It is increasingly likely – almost inevitable, it seems – that the Conservatives will form the next government. Equally probable, to judge by recent remarks, is that the incoming administration will try to ‘fix’ public sector pensions.
There is growing disquiet amongst the political classes and the media about public sector pensions. They are too generous, the payments are guaranteed and schemes allow workers to retire too early, say the critics. While most private sector pension plans are now defined contributions, public sector schemes remain defined benefit and the local government pension scheme is still final salary. Where the LGPS normal retirement age is 65, private sector workers will often stay in employment for several years longer.
And, of course, the total cost must not be overlooked. Most public sector schemes are ‘unfunded’ – they will be paid for out of future government revenues and contributions from tomorrow’s workforce. Although LGPS is unusual for a public sector pension in being funded, the deficits are – in part because of the recession and stock market collapse – massive. According to accountants PricewaterhouseCoopers, the deficit as at the end of last year amount to 34% of their liabilities – or 43% if typical private sector calculations are used.
A Conservative government can now be expected to take the issue head on. Shadow chancellor George Osborne is the latest Tory front bencher to indicate that action would be taken. Speaking on the BBC’s Andrew Marr Show, Osborne said: “When it comes to [public sector] pensions, I’m not bound by any deal that the Labour Party has done with the public sector unions who pay their bills, but I will do this in a way that is fair. When I reform public sector pensions, I will want to do it in co-operation – I hope – with those who represent the public sector. You know I am not out to slash and burn the public sector. I want to do this in a way that gets value for money for the taxpayer, but treats the public sector fairly.”
Osborne added: “We are going to look at public sector pensions. I mean public sector pensions are actually a long-term burden on the state and that’s why they need to be reformed.” To add to the anxieties of public sector workers, Osborne also said: “We will take decisions to make sure that public sector pay reflects prevailing economic conditions.” But a spokeswoman for the Conservative Party says it is not willing to provide any details on the nature of likely pension reforms.
Assuming a proposal is made to amend the LGPS, Unison pledges not to accept anything that damages its members’ interests. A Unison spokeswoman says: “We will resist it fiercely, like we have done before. We have drawn up a new pension scheme that is sustainable for the future and there is no reason why the Tories should attack it. Don’t forget, most of the local authorities are Tory controlled and they were responsible for working on the local government pension schemes.”
Gary Simmons, local government partner at PwC, argues there are a lot of uncertainties about the LGPS, including both the real size of the deficits and how they can be reduced. Estimates of the deficits, says Simmons, range between £50bn and £100bn – an impressively large margin of doubt.
But LGPS obligations have been built-up by past employment and it is unlikely those liabilities can be cut by retrospectively reducing entitlement. “In the private sector, you cannot change this,” says Simmons. “I think the same is likely to apply with public sector pensions.”
The existing deficit will need to be addressed by increased contributions, either from employers or the Government. To prevent the deficit growing even larger, and to prevent it recurring, either contributions will need to increase, or entitlements cut back.
“It’s not an easy thing to solve,” says Simmons. “You can’t magic money up from thin air. The benefit structure could be looked at.” But, argues Simmons, pensions need to be considered as part of a broader staff reward structure and it may prove very difficult to cut the cost of LGPS, even if the way benefits are distributed is reformed.
Simply moving from final salary to career average pay would not, in itself, cut the cost of a scheme, points out Simmons. It might, though, be attractive to a government that wanted a fairer scheme, or greater flexibility. Similarly, moving to a defined contribution scheme would not necessarily reduce costs to employers. It does, though, transfer risk to the employee – with the possible result that a retired employee with an underperforming pension could then become entitled to more state benefits. This, in turn, could increase the burden on the public purse.
Independent pensions consultant John Ralfe is also doubtful about the ease with which savings can be achieved in the LGPS. He agrees that simply moving from a final salary to a career average scheme would not resolve the underlying problems of the LGPS. “It would not go anywhere near,” he says. “Most people aren’t very affected, because salaries over their working lives don’t increase much above inflation. The cost saving is derisory.”
On the costs side, it is the salary growth of local government staff that is increasing pressure on the scheme, Ralfe argues. Given Osborne’s comments in the Andrew Marr interview on public sector remuneration, cutting pay may be a means of reducing future LGPS liabilities, as well as cutting other revenue costs.
“Whatever the Tories may do to address the issue, must be much stronger than just moving from final salary to career average,” says Ralfe. It is necessary, Ralfe suggests, to consider the future of the LGPS alongside other public sector schemes, including MPs. “Unsurprisingly MPs are showing no sign of accepting reduced pensions,” he says. “The politics are very interesting. MPs are a very effective lobby group.”
“Before you start looking at local government you should look at the unfunded public schemes, which are more generous because the normal retirement age is 60, not 65 as in the LGPS,” says Ralfe. “So I don’t think any changes will start with local government.”
But making changes to the LGPS and other public sector schemes that are both effective in reducing cost and are politically achievable are bound to be extremely difficult. “I cannot see that an incoming Conservative government would find it any easier to grasp the nettle than the current Labour administration,” says Ralfe. Rather, it would be more difficult, he argues, drawing the analogy that Republican governments in the United States are better able to cut military spending, than are Democrats.
Nor should voter self-interest be overlooked. “If you tot up the total number of members of unfunded [public sector] schemes and members of LGPS including current and former employees, and pensioners, it’s almost ten million people,” calculates Ralfe. “I can’t see that the Conservatives would find this easy. What we have heard so far is more rhetoric than anything else.”
Many local government staff will hope Ralfe’s analysis is correct.
The transparency trap
One approach an incoming Conservative government could take would be to proclaim a commitment to ‘transparent accounting’. Putting all PFI liabilities, future nuclear decommissioning costs, liabilities of banking giants RBS and the Lloyds Group, the liabilities of unfunded public sector pension schemes and the deficits of the LGPS onto the Government’s balance sheet is favoured by many Tories, including – judging by his blogs – front bencher and former minister John Redwood. It would take public sector net debt to around £3 trillion or £4 trillion, calculates Redwood. This compares with the current official PSND of £744bn.
The political advantage of this tactic would be more than taking the honesty high ground. By stressing just how bad things are, more radical policies might then be adopted to cut the liabilities and deficits. It could be just enough to allow a government to take an axe to cherished parts of the LGPS and other public sector pension schemes.