Lord Hutton has recommended changes to public sector pension schemes. Joshua Chambers picks out the winners and losers from the proposals, and explains how they affect both civil servants and government policy.
People are irrational; this explains why they’re so bad at saving money for their later lives. That’s what behavioural economists will tell you, anyhow. Professor Andrew Oswald of Warwick University observes that “human beings can’t be trusted to save for their own future. That’s a problem we need to solve for society.”
The solution to this dilemma was once said to be final salary pension schemes, but as life expectancy grows they have increasingly been dismissed as unaffordable. The government’s financial problems have added weight to this argument.
Public sector pensions are the last bastion of final salary schemes, but last month Lord Hutton of Furness recommended that they be scrapped. The former Labour cabinet minister, tasked with assessing our public sector pension rules, had set up the Independent Public Service Pensions Commission to do so.
Hutton thinks the current system is unaffordable and unfair, and creates a barrier between the public and private sectors; he recommends reform. His proposed changes have gone down well with the chancellor, who in his Budget speech said: “The government accepts Hutton’s recommendations as a basis for consultation with public sector workers, unions, and others. There should be no cherry-picking on either side.”
As the consultation begins, CSW has looked at the findings of the Hutton report to explain how they affect senior civil servants – not only as pension scheme members, but as policymakers and managers too.
Final salary pension schemes have not been available to new public sector workers for some time, but even people currently in such schemes will now be transferred into career-average pension schemes. The specifics will be determined after consultation, but this type of scheme links pension payments to average pay over the employment lifetime of an individual, rather than to pay during their last year or two in the job.
The commission has stressed that the changes will not affect the ‘accrued rights’ of civil servants currently on final salary pension schemes. The Hutton report says that “government must honour in full... accrued rights. In doing so, the commission recommends maintaining the final salary link for past service for current members.” So if someone contributes for 40 years to a final salary scheme and it changes to average salary five years before they retire, the 40th year would count towards their pension under the old terms, with the last five years accruing under average salary terms.
Meanwhile, the government decided last year that it will raise employee contributions by three percentage points. This may encourage some public sector workers to leave the pension scheme altogether, according to Charles Cotton, a pensions expert at the Chartered Institute of Personnel and Development (CIPD): “The concern is that if people have got to find three per cent more when many of them are facing pay freezes and increases in the cost of living, they may opt-out,” he warns. To avoid this, he argues, the government should raise contributions incrementally over some years. He acknowledges that the chancellor may be reluctant to forego the extra income at the moment, however.
Hutton recommended that the new pension scheme be tied to inflation using the Retail Price Index (RPI), where previously it was tied to the Consumer Price Index (RPI): RPI gives a lower rate, reducing government pension obligations. The government is also tying the public sector retirement age to the state pension – which will rise to 66 in April 2020. The 2011 Budget set in place mechanisms to continue to assess, and perhaps therefore to increase, the state pension age.
Under Hutton’s plan, the government pays less and future high-fliers lose most: under average salary schemes, their pensions will be smaller – but they’ll still be paying increased contributions and retiring later.
It may not be immediately obvious, but there are actually some winners from the new scheme. Doctor Ros Altmann is director general of Saga, a company which provides services for older people, and she says career-average schemes can benefit women who take career breaks to look after their children and return on a part-time basis. “They get credited for each year of their earnings, rather than focusing on a chunk of their career at the end, which for many women is not their highest [paid period],” she says.
The new pensions scheme could also theoretically benefit the lowest-paid workers. Altmann says that with the end of final salary pensions, money won’t be “disproportionately” paid to the most senior officials; with overall expenditure on pensions remaining static, more money could be distributed to the lowest-paid. Given that much of the motivation behind pensions reform is to find savings, however, the government may be eager to claw back any potential savings that it sees.
Meanwhile, ending final salary pensions may reduce the incentive for highly-skilled professionals to work in the most stressful roles, or to join the public sector from elsewhere. “One of the advantages of a final salary pension scheme is to incentivise senior people to take high-stress jobs towards the end of their careers,” says Professor Oswald. “You’re going to have to raise the pay packet to replace these final salary benefits.” However, at a time of downward pressure on higher public sector salaries, this looks unlikely; generous pensions provided a stealthier way of encouraging talented workers to join the civil service, he believes.
Professor Nicholas Barr was on the commission, and denies that salaries will have to increase. The career-average scheme is still an incentive to join the public sector, he says, and much better than most private sector pensions. Barr also argues that younger employees aren’t incentivised by pension schemes, and criticises final salary schemes for “distorting” the labour market: they tie civil servants to the public sector for life, he believes, reducing labour market flexibility. This dynamic also undermines the exhortations to civil servants to “get out to get on”, hitting those who might otherwise be willing to gain experience outside government before returning with newfound skills.
One of the commission’s aims was to level the playing field and reduce the disparity between public and private pensions, without engaging in what Lord Hutton called a “race to the bottom”. And in part, Cotton believes, the proposed new scheme does create a more level playing field. Within the public sector, it will be easier to transfer between local and central government, he says. However, there is still a big disparity between public and private sector pensions – and this could damage other coalition policies.
The Cabinet Office is keen to champion mutualisation of public services. In the past, workers in many healthcare mutuals had the ability to remain in a public sector pension scheme – removing one big barrier to mutualisation. But Hutton has now said that it is “undesirable for future non-public service workers to have access to public service pension schemes, given the increased long-term risk this places on the government and taxpayers”.
Cotton believes it would be “too costly” for mutual organisations to set up similar pensions schemes, as recommended by the Hutton review. A balance has been struck between encouraging labour mobility, outsourcing and mutualisation on the one hand, and retaining employee benefits on the other.
The new scheme will come into effect only once the government has negotiated with the unions. Given the problems and delays faced when both the Labour administration and now the coalition government tried to change redundancy pay, this may take some time.
Hutton believes that his solution is the right approach to a difficult dilemma. The changes represent a reduction in the remuneration for many public sector employees. However, they could be worse: Barr says that the career-average scheme “gives you much more certainty than schemes in the private sector, where you are dependent on the stock market value of your pension pot on the day you retire – which is, at its worst, a lottery”.
This is a complex and controversial topic. But the Independent Public Services Pensions Commission, at least, believes its reforms will ensure that even creatures as irrational as humans continue to see joining the civil service as a rational choice.