Pay more for longer to get less was the spin that the newspapers put on Lord Hutton’s second and final report on public sector pensions but “former Labour minister ducks key questions on affordability” could have been equally appropriate. In reality, Hutton’s final report on public sector pensions genuinely plots a middle course, introducing some key reforms that will save the taxpayer significant sums of money over thelong term while leaving the principle of defined-benefit in place.
The key proposals are a switch from finalsalary to career average, an increase in normal retirement age from 60 to state retirement age, which will be 66 by 2020, and an increase in employer contributions. Retirement age for the police and armed forces will be capped at 60.
Critics on the right will say even with these changes, civil servants still enjoy definedbenefit pensions that are the envy of virtually everybody in the private sector. Hutton has ignored calls that high-earning public sector workers should have some element of defined-contribution on top of a capped DB base, which means his proposals still leave the taxpayer picking up virtually all of the longevity risk on schemes.
Those on the left will argue that the Hutton proposals come hot on the heels of a series of other cuts to public sector pensions. Many public sector pension schemes have already been substantially reformed, they point out, and to make matters worse for public employees and pensioners, the switch from RPI to CPI for indexation of benefits has already just taken 15 to 20 per cent off their pensions over the next 20 years.
The Teachers’ Pension Scheme is a case in point. National Union of Teachers general secretary Christine Blower says: “Pensions have already been cut by changing their link from RPI to CPI inflation. As a result of this, next month’s pension increase will be 1.5 per cent less than it should have been.
“The Government’s already stated desire to increase pension contributions by more than half could cost newly qualified teachers up to £60 a month – an additional cost which could see many leaving the Teachers’ Pensions Scheme on the grounds that it is no longer affordable.”
But the Teachers’ Pension Scheme is a good example of how Hutton wants to introduce greater fairness across schemes as well as across the entire UK population. The normal retirement age for teachers was raised in 2007 from 60 to 65 for new entrants, creating a divide between old and new joiners. Hutton’s proposals will see existing members’ future accrual shift to a normal retirement age equal to the state pension
age of 65, rising to 66 by 2020 and even older thereafter.
How much money the reforms will save the public purse remains to be seen, as Hutton has passed back some of the thorniest issues to the Government – the level of contributions and accrual rates.
Towers Watson senior consultant David Robbins says: “There is still a lot to be decided about what the shape of the package actually is.
Hutton has set out in the shape of the deal but he has not really said how much the package is going to be worth. You could have a very valuable scheme if accrual rates are generous or you could have a very stingy one if they are not. But he has made it difficult for the unions to say they are going to go on strike about this.”
The Treasury had already announced a 3 per cent increase in contributions from public sector workers, due to come in from next year, but unions are lobbying for this figure to be reduced.
This 3 per cent figure is per scheme and not per employee, creating huge problems for the funded local government pension schemes in particular. This is because ministers have said people earning less than £24,000 a year are not to suffer an increase in contributions, which in local government schemes means two-thirds of members will see no increases.
That means the entirety of the contribution increase has to come from the remaining third of members with salaries above £24,000.
The Association of Consulting Actuaries says a local government employee on between £30,000 and £35,000 would see their contributions increase from 6 to 12 per cent of earnings if the target is to be met.
And the Local Government Association says such an increase could lead to widespread opt-outs from schemes, which in turn would lead to reduced employee contributions today, putting schemes under even greater financial strain.
A survey carried out by the GMB union indicates that as many as 40 per cent of staff could opt out of schemes if contribution rates increase.
ACA main committee member Graeme Muir says: “At a time when you have got a pay freeze, an increase in pension age and a reduction in indexation, this could prove to be the straw that breaks the camel’s back for some members.”
Unions should, however, take comfort that Hutton in his report has said the aim of public sector pensions is to provide decent incomes in retirement rather than to compete with benefits offered in the private sector with a view to attracting and retaining staff. The report models employees with 20 years’ service potentially beating Turner’s pension income replacement rates on a 1/61st scheme basis.
Robbins says: “Hutton has referred back to the Turner report definitions of adequacy and his projections are that they could beat that on 20 years’ service. That could lead to the government introducing an accrual rate that is less generous than the 1/61 rate that he has been modelling.”
Another proposal in the Hutton report that has been called into question is the proposal to uprate pension benefits in line with average earnings during the accrual phase for active scheme members, one of the key factors in putting in place a career average revalued earnings scheme in place of a final salary scheme. But the idea of average earnings for active members but CPI for deferred members has raised eyebrows.
Muir says: “This stops job market flexibility because if your benefits go up by CPI if you leave, whereas they go up by average earnings if you stay, that creates an incentive to stay, just to protect your pension benefits.
There are other ways he could have achieved the same outcome.
“We would have suggested using CPI as the indexation rate for both current employees and leavers and improve the accrual rate to make up the difference.
That also has the added presentation benefit of giving people more years’ pension now, even if the lower indexation rate means they won’t be any better off when they come to retire.”
The report recommends that over time, public service pensions should move towards a common framework for scheme design. At present, public sectors have been set up by a variety of statutes and a wide range of approaches to scheme management are adopted.
Standard Life head of pension policy John Lawson says: “He basically wants to see that all schemes are investing their funds wisely and using a common approach to things such as discount rates, which makes sense. Administration standards are important even in unfunded schemes. People go missing and you can end up with lengthy disputes when they try to claim their entitlement years down the line.”
With so much of the new pension deal for public sector workers still to be thrashed out, talk of implementation may seem premature. But pension professionals point out the huge communication challenge that the government faces in actually implementing the new scheme.
Lawson says: “Standard Life changed its scheme from a final-salary to a career average one three years ago and that required a massive communication exercise. The scale of the comms exercise is massive.”
’At a time when you have got a pay freeze, an increase in pension age and a reduction in indexation, this could prove to be the straw that breaks the camel’s back for some members’
Just how huge a job it will be actually bringing in the new system is reflected by the scale of the undertaking the NHS is already engaged in with the review already under way in its scheme.
Paul McGlone, UK benefits lead, global risk services at Aon Hewitt, points out that with Hutton planning for the changes to be introduced by the end of this Parliament, some scheme members will have only just come to terms with the last batch of changes to their benefits before a new set of changes comes along.
He says: “The NHS is in the middle of a two-year rolling communication programme that literally starts in one part of the country and deals with different regions at different times because it physically cannot deal with sending out forms to everyone on the same day.
Doing the entire public sector will be a massive job.”
But there is a lot of water to pass unde the bridge before implementation and the unions are not going to take these changes lying down.
Michaela Berry, a partner at law firm Sackers, says: “Hutton has moved the argument on but pushing back normal retirement to a moving state pension age, contributions and accrual rates look like being the key battlegrounds.”
This may have been Hutton’s final report but it is certainly not the end of the story.
KEY RECOMMENDATIONS OF THE REPORT
- The Government should honour accrued benefits in full
- Public sector defined-benefit schemes should remain open and should not be replaced with defined-contribution schemes
- Public sector DB schemes should be calculated on career average salary rather than final salary. This change should be implemented this Parliament
- Most public sector schemes should have their normal retirement age aligned with the state retirement age and retirement ages should be reviewed regularly
- Uniformed services should be the one exception to the implementation of standard retirement ages. Uniformed services should have a normal retirement age of 60
- A cost ceiling for taxpayer contributions should be introduced
- Contributions from scheme members should be tiered to reflect increased longevity for higher earners and offset affordability for lower earners