6. Public sector pensions

The coalition programme

The two coalition parties were equally critical of public sector pension arrangements before the 2010 general election. Coalition prime minister David Cameron had spoken previously of an “apartheid on pensions”. An independent commission to review the long-term affordability of public sector pensions while protecting accrued rights was in its programme from the start.

The Treasury was expected to take the lead on this but pensions minister Stephen Webb highlighted differences between different schemes (whether or not they are funded, how much members put in, whether they are on relative low pay). There was no “one size fits all” approach but the review would be “fair” to those who work in the public sector — some of whom are on relatively low wages and retire on pretty modest pensions.

Public sector schemes

The public sector is dominated by a relatively small number of very large pension schemes which between them have five million active members and two and a half million pensioners: More than a fifth of all pensioners receive income from a public sector pension. All the major schemes are established under the Superannuation Act 1972 and have a statutory guarantee (rendering them exempt from the PPF levy).

Pension coverage is higher among public sector workers than private sector workers. Among members of pension schemes, pension accrual — measured as a share of earnings — is typically higher among public sector workers than private sector workers (Institute for Fiscal Studies).

Compared with the lack of occupational pension saving by “vast swathes” of the working population, the public sector shows how the trend for non-saving can be countered. As the GMB report on Public Sector Pensions points out: “The key reason for this disparity is the value of schemes to employees … the better a scheme is more likely people are to participate”.

The “unfunded” schemes

Criticism of public sector pensions rests heavily on the question of cost and funding (although superior pension benefits are also part of the political equation). Most of the big public sector schemes operate on a pay-as-you-go (PAYG) basis unlike the defined benefit schemes of the private sector. The local government pension scheme (LGPS) and university lecturers’ USS scheme are exceptions (see below).

These schemes, in the NHS and civil service or covering school teachers have no investment fund and are therefore referred to as “unfunded”. Today’s contributions from current employees and employers are used to pay today’s pensions, with the Treasury covering any difference. Huge sums are often quoted as the cost of settling the liabilities of the unfunded public sector schemes.

The Office for Budget Responsibility (OBR) quotes a figure of £770 billion but that would include future payments. The net current cost, the difference between contributions and pensions being paid out, is predicted by the OBR to rise from £4.4 billion to £10.3 billion by 2015-16, a gap that will be widened by pay freezes and job cuts.

In 2009, it was reported that public sector pension liabilities in the UK amount to the equivalent to 85% of Gross Domestic Product (GDP), about £20,000 per person in the UK” (British North American Committee). Even bigger numbers have been published by other pundits.

But a long-term view tells a very different story. Instead of calculating liabilities for decades ahead and presenting the total as a sum that has to be paid now, the National Audit Office (NAO) focused on cash flow, payments out to pensioners and payments in from employee contributions in a report on the unfunded schemes published in March 2010. Payments made by the four largest “unfunded” amounted to just 1.7% of GDP over the last decade and, although set to rise to 1.9% over the next eight or nine years, were expected to fall back to 1.7% by 2059-60.

The TUC welcomed the NAO report as evidence that these schemes are affordable, sustainable and far from gold-plated.

Similar figures appeared in the OBR pre-Budget report and the OBR acknowledges that the PAYG schemes “have some advantages for the government in terms of fiscal management”.

The funded schemes

The Local Government Pension Scheme (LGPS) for England and Wales is, in effect, around a hundred separate funds operating within a single set of rules. The GMB report on Public Sector Pensions (January 2010) says that, on a year by year cash flow basis: “Not only is the LGPS not in deficit, it’s actually in surplus”. For Great Britain as a whole income exceeded expenditure in 2007-08 by over 6.5 billion. A similar scheme operates in Scotland.

The LGPS does not operate on a cash flow basis and its funds are actuarially assessed on the basis of real assets and liabilities with each individual fund valued every three years like any other funded scheme. The funding level for 2007 was 83.5% (up from 74.9% in 2004) but its assets and investments could pay benefits for over 20 years while contributions exceed expenditure by £4-5 billion a year.

The Universities Superannuation Scheme (USS). USS is the main pension scheme for academic and academic-related staff in more than 300 higher education institutions and is the second largest private pension fund in the UK. In May 2010, members of the UCU lecturers, union voted overwhelmingly to reject the creation of a two-tier system involving a CARE scheme for new starters which would allow the employers to establish a precedent to remove final salary pensions.

