From the TUC

What John Hutton might say

05 Oct 2010, by in Pensions & Investment, Public services

On Thursday October 7th Lord (John) Hutton will publish his interim report on the future of public service pensions. He has been asked by the Government in this first report, to identify immediate savings that can be made and it is likely that he will indicate the changes he is considering for more fundamental structural change in his second and final report. What might he say?

Reducing costs

There are only two ways to reduce the immediate cost of pensions:

  • pensions in payment could be immediately cut, but while this has happened in some other countries both coalition parties pledged to protect “accrued benefits” before the election. While this term only has clear legal meaning in private sector schemes, it is unlikely that the statement is compatible with immediate cuts in pensions in payment or a reduction in pensions that people have already built up.

However the switch to indexing public service pensions in payment by the CPI measure of inflation rather than the RPI will have a very significant effect on the costs of future public service pensions. The CPI measure of inflation excludes housing and council tax costs, and is calculated on a different basis to RPI.

The table shows that the Treasury are predicting a 7.4 per cent cut in pensions by changing the link to CPI over the next six years.

Forecast Increase (%)
Year of increase 2011 2012 2013 2014 2015 2016 Overall
CPI 2.7 2.4 1.9 2.0 2.0 2.0 13.7
RPI 3.7 3.2 3.2 3.3 3.4 3.5 22.1
Shortfall 1.0 0.8 1.3 1.3 1.4 1.5 7.4
  • member contributions could be increased – this would reduce the take-home pay of public sector staff and the Treasury would pocket the savings. But public sector pay is frozen  and inflation is alreay causing a cut in living standards, and the indexing to CPI has already significantly cut the value of public service pensions.

While most speculation has been that Hutton will recommend a contribution increase, it is unclear whether he will put a figure on it. It has also been suggested that he may recommend some protection for the low paid. While how much in total should be paid by employer and employee in total for a given retirement income is a pensions issue, how you split these contributions between employer and employee is an industrial relations issue.

It has also been suggested that Hutton may recommend an immediate increase in the pension age for future pension accruals.

This is often misunderstood. The pension age is not the same as the age at which people retire, but part of the formula used to work out how much pension you receive when you retire. If you retire before your pension age, your pension is reduced. If you defer your pension and retire at a later date then it is increased.

Public servants already have a range of pension ages in their schemes. Everyone in local government has a pension age of 65. The police, firefighters and armed services have lower pension ages ro recognise the arduous physical nature of their jobs. In the rest of the public sector changes were negotiated in 2005 that means that new staff taken on since then have a pension age of 65, while existing staff kept a pension age of 60.

It is perfectly possible for people to have pensions with different pension ages. If people change employer, it is possible that they may move between schemes with different pension ages. Similarly people can stick with the same employer but move from one scheme to another.

Longer term issues

Hutton may set out his thinking on possible structural changes to pensions in future either with a range of options or his favoured alternative. Possible elements include:

  • a move to career average pensions – Most public sector pensions are final salary pensions (however the civil service scheme is already a career average scheme). The pension paid out  by a final salary scheme only takes into account what you earn when you leave your job. A career average scheme instead takes your average pay while in employment (updating earlier years by inflation.)

Final salary schemes clearly benefit those who get promoted. In the private sector, it is not unknown for top staff to receive a big salary bonus in their final year to bump up their pension. A career average scheme provides much less reward for such promotions and is therefore cheaper to provide.

It is often said that career average schemes are fairer than final salary schemes. But moving from a final salary to a career average pension may not benefit anyone, it may simply hit better off staff harder than lower paid staff.

When the civil service scheme moved to a career average  some of the savings were put back into the pension scheme thus providing a better deal for low paid staff whose pay did not increase by miuch over their employment at the expense of those winning promotion. If none of the savings are put back into the pension then everyone can lose – though high-flyers lose more.

In some public sector schemes higher paid staff already pay a higher per centage contribution than lower paid staff.

  • a cap on pensionable pay – One suggestion is that Hutton may limit the pay on which people can build up a salary related pension. This would mean that only pay below a certain figure (£50,000 has been mentioned) would be pensionable. Above this, staff would contribute to a new notional DC scheme (with or without an employer contribution as well). DC schemes (defined contribution schemes) in the private sector invest money on behalf of their members. When they retire their pension depends on how their investments have performed and how big an annuity they can buy with their pension pot. In a notional DC scheme the money is not invested but kept by the Treasury who add a return to it each year. The member then gets this pension pot when they retire as if it has been invested.
  • reduced accrual rates – This is a simple reduction in how much pension you build up each year. Different public sector schemes have different accrual rates but 1/50 is common.

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