Dissecting Andrew Lansley’s letter
The full text of Andrew Lansley’s leaked letter to Danny Alexander on public service pensions does not seem to be available anywhere (at least yet).
But the Daily Telegraph has published enough to show that this was a well-argued and comprehensive critique. It ran to five pages.
While he claims that he is writing on behalf of health workers, most of his arguments apply equally to other schemes – though as the health scheme (like the local government scheme) collects more in contributions than it pays out in current pensions he may feel that his arguments are particularly strong.
Much of what he says is common to the union critique of the government’s plans. We do not know the precise date that this letter was written, though it was clearly some months ago. The Department of Health has tried to say that things have moved on since the letter was written. But while there have been some modest changes in the government’s position, they certainly don’t meet the objections that have been revealed so far.
These are some of the points he makes:
The paper … assumes that public sector workers, many of whom are women, will work a 48-year career (to get a full pension). In the NHS currently, the average full time career for those taking a pension is only 18 years and it seems unrealistic to suggest that pension scheme design should be based on the assumption that a predominantly female workforce would need to work full-time, 48-year careers in future to receive a full pension.
This is just one reason why unions are so critical of the proposal to raise the pension age – the age you need to work to to earn a full pension. It is not the same as the retirement age – the age you stop working.
Some people work past their pension age and usually get a bigger pension. Many people stop working before their pension age and retire with a smaller pension. It is smaller because they both have fewer years of contributions and start to draw it earlier than the pension age. What is called an actuarial reduction is made if you claim a pension early. In simple terms you end up with the same total pension but spread over the longer period of retirement.
There is also the risk that lower-paid staff in particular will simply opt out, leaving HMT (HM Treasury) with reduced receipts in the short term while still having to pay for past pension promises.
In the NHS, if it appears that we intend to significantly reduce the value of future accrual we also face the risk of opt-out from higher-paid groups as well as the lower paid. GPs for instance pay both employer and employee contributions and can choose to invest them elsewhere or take them as pay. This would create a significant fiscal pressure in the short to medium term and in respect of lower-paid staff who opt out would increase pressure on the social security budget in the longer term.”
This is an important point. Other than the local government scheme, the big public sector pension schemes have pay-as-you-go arrangements. The Treasury pays out pensions from its current income and treats contributions in the same way as it would tax receipts. As such schemes don’t have investments technically they are called unfunded. although this implies incorrectly that no-one pays for them.
If members opt-out of a pay-as-you-go scheme, the Treasury still has to fork out for pensions in payment, but no longer gets the benefit of the contributions from those who leave the scheme. In the very long term this will save money – although it’s likely that there will be hidden costs in extra means-tested benefits – but in the short term it simply makes the deficit worse.
Next is perhaps the most interesting argument:
These accrual rates (the amount people will earn in a pension for each year they work) imply a significant reduction in the employer contribution rate. This would result in a further substantial reduction in the value of the public sector reward package on top of the increase in employee contributions, the move to CPI (inflation) and the previous government’s changes. All the accrual rates modelled would result in lower employer contributions if employee contributions remained at the level set out in our plans.”
This is rather technical and needs unpacking. Although most public sector pensions are pay-as-you-go there is still a rigorous process used to work out what contributions need to be made to keep pensions properly funded. It’s called SCAPE – Superannuation Contribution Adjusted for Past Experience. There may not be funds under investment, but there is a notional fund within the public purse that is assumed to grow in line with economic growth.
If the value of the pension is reduced – and it has been by both the switch to CPI indexation and the changes negotiated with the previous government – that valuation process would produce a lower contributions. Other factors are in play wyhen working out contribution rates such as how long people are living and the discount rate – how you measure future spending in today’s money. But a sudden and big reduction in a pension scheme’s value such as the 15 per cent impact of the CPI switch would produce lower contributions from the SCAPE process.
Once the size of the contributions required has been worked out, there is a separate decision about how they should be split between employer and employee. Lansley appears to be arguing that when you take into account both the government’s demand for an increase in contributions – effectively a switch from employer to employee of part of the funding burden – and the reduction in total contributions due to the cut in the value of the pension, a hugely unfair extra cost is being put on staff.
In other wordspeople will be paying much more for significantly less. As Lansley says
It is also difficult to see how this meets our commitment to maintain gold-standard pensions.”