Public Sector Pensions - 13th March 2011

A fireman emailed me this week, he was outraged by the Hutton Report into public sector pensions and he demanded to know why workers like him should have to suffer because of what the banks had done.  This is a common theme in much of my correspondence but it is utterly misconceived.

The need to reform public sector pensions has absolutely nothing to do with the banks, the banking crisis, or the recession.  For years private sector pension providers have been adapting to the long term demographic changes that have been making much of our pension provision increasingly unaffordable.  Most company pensions used to be ‘defined benefit’ schemes i.e. you got a proportion of your salary for every qualifying year of your employment.  As people started to live so much longer these schemes became increasingly unaffordable and started to shut down completely or close to new members.  (Of course, there were other forces at work from regulatory changes by government to daylight robbery by some employers). Instead, private sector pensions will now overwhelmingly made up of ‘defined contribution’ schemes, where the pension one gets will depend on what the invested value of all your -and your employers’- contributions will buy at the time you come to retire.

Throughout these changes over the last decade or so, employees in the private sector have seen the generosity of their pension provision diminish whilst the value of unreformed public sector pensions has continued to increase.  Now, it was always argued that more generous public sector pension arrangements were a compensation for relatively lower wages in the public sector than in the private sector.  In recent years however, public sector remuneration has improved significantly in comparison and, in addition, many argue that other employment terms and conditions are more generous in the public sector. In any event, there is a perception of an increasing pensions ‘apartheid’ in the economy with much more generous tax-payer funded provision in the public  sector that is still based on final salary schemes, which the private sector can no longer afford.

In fact there are a myriad of different schemes in the public sector.  Some public sector workers are required make contributions from their salaries and some are not. Some schemes are funded –that is, the contributions are invested to pay for the future pensions- and instead, others are wholly dependent on future tax payers to afford.  All these public sector schemes have however, remained unreformed whilst the private sector has been adapting over decades to increased longevity. The same forces that have brought about change in private sector provision need now to drive change in the public sector. As people live longer the burden on future tax payers to pay their pensions will become intolerable, especially as the proportion of the working population shrinks relative to the retired population.

We can no longer ignore this ticking time-bomb and it was for this reason that the coalition government asked John Hutton –Labour’s last secretary of state for pensions- to produce a report on what the government should do. He has recommended that the public sector pensions remain ‘defined benefit’: he is not arguing that, like the private sector, we move to a system based solely on what the invested value of contributions will buy.  The system will still therefore, rely very largely of future tax payers, but to make it more affordable for them he is suggesting two changes: first, significantly greater contributions from public sector workers; and second, that the pension paid be based on ‘career average’ rather than final salary. Clearly, these changes have to be for the future, as it would be quite improper to alter retrospectively the accrued entitlements that workers have earned under their existing contracts.

Undoubtedly, if the government accepts the recommendations and legislates to implement them, then there is going to be a battle with the unions who will seek to defend the interests of their members. It will not be popular to raise contributions whilst cutting the value of the pension, especially at a time when most public sector wages have been frozen, and prices have been rising.

The government will need to lead by example by addressing the issue of ministerial pensions, and MP’s pensions too, if it is to have the moral authority to proceed.