-go schemes - a fact often ignored in more recent hyperbole - and make some recommendations.
The NAO report concludes that the real term cost of paying pensions in the four largest public sector schemes over the past 10 years has increased by 38%, driven primarily by increases in the number of employees retiring. Using Treasury assumptions, it estimates that this cost as a proportion of GDP will rise from 1.7% to 1.9%, before falling back to 1.7% over the next 50 years. Crucially, the NAO points out that the Treasury has not assessed the impact of anything other than zero growth in the public service workforce on the cost of pensions in future, adding that "in our view, such an analysis is needed to understand the potential impact on public service pension costs of plausible alternative outcomes."
The TUC seized on some of the NAO findings to make its case - in particular, that a growing public sector workforce in recent years has boosted total payments into the four main schemes, reducing the taxpayer share of pay-as-you-go pension costs and increasing the employee contribution share by 56% in real terms since 1999/2000.
Liabilities top £1 trillion, says CBI
Employers' body the CBI has developed a model pay-as-you-go defined-contribution (DC) public sector pension scheme as part of its contribution to the debate. In a briefing paper (external website), it argues that public service pensions include an unpredictable guarantee from employers, and that employee contributions are out of kilter with the pensions paid out. The CBI puts the true cost of public sector pensions at £1 trillion, calculating that the financial black hole for unfunded schemes is £10 billion a year, or £40,000 for every UK household.
Public sector benefits are, on average, worth 26% of an individual's salary every year, "far higher than private sector norms," says the CBI, arguing that it is about time that the public sector "pays its way" for pensions, so that benefits are fully linked to the contributions made by staff and employer, with no taxpayer subsidy.
Schemes changed in 2007 and 2008
The Pensions Policy Institute (PPI) (external website) urges those absorbed in the current debate to remember that many large public sector schemes have only recently emerged from a period of significant change, which included the introduction of future cost-sharing mechanisms in the case of four main schemes. Crucially, the PPI is not calling for further reforms of schemes, but will set out policy options in a further report due late in 2010.
Cost sharing and capping introduced in recent years in the schemes for teacher, local government workers, civil servants and NHS staff allocates unanticipated increases in future costs 50:50 between the employer and scheme members, and limits the employer contributions to a maximum level, so that unplanned increases above this amount fall fully on members. The PPI estimates that cost sharing and capping, together with other measures, which include an increase in normal pension age in the NHS, civil service and teachers' schemes, has reduced the value of scheme membership from about 23% to 20% of salary in the case of these schemes, and from around 37% to 33% of salary in the case of those joining the "uniformed" services' schemes.
Pension rights bolster private/public gap
The Institute for Fiscal Studies (IFS) examines the relative contribution of pension rights to total remuneration in the public and private sectors in a recent working paper (external website). It concludes that, despite little change in the value of pension accrual in the public sector over the period 2001-05, falling provision in the private sector due to the decline of final-salary scheme membership served to widen the pay gap between the two groups of employees.
The total value of pay and pensions for public sector workers increased by 2.4% a year in the period, compared with 1.3% for private sector employees, the IFS paper concludes. In a possible pointer for future policy, the IFS also examined what would have happened to relative pension accrual value if a normal pension age of 65 had been in place for all members of public sector schemes between 2001 and 2005. The institute concludes that such a measure would have reduced the value of pension accrual to the extent that the average growth in total remuneration would have been almost the same in the two sectors.
Irish-style pension levy
The right-leaning think-tank Policy Exchange also seeks to draw comparisons between public and private sector workers in a paper on controlling public spending (external website), suggesting that an Irish-style graduated pension levy on public sector workers, rising to 7.5% of total earnings, could close half the gap between funded and unfunded liabilities. This would split the real additional cost of funding public service pensions 50:50 between government and employees, the think-tank argues, but appears not to recognise that such arrangements already exist in the cost-sharing and capping mechanisms introduced two years ago for the four main schemes.
The Policy Exchange claims that only 8% of private sector employees were in defined-benefit (DB) schemes by 2007, compared with 80% of public sector workers. Public sector workers, it says, are receiving a subsidy that is rapidly inflating the liability that future taxpayers will have to meet. In 2007/08, the total cost of making pension promises was £34.1 billion, but "because the [previous] Government is not applying a proper interest rate to the contributions it asks for", it only receives £19 billion, of which it pays £13.2 billion itself in the form of employers' contributions. The full subsidy to public sector workers, the Policy Exchange calculates, is worth £28.3 billion, or about £5,700 a year for each of the five million employees in unfunded public pension schemes.
