From the TUC

Robert Peston’s peculiar public sector pensions story

05 Jan 2012, by in Pensions & Investment

It may be a quiet news day today, but that does not explain Robert Peston’s curious report, first on the Today programme and now on his blog, on public sector pensions. This claims – based on the work of John Ralfe:

The increase in the normal retirement age from 60 to 67 for public sector workers has not led to significant savings in the cost of public-sector pensions.

The story is odd in a number of ways. We can wonder why the BBC’s Business Editor is reporting on a non-business story in which he has not been much  involved before – unlike say John Moylan, their industry correspondent who has covered the story in depth. It is also strange that the BBC is covering research that has not – as far as we can tell – been published. It is certainly not on Mr Ralfe’s website.

Mr Ralfe has been a leading critic of public sector pensions for many years. If a journalist wanted an “unsustainable” quote they knew where to go. His consistent argument has been that the discount rate used to value the cost in today’s money of public sector pension payments in the future is wrong. His preferred  figure produces significantly higher costs. They are a great source for those who like big scary numbers to attack future public sector pension costs.

It’s a point of view, but not one that is widely shared beyond the predictable right-wing critics of public sector pensions.

The National Audit Office and the Hutton Report both say that expressing future costs in today’s money is not a helpful way of valuing the cost of pensions.  They say the better measure of measuring future commitments is to look at the share of future GDP they will take. The Government’s Actuary Department predicted this to be steady after the deal negotiated with Alan Johnson, and now says it will fall, mainly because of the impact of the change in indexation from RPI to CPI. This approach is also endorsed by the OBR. Government ministers came unstuck on the Today programme on consecutive days when they tried to argue the “unsustainable” line against this analysis.

There has also been a Treasury led review of the discount rate used in pensions. This resulted in a not insignificant change from a member perspective, but Mr Ralfe was disappointed by the review as it rejected his arguments. 

As Mr Ralfe has not published  his work, we cannot say how much of the argument in Robert Peston’s blog are his and how much Peston’s gloss, but whatever the balance they are misleading and confusing.

They focus on just one change in public sector pensions – and ignore the other two. If Robert Peston had put his claim to the TUC that contribution increases and the switch to CPI indexation:

“were not seen as the major source of acrimony between ministers and trade unions”

we would have laughed (or perhaps more appropriately cried).

Government changes need to be seen as a package. The union complaint is that people are being asked to pay more (ie higher contributions), work longer (ie increase in the normal pension age) and get less (ie the change in indexation to CPI).

In addition there are scheme design issues, such as the move to career average pensions. These flow from the Hutton report. Most of these can be done in ways that are cost neutral. Some may lose and some may gain but the change can be made in ways that do  not change the overall cost of pensions.

Mr Ralfe’s figures do not chime with our analysis, nor with Channel Four’s factcheck that  found againt the government’s claim that pensions would be just as generous under their proposals. But even if you accept them, it is absurd to ignore all the extra income that will be raised not just from significantly higher contributions – Peston is right about this – but also from the extra years of contributions that will be paid.

Nor is it right to say that the government’s proposals are a straightforward increase in pension age from 60 to 65.  Local Government already has a pension age of 65 for all. In other schemes the Johnson changes have meant that new starters have had a pension age of 65 for some years.

But the most misleading argument is the section about accrual rates. As Jon Rogers shows, the statement about existing accrual rates is wrong.

What is worse is that accrual rates in a final salary scheme are compared with those in a career average scheme. A career average scheme needs a significantly higher accrual rate to provide as good a pension as a final salary scheme for the vast majority.

This is because people’s earnings tend to go up over time. If you take a calculation based on a final salary it will therefore be higher than if you use the same factors but start with someone’s (almost inevitably) lower average salary.

It is made even more complicated by how you work out average salary. In any career average calculation you need to uprate past service by inflation to express past earnings in today’s money. This is not straightforward as there are different ways of doing this. The civil service NUVOS scheme, the one existing career average scheme, uses price inflation (which of course has changed from RPI to CPI to the detriment of NUVOS members).