The value of the USS fund fell from £28.8 billion at 31 March 2008 to £21.4 billion at 31 March 2009 (32%) but employees’ contributions increased from 14% to 16% in October 2009 following the 2008 actuarial valuation.

A valuation of the Royal Mail Pension Fund in 2006 indicated a £3.4 billion shortfall, obliging it to pay £280 million per year to service the deficit alone. The scheme closed to new members in 2008 (a DC scheme was introduced), career average benefits were introduced going forward, and normal pension age increased to 65 in April 2010.

However, with the 2009 valuation expected to indicate a tripling of the deficit to around £10 billion, adjusted repayments calculated on similar criteria could see annual costs rising to £1 billion. The union (CWU) argues that as sole shareholder the government has a responsibility to address this crisis, “particularly in light of the fact that decisions made and regulatory environments created by successive governments have actually created the deficit”.

The Hooper review into postal services in December 2008 recommended that the responsibility for historic liabilities should be transferred from the Royal Mail to government: “The government would have received £23.5 billion in assets immediately”, the union pointed out: “Though future liabilities were estimated at £29.5 billion, the £6 billion deficit would have been absorbed gradually over the lifetime of the scheme”. But the decision by the Labour government not to go ahead with its Postal Services Bill, meant that the plan to implement the Hooper Report’s recommendation on pensions was shelved.

A major cause of the deficit in Royal Mail’s pension fund, CWU argues, is the 13 year pension contribution holiday taken by the business between 1 April 1990 and 31 March 2003. An estimated £100 million per year in contributions were missed which, if invested, “would have gone a long way towards preventing, or at least minimising, the current deficit”.

“Unreformed and gold-plated”

Deputy prime minister Nick Clegg attacked public sector pensions as “unreformed and gold-plated” following the OBR report in June 2010 but the schemes have recently been reformed and the level of pensions payment is modest.

The Institute for Fiscal Studies (IFS)pointed out that reforms by the previous Labour government on average reduced the generosity and future cost to the tax payer of pensions provided to new entrants by increasing the age at which a new entrant can receive an unreduced pension from 60 to 65 (teachers, TPC, NHS and civil service PCSPS schemes), by changes to ill-health retirement provisions and changes to employee contribution rates.

These changes were the result of the2005 Public Services Forum agreement between the government and unions. In the years that followed all the main schemes in the public sector, including LGPS, were reformed resulting in reduced costs to employers and a redesign of benefits and contribution rates for members. Going forward, employer costs will be capped (at around 14% for the NHS and teachers, and 20% in the civil service).

The IFS highlighted a 2005 Treasury estimate of the net savings of these reforms put at 2.8% of total projected public sector pension liabilities, mostly coming from new entrants to the schemes. This was before Labour’s proposed £1 billion cap on employer contributions. Cuts in unfunded public sector pensions “would not contribute towards the immediate goal of reducing the headline deficit”.

In schemes covered by the NAO report the average (mean) pension paid in 2008-09 was £7,388 (£5,928 for civil servants, £6,931 for NHS staff, £7,519 in the armed forces and £9,358 to teachers). The average council workers’ pension is less than £4,000 and less than £3,000 for a woman. Averages like these don’t tell the whole story, with large numbers on lower pensions (either because of low pay or short service) balanced by much bigger pensions for a smaller number on the highest salaries before their retirement.

The TUC points out that “the vast majority of pensions in payment are modest” with most pensions paid in both the NHS and civil service below £110.00 a week: “A quarter of NHS pensions are less than £40.00 a week and a quarter of civil service pensions are less than £60.00 a week”. Normal pension age in the civil service, NHS and for school teachers is now 65.

Comparing similar DB schemes (in terms of size) active members in private sector pension schemes had more generous accrual rates than those in public sector schemes (Pension Trends, ONS).

“The pension critics forget that for many years contributions were greater than pensions in payment. That money just went into the general public finance coffers, and was cash that did not have to be borrowed or raised in taxation”, says the TUC. “The point of unfunded pensions is that the government does not have to invest in assets to try and chase GDP growth as tax revenue is already broadly linked to GDP”.