Not surprisingly, the TUC reacted strongly to the Policy Exchange report, calling the statistics it uses "deliberately misleading", and accusing the organisation of possessing a strange notion of fairness, wanting to beat down conditions in the public sector to those now experienced by pensionless workers in the private sector. "In the private sector there is a huge gap between the diamond-encrusted, platinum-plated pensions in Britain's top boardrooms and the collapse of provision for everyone else… This is grossly unfair, yet Policy Exchange seems to think that this unfairness should be spread to public sector workers too," TUC general secretary Brendan Barber comments.
"Pension envy"
The body for human resources professionals, the Chartered Institute of Personnel and Development (CIPD) (external website), claims that the debate surrounding public sector pensions is at risk of becoming mired in "pension envy", with the focus on so-called "gold-plated" pensions awarded at the taxpayers' expense. It calls for greater focus on how public sector pensions can be reformed to meet the needs of employing organisations to provide a quality service in a period of undoubted austerity.
The CIPD argues that the short-term focus should be on sharing the cost and risk of public sector pensions more equitably between employer and employees, and then on the development of more flexible savings vehicles, such as corporate Isas, and alternatives to the current pay-as-you-go basis underpinning many schemes.
True cost is 40% of pay, not 20%
The true cost of the main unfunded public sector schemes, when measuring liabilities using a discount rate based on current yields on index-linked gilts, is a joint employer/employee contribution of more than 40% of salary, double the notional 20% used by the Government to calculate actual contributions. This is the headline finding from the report (external website) of a, non-official, Public Sector Pensions Commission sponsored principally by the Institute of Economic Affairs (IEA) and the Institute of Directors (IoD).
In its July report the commission calls for any reforms arising out of John Hutton's review to apply to the future accrual of all current members of public sector schemes, not just new members. It proposes a number of reforms that would bring down the true combined cost in contribution terms towards the 20% assumed by the Government, including a switch to a career-average revalued-earnings basis, increasing employee contributions, and consideration of hybrid DC/DB schemes. Other options considered by the IEA/IoD commission include a switch to funded or notionally funded DC arrangements, although it accepts that such structures would raise major transitional issues. Notionally funded arrangements avoid the problem of paying pensions for existing pensioners in pay-as-you-go schemes as well as contributing to a funded scheme for current staff during a transitional period.
TUC and union stance
Government ministers helped fuel the pensions war of words this summer in the period before and immediately after the emergency Budget in June. In his verbal Budget statement the chancellor described the cost of public service pensions as "one of the greatest long-term pressures facing our nation's finances", citing figures from the new Office for Budget Responsibility (OP, July 2010) showing that, by 2015/16, spending will top £10 billion just to "meet the gap between pension contributions and payments to the unfunded pensions they support".
The TUC and unions grew increasingly frustrated at these and other comments from government sources on the issue. Brendan Barber said: "Ministers are presenting the costs of public sector pensions in a highly selective way. They are not comparing like with like - and have not been clear that a main cause of the increased net cost of public sector pensions is their [the Government's] decision to freeze public sector pay."
Support for the TUC and union stance came from an unlikely source - the Chartered Institute of Public Finance and Accountancy (CIPFA). The chair of its pensions panel, Bob Summers, warned against the hidden costs of radical reform, arguing that, in 2008/09, members of public sector schemes paid pension contributions of more than £8 billion, a sum which was used to pay the benefits of today's public sector pensioners. "If these schemes were to close then the effects would be felt on the public purse immediately, as public funds would be needed to fill the gap," Summers says.
Sustainability of public sector provision
The true picture of the financial sustainability of public sector provision may be yet to emerge. What is clear is that the battle lines are firmly drawn between those arguing the current low levels of benefit received by most members of public sector schemes are far from "gold plated", and those arguing that the growing disparity between provision in the private and public sector is unsustainable, both morally and financially.
Our research
This feature is based on a series of reports into the cost and structure of public sector pensions produced over the past six months; on statements and analyses from government sources; and on comments from a wide range of bodies.
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Independent Public Service Pensions Commission: terms of reference "To conduct a fundamental structural review of public service pension provision and to make recommendations to the chancellor and chief secretary on pension arrangements that are sustainable and affordable in the long term, fair to both the public service workforce and the taxpayer and consistent with the fiscal challenges ahead, while protecting accrued rights. "In reaching its recommendations, the commission is to have regard to:
"As part of the review, the commission is invited to produce an interim report by the end of September 2010. This should consider the case for delivering savings on public service pensions within the spending review period - consistent with the Government's commitment to protect those on low incomes - to contribute towards the reduction of the structural deficit. "The commission is invited to produce the final report in time for Budget 2011." The terms of reference go on to indicate that the schemes to be covered by the review include those for civil servants, armed forces personnel, NHS employees, teachers, local government workers, police, firefighters, and employees of the research councils, UK Atomic Energy Authority, judicial system and the Department for International Development. Source: HM Treasury (external website). |
