From the TUC

John Hutton is confused and confusing on pensions

16 Sep 2011, by in Pensions & Investment

According to the FT (£) John Hutton has said:

Trade unions are suffering from a “fundamental misunderstanding” in arguing that public sector pensions are affordable without reform …

Lord Hutton said the figures “assume we have successfully implemented the reforms” that he recommended. “The fundamental mistake the trades unions are making is that the chart assumes that the reforms have taken place,” he told the Financial Times. “They are the post reform costs. But people are still choosing the facts that most suit them from the report and then torturing the data until it confesses. That chart does not show that public sector pensions are sustainable as they stand. If they were, I would not have made 27 recommendations for fundamental change”.

But this cannot be right, as I will explain.

What is at stake is the use of this graph.

public sector pension costs as a share of GDP

It is important that we understand exactly what it measures. It is the cost of making pension payments (from the pay-as-you-g0 schemes) as a share of GDP (in lay terms GDP is the wealth the nation produces each year).

I am almost certain that it does not take account of contributions – either from employer or employee. Few commentators have grasped this and made much of the commentary elsewhere redundant. I say this because if you include contributions the cost comes down to a much smaller share of GDP. Indeed the net cost of some pension schemes (eg NHS) is negative as contributions are greater than pensions payments.

The pensions paid are assumed to be those agreed through negotiations with the last government, but with CPI indexing for pensions and deferred members’ benefits.

It does not take account of any other changes to pension schemes recommended by Lord Hutton or the government. It cannot have done so because it was included in Lord Hutton’s interim report before he made any recommendations and before the government had announced any further changes. The chart was produced by the Government Actuary’s Department and not his enquiry.

An important part of the agreement with the last government was the introduction of “cap and share”. This was a means of sharing the burden betwen employer and employee if longevity rose faster than expected.

By the time this chart was published GAD would have been able to include some of the costs of changed longevity as it had become clear that in some schemes cap and share would be triggered. This was announced by the previous government.

In addition the chart may have made some allowances for reduced public sector staffing numbers, and will have included the effect of people working longer as the agreement with the last government set new pension ages for new entrants.

As the Hutton report itself says:

Ex.11 This change in the indexation measure may have reduced the value of benefits to scheme members by around 15 per cent on average. When this change is combined with other reforms to date across the major schemes the value to current members of reformed schemes with CPI indexation is, on average, around 25 per cent less than the pre-reform schemes with RPI indexation.

Ex.12 All these past reforms, the current pay freeze and planned workforce reductions will reduce the future cost of pensions. The gross cost of paying unfunded public service pensions is expected to fall from 1.9 per cent of GDP in 2010-11 to 1.4 per cent of GDP by 2060 as the central projection of Chart 1.B shows.

My suspicion has always been that Lord Hutton agreed to do his report before finding out about the shift to CPI indexation. At a stroke that reduced the cost of pensions by 15 per cent as he recognises, and went much further than making pensions affordable as the previous negotiations had done into a pretty deep cut. That has always undermined anything the report had to say about affordability, even if he makes more substantial arguments about scheme design issues such as moving to career average pensions.