With a fiscal deficit this year alone of £175bn, the challenge of how to meet public sector pension liabilities exceeding £1trn is rapidly jumping up the political priorities.
The new context was dramatically illustrated in David Cameron’s high profile ‘hairshirt’ speech, in which he proposed cutting the number of MPs. He also argued that “public sector pay, gold-plated pensions….. can no longer be sacrosanct”.
In case there is any misunderstanding of what is likely to emerge from a Tory government, shadow chancellor George Osborne made it even clearer on the BBC’s Andrew Marr Show.
“On public sector pensions, first of all I think we should lead by example – I think the MPs’ pension scheme should be closed to new entrants – and we need to look at these mega pensions in the public sector, these fat cat pensions where people are retiring on huge payouts,” said Osborne.
“And, what’s worse, you get this revolving door where someone retires from a public sector job on a large pension and then is rehired, often by the same organisation, and so they receive the pay that they get on being rehired on a contract, plus the pension from their previous job at that organisation. That is totally unacceptable.”
But Osborne’s comments are merely the latest sign of a widespread anxiety amongst politicians about the ‘generosity’ of public sector pensions. Both the Conservatives and the Liberal Democrats have promised to review public sector pension arrangements if they enter government.
Nor is disquiet limited to the opposition parties. Terry Rooney, Labour MP and chairman of the House of Commons’ Work and Pensions Select Committee, suggested that a cap of £50,000 should be placed on the pension paid to retired public sector workers. And former local government (now housing) minister John Healey has led consultations on reforming the local government pension scheme.
Under the latest published proposals from DCLG, there would be a sharp increase in the use of graduated bands to determine the level of employee contributions to the LGPS. Top earners – receiving pay over £110,000 – would contribute 10% of their salaries to their pensions. The consultation is also considering whether local government pension funds should be permitted to carry deficits in periods when investment returns are weak. At the last three yearly review of funds, the LGPS was funded to 83% of potential liabilities. If this were to rise to 100% at next year’s triennial review, this could lead to a big hike in council tax bills.
A second DCLG consultation on public sector pensions is expected, which may recommend moving to a career average scheme, as has already been adopted for new entrants in the civil service. But while many people regard this as fairer, it would do little to address the deficits. That may require higher contributions, raising the retirement age, reducing the value of benefits, or switching (or part switching) to defined contribution schemes.
The reality of a political imperitive to tackle public sector pension liabilities is no longer in doubt. Two new reports put unfunded public sector pension fund liabilities at £1trn or higher. The British-North American Committee – a respected group of business, unions and academics – calculates this as equivalent to 85% of annual GDP and says the crisis in the UK is even worse than that in the US and Canada.
Another new report, from the Policy Exchange, puts the value of unfunded public sector liabilities in 2007/8 even higher – at £1.1trn – a jump of £173bn in just one year. It argues that improving the quality of reporting on pension liabilities is essential.
While the burdens on pension schemes have grown in recent years – hit by rising longevity and weak investment returns – the private sector has been ruthless in purging costs. A report just published from Pension Capital Strategies reveals that a mere 20 of FTSE250 companies still have final salary schemes for more than 5% of their staff. This is in stark contrast to the public sector, where 90% of staff are members of final salary schemes.
As the private sector cuts back even further on their pension provision, so companies’ anger at public sector schemes increases. Led by the CBI, businesses complain that as taxpayers they are footing the bill, while as tenderers for public contracts they lose out because of the vagaries of the calculations of pension comparability.
The CBI’s argument is that with the NHS, in particular, contractors must provide equality of terms for their workers, similar to those who would have done the work within the NHS. But, it argues, NHS employers operate with an unrealistically high ‘discount rate’. The discount rate is the level of assumed investment return – the higher it is, the less the employer has to contribute. (A discount rate is applied in the NHS, even though the scheme is actually unfunded – so there is in fact no investment.)
Companies argue that they would need to put in an extra 30% on top of salary to match NHS pension standards, making the private sector uncompetitive in bidding for work. As an incoming Conservative government is likely to greatly increase the outsourcing of public sector work as a means of reducing service costs, this issue could move high on the political agenda in coming months.
The sense that lobbyists are now in a position to achieve a significant change is illustrated by comments from the Taxpayers’ Alliance, which has close connections to the Conservative Party.
“The extremely generous terms of most public sector pensions are utterly unsustainable, and are increasingly placing a stranglehold on the public finances,” says the Taxpayers’ Alliance’s chief executive, Matthew Elliott. “Almost every single private pension fund has moved away from final salary schemes for exactly that reason, but the public sector is just carrying on as if the money will simply keep flowing.
“It is becoming increasingly urgent for these pensions to be changed into more feasible funds based on contributions. Paying pensioners out of existing workers’ contributions and then topping the rest up with ever larger amounts of taxpayers’ money is a sticking plaster that was never going to last. If we don’t reform these pensions now, the day may well come where there simply isn’t enough money to pay out what is owed.”
But John Wright, head of public sector consulting at scheme consultants and actuaries Hymans Robertson, urges policy makers not to rush into hurried reform of public sector pensions. “It is obvious with the budget cuts that there will be a strong temptation to slash benefits. That is short sighted, as it could increase the burden on the state in the long-term.
“Before doing anything, we really need to have a review of public sector pensions – and pensions in general. And, at the same time, to look at how long-term care provision dovetails with this. The cost of long-term care is just about as much as public sector pensions when you look at it in terms of the percentage of GDP – and it looks as if they are increasing much more rapidly.”
And trade unions will not readily agree to reduced conditions of service. Jonathan Baume, general secretary of the First Division Association – representing the most senior civil servants – says: “I do not accept that there is a problem with sustaining public sector pensions. The real crisis is the cutting away of pension provision in the private sector.”
Baume adds that civil servants are penalised by lower pay for working in the public sector and expect this to be compensated for in their pension entitlement. A similar argument is put forward by Unison, on behalf of members in local government and the NHS.
Unison, though, has its own problems. Its pension scheme is in deficit, leading to a review of the funding and benefits associated with the scheme. The union denies this will mean that the scheme will cease to be linked to final salary. It declines to say what options are being considered to reduce the deficit.
But the sense of crisis hanging over pensions in the public and private sectors, and even in the unions, is clearly undeniable.