Hutton argued for the increase in average earnings to be used for indexation, rather than prices. As this tends to be higher than prices over time, this produces a higher figure for average salary. To maintain a cost neutral pension package a career average scheme with earnings related indexation would therefore have a somewhat lower accrual rate than one with price indexation.

You do not need to follow all the technicalities of this to see that the generosity of a career average pension depends on three factors: the accrual rate,the normal pension age and the indexation factor, while a final salary pension only depends on the accrual rate and the pension age.

Therefore it is highly misleading to say that:

Before the changes, which were finally agreed before Christmas, public-sector workers accrued pension entitlements at the rate of 1/80 of salary per annum, plus a cash lump sum on retirement of 3/80 of salary, which was equivalent to an accrual rate of 1/70. For teachers the new accrual rate is 1/57 of salary per annum, for healthworkers it is 1/54 and for civil servants it is 1/44 – which is significantly more generous than the old arrangements. (my emphasis.)

Curiously everything else I can find on public sector pensions written by Robert Peston also seems to come from John Ralfe. This is not to say that Mr Ralfe is not a legitimate figure in the pensions debate, but it is odd that such a distinguished journalist  should appear to rely on a single source.

I’ve always liked and admired Robert Peston’s work. I’ve not always agreed, but have always respected him as someone who does his homework and knows his subject. His somewhat stumbling piece on the Today programme this morning did not meet this expectation. ‘More in sorrow than in anger’ is probably a bit of a cliche, but it captures my mood rather well in writing this.

5 Responses to Robert Peston’s peculiar public sector pensions story

  1. Luke Snell
    Jan 5th 2012, 7:38 pm

    “Hutton argued for the increase in average earnings to be used for indexation..this tends to be higher than prices over time”
    Are we sure this assertion is valid given trends over the past 10-15 years?

    (The quote from Preston you start with, attributed to data from Ralfe, is a strange choice. It seems to go against the main thrust of your post – instead suggesting that Preston argues changes are *not* cost-saving based on Ralfe’s data.)

  2. Bryn Davies
    Jan 6th 2012, 9:40 am

    Thanks for a great post. One additional inaccuracy in the BBC’s reports on this was the description of Ralfe as a “pensions expert”. He is an accountant with a background in investment who shows only limited knowledge of pensions as such. At best he is a “pensions investment expert”, although his main argument is that pension schemes should be invested in low yielding bonds, which means, inevitably, that over time they will be much more expensive to finance than is necessary. He has made one notably good call, moving a large part of the Boots fund from equities into fixed interest at the right time, although there is more than a flavour of this being right in the sense that a stopped clock is right twice a day.

  3. Nigel Stanley

    Nigel Stanley
    Jan 6th 2012, 10:24 am

    @Luke It’s certainly the case that in the very recent past that prices have gone up more than earnings. This may continue, though inflation is set to fall.

    I’ve not looked at the longer term figures in enormous detail (though I’m now tempted to do so if I get the time) but would expect the difference to have come down over the last couple of decades or so.

    But if you take the span of working lives (the right scale for pension schemes) I think you will find it hard to find arguments that we can expect prices to outstrip average wages.

    (And the original piece was so confused it was hard to find a single quote. People should really read the whole thing, not rely on my one extract.)

  4. Does uprating by prices lead to better results than uprating by wages? | ToUChstone blog: A public policy blog from the TUC
    Jan 19th 2012, 2:01 pm

    […] my earlier post on public sector pensions I asserted that indexing by earnings produces better results than […]

  5. Nigel Stanley

    Nigel Stanley
    Jan 19th 2012, 2:02 pm

    @Luke I’ve now looked at the difference between indexing by earnings and prices – both CPI and RPI. It’s only in the atypical last few years that prices have gone up more than earnings.