| SPOTLIGHT |
The final salary link in public services pensions is “inherently unfair” and the case for reform is clear, the Independent Public Services Pensions Commission led by Lord Hutton of Furness has said in an interim report.
However, the former Labour government minister said he rejected the argument that the downward drift of pensions in the private sector is justification for public sector pensions to follow the same course. “I have rejected a race for the bottom,” he said.
Lord Hutton argued that the current public service pension provision had been unable to respond flexibly to changes in life expectancy over recent decades, with someone retiring now expecting to spend 40% of their adult life in retirement.
He added: “This has driven up costs – by a third in the last decade – and these extra costs have fallen almost entirely to taxpayers. The final salary link in public service pensions is inherently unfair and can lead to high flyers getting almost twice as much back in pensions than those on more modest earnings for the same amount of pension contributions.”
The peer nevertheless said it was wrong to describe public service pensions as gold-plated. The average pension paid to pensioner members is £7,800 a year, with half of pensioners receiving less than £5,600 a year. Some 90% of pensioners receive less than £17,000 a year. The figures provide a modest – not an excessive – level of retirement income, he insisted.
The Commission will look at long-term structural reform options in its final report, which will be published in time for the 2011 Budget. It recommended raising the retirement age for public sector employees in the long run.
Lord Hutton said he will consider a range of alternative structures to the traditional final salary defined benefit scheme or the funded individual account defined contribution model, both of which he argued would not deal with the problems of the current system.
These other structures will include a career average alternative. “Drawing upon international experience, alternatives such as Sweden’s use of notional defined contribution schemes and the Netherlands’ collective defined contribution schemes will be examined, as will risk sharing models, such as hybrid schemes that combine elements of defined benefit and defined contribution models,” he said.
The Commission – as required by its terms of reference – looked at savings within the spending review period and concluded that there was a case for short-term changes. It said that raising contribution rates was the most effective way to make these savings. However, if implemented, steps should be taken to protect the low paid, and contribution rates should not be introduced for the armed forces at this time.
Michaela Berry, partner at leading pensions law firm Sacker & Partners, said public sector workers could breathe a sigh of relief that they are to keep their final salary benefits for at least the next four years – until after the current spending review period, the tax year 2014/15.
However, she added that “celebrations should be on hold until George Osborne tells them how much more they'll have to pay for these final salary benefits in the short term in the Spending Review on 20 October. Only the armed forces will be spared from this pain.”
Berry suggested that Lord Hutton’s interim report was the public sector’s Sword of Damocles, “laying the foundations for long-term structural reform of public sector pension schemes”.
She added: “The first shot of the battle for hearts and minds has been fired with Lord Hutton calling final salary benefits ‘fundamentally unfair’. We'll have to wait until his final report in Spring to discover what he recommends – but reading between the lines it looks like Career Average Revalued Earnings (CARE) is the front runner to replace final salary in the public sector.”
Berry said: “Hutton has kick started the process of change. The only sure thing is that public sector pensions will never be the same again."
Neil Bhan, a pensions expert at Beachcroft, suggested that the Hutton report findings represented the start of a process to reduce the costs to the taxpayer of funding public sector defined benefit pension provision.
He said: "The key issue will be whether increased contributions, a potentially later retirement date and introducing an element of career average and/or defined contribution style benefits are considered reasonable and necessary. The answer to that question may depend on whether such changes are perceived as an end point for reform or merely a stepping stone on the road to a complete removal of public sector defined benefit pension provision.
"The potential abolition of the pension protection afforded by the 'Fair Deal' regime for public sector employees who are outsourced to the private sector will be a key bone of contention for the unions, although the negative impact of its abolition would be reduced to the extent that the future public sector pension provision is itself diluted."
