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Pension puzzle

With so many varying factors to consider, John Hutton faces a complex task in reforming public sector pensions fairly

The public and private sector are very different types of employers. This is demonstrated by recent attempts by both the Institute for Fiscal Studies and the Office for National Statistics to get to grips with their different occupational pension systems. It is into this muddy water that the report by the Independent Public Service Pensions Commission (chaired by Labour peer John Hutton on behalf of the coalition Government) dives headfirst.

The old adage is that public sector workers accept lower pay in return for a higher pension. Total reward, however, is roughly the same. This assumption is far too simplistic.

The IFS analysis (using scheme-level data), as they admit, is not entirely on whether private sector pensions are less generous than public sector pensions. We know that there has been a dramatic shift towards defined-contribution pensions in the private sector, away from defined benefit, and that DC pensions tend to be less generous. But they are not by definition less generous, so the devil will be in the detail of each individual scheme.

Crucially, most private sector workers (around 60 per cent) have no occupational pension provision. This compares with around 10 per cent in the public sector. Individuals are, generally speaking, better off in the public sector if they care about their pension. But as the ONS informs us, if they are lucky enough to have an occupational pension on the private sector, they will not necessarily be better off, but the difference is far less stark.

Moreover, according to the ONS, once you factor in higher pay in the private sector, total reward for those with an occupational pension is probably higher.

Incidentally, the IFS thinks that pay, as well as pensions, is more generous in the public sector – thereby contradicting the old adage – but adds that this is explained by the public sector’s better educated workforce. Very confusing.

So, John Hutton’s task in seeking to reform public sector pensions in a fair manner is almost impossible. As such, his interim report is a mixed bag.

First, today’s workers will be asked to make higher contributions. These higher contributions, however, will not fund their own pensions, but the pensions of the retired members of their schemes, who are more numerous and living far longer than most people anticipated.

This is to avoid the burden falling exclusively on taxpayers, the ultimate insurance policy of most public sector pension schemes.

In such a tight fiscal environment, this is understandable. But from the perspective of intergenerational fairness it is extremely problematic.

Hutton’s own analysis shows that the costs of public sector pensions will fall or stabilise over the long-term. The problem, then, is short-term cash-flow.

Asking today’s workers to subsidise today’s pensioners smells suspiciously like a political decision. It should be noted that the report recommends protecting low-paid workers and the armed forces from this measure.

The unfairness is made worse by the fact that, secondly, today’s public sector workers will almost certainly be receiving a less generous pension when they retire.

The final report will make recommendations on raising the normal pension age for public sector schemes (probably to 65; it is currently 60 for most schemes), and it will probably advocate a move away from final-salary pensions. In themselves, neither reform is unwarranted. The public sector is, in general, kinder to older workers, and more amenable to options for gradual retirement. There is therefore no justification for public sector workers to be able to retire earlier than state pension age, given the reliance of most private sector workers on the state pension financially.

Indeed, Hutton could go further, in tying normal pension age to state pension age, perhaps while introducing options for graduated access to pension entitlements. In this way, the public sector could pioneer a more flexible approach to pensions and retirement, while saving money over the long term.

Similarly, the move away from final-salary schemes is not unjustifiable. Hutton is likely to recommend careeraverage schemes, an alternative form of DB schemes, but apparently DB/DC hybrid schemes remain possible. Although final salary schemes are the holy grail of pension provision, there is no reason that DC schemes must be less generous.

In important ways, DC schemes provide greater flexibility to individuals, better reflecting the way that people work, save and live in contemporary society. As such, the commission should not be afraid to move the public sector towards DC pensions – as long as this is not a backdoor way of reducing employer contributions.

The public sector, again, could pioneer new approaches to occupational pensions, providing a realistic benchmark for the private sector to compete with.

Dr Craig Berry is a senior researcher at the International Longevity Centre

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