Career-average revalued-earnings recommended for public sector pensions

Lord Hutton has produced a measured final report on public sector pension provision. However, commentators are concerned that any attempt to "cherry pick" the commission's recommendations could perpetuate intergenerational unfairness and undermine Lord Hutton's aims of affordability and sustainability.

On this page:
Career-average revalued-earnings
Salami slicing of retirement incomes
Intergenerational fairness
Key Hutton recommendations
CARE could be fairer
Tight timetable.

The final report (on the Treasury website) of the Independent Public Service Pensions Commission picks up where the interim report left off, setting out a framework for the design of new pension arrangements that Lord Hutton argues are tenable and affordable in the long term.

Career-average revalued-earnings

Its main recommendation is that existing final-salary schemes should be replaced by career-average revalued-earnings (CARE) arrangements, and that all existing scheme members move over to new CARE schemes for future-service accrual. Lord Hutton wants the Government to get moving, arguing that it should be possible to introduce the new schemes before the current parliament ends in 2015. Normal pension age for most public sector workers should be linked to the rising state pension age, and that of the uniformed services - police, firefighters and armed forces - should increase to 60, Hutton proposes.

Launching the report, Lord Hutton said that the recommendations in his final report aim to strike a balance between public sector workers and taxpayers by ensuring access to good pensions for workers, but giving taxpayers greater control over costs. For example, the report recommends a clear cost ceiling be set for the proportion of pensionable pay that taxpayers can be expected to contribute to employees' pensions, with automatic stabilisers to keep future costs under more effective control. How such arrangements will differ from existing, recently introduced capping and sharing mechanisms in many public sector schemes is unclear.

"The current model of public service pension provision is clearly not tenable in the long term," Lord Hutton argues. He adds: "There is a clear need for reform. Getting the decisions right on the most appropriate structures and designs will be crucial to making any changes work in the future. This will only be achievable if there is effective dialogue between public service employers, employees and unions."

Salami slicing of retirement incomes

This "dialogue" is likely to be lively, judging by the initial responses of the public sector trade unions to Lord Hutton's final report. The union Unite describes the report as "another big slice of the salami attack" on the retirement incomes of employees, and argues that many public sector workers, particularly low-paid women, will vote with their feet and opt out of pension saving. The union claims that it is not necessary to increase normal pension age, as the existing schemes already have mechanisms in place for members to bear the additional cost of rising longevity.

The trade unions point to other changes being made to public sector pensions, beyond the remit of Lord Hutton's review, which they claim partly undermine his recommendations. These include a switch to using the consumer prices index (CPI) to uprate pensions in payment, the Comprehensive Spending Review's announcement of an increase of three percentage points in average member contributions, changes to the admission arrangements for workers whose employment is privatised, and the Treasury's current review of the discount rate used to value future pension liabilities in public sector schemes.

Intergenerational fairness

Lord Hutton argues that future public sector workers should not subsidise further final-salary accrual by current workers, and so recommends that existing employees also move to the new CARE arrangements, alongside new entrants, for future-service accrual. "Allowing current members to continue to accrue further benefits in the present schemes for many decades would be unfair and inequitable to the new members coming behind them," the report maintains.

However, limiting the maintenance of a full final-salary link for past-service benefits accrued by current members will introduce new complexity into an already complicated picture, and could have implications for public sector outsourcing contracts, according to consultants Mercer. Allowing existing members to keep final-salary benefits on past service also means that any significant cost savings will only emerge over the long term.

Hutton also recommends a system of tiered, salary-related contributions. Paul Middleman, a principal at Mercer, welcomed this approach, arguing that increases in contributions for some could make the cost of pensions clearer to all. However, Mercer is concerned about a blanket increase in member contributions, suggesting that levels for some groups are already high, and that further rises could "damage the enthusiasm for saving amongst members", leading to rising numbers of opt-outs.

CARE could be fairer

The proposed move to CARE arrangements is welcomed by the National Association of Pension Funds, and its chief executive, Joanne Segars, argues that such a basis "could be a better deal than the current final-salary arrangements for the lower-paid and those whose earnings spike mid-career".

Brendan Barber, TUC general secretary, agrees that Lord Hutton's report is "a serious piece of work with aspects we can welcome", but argues that a move to a CARE basis for future accrual will have very different impacts on different schemes. He says: "Unless there is an increase in the accrual rate, the switch will simply mean that some will lose out more than others."

Whether CARE is fairer than a straight final-salary basis is an issue addressed in a response to the Hutton report by Carl Emmerson of the Institute for Fiscal Studies (IFS). The balance between the two bases depends on how average salary is calculated - Lord Hutton recommends average earnings growth be used, which is less generous than a final-salary basis for high flyers, who typically see higher-than-average salary growth. Conversely, using average earnings to revalue accrued rights will be more beneficial to those with below-average salary growth.

The Institute and Faculty of Actuaries produced figures on the day the final report was published showing that a lower-paid worker on a salary of £15,000 per year with future annual earnings growth of only 1% above the CPI would receive a CARE pension 21% bigger than that accrued under a pure final-salary arrangement, compared with a pension 17% smaller for an employee on a salary of £30,000 with annual earnings growth of 3%.

Tight timetable

Lord Hutton believes new arrangements can and should be in place by 2015, but some commentators have already suggested that this is unrealistic. The Association of Consulting Actuaries (ACA) is concerned that the framework proposed by Hutton will require much further detailed negotiation, scheme by scheme, and also raises questions about the Government's resolve - particularly as the next election approaches - to push through the reforms.

Andrew Vaughan, ACA secretary, says: "The report follows very much along the lines of what we had expected and the proposals make sound sense for the future. But much remains to be done to make a reality of the package - all the hard work is being left to government and public sector employer bodies."

The IFS echoes concerns over the tight timetable, particularly as Hutton is silent on detail such as accrual rates and actual employee contribution rates in a new, tiered structure. The president of the Institute and Faculty of Actuaries, Ronnie Bowie, says: "The challenge is now for the Government to fill in the missing pieces. There remain significant design and implementation risks to be overcome before we can be confident that what is eventually put in place is similarly coherent and sustainable."

Joanne Segars of the NAPF describes the timetable as "ambitious", but adds: "It is important to crack on with these reforms." The Government has decided to accept the report's recommendations, and the Chancellor gave the coalition's formal response in the 2011 Budget.

A process will be needed to move the recommendations from the framework set out in Hutton's report to a blueprint for implementation. "How this is approached could make a real difference to how and when the reforms are implemented," Lord Hutton concludes.