Express - public sector pensions must change

by Dr. Ros Altmann

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Daily Express, 16 June 2010

Public Sector Pensions - fairness and affordability

Finally we have it. The verdict from the Deputy Prime Minister is that the ballooning cost of public sector pensions is 'not just unfair, it's not affordable'. Many experts have warned for years about of these hidden public sector pension costs and the growing divide between public sector pensions and those available in the private sector. Almost all private sector final salary schemes have now closed, as employers have discovered that they are far more expensive than expected and no longer affordable. But around 90% of public sector workers are still in their super-safe, fully inflation-linked final salary pension arrangements, which must be paid by future taxpayers.

Public sector workers do a wonderful job, often in difficult circumstances and they are entitled to decent pay and pensions. However, with huge pressure on the public finances, we have to scrutinise all areas of spending.

This week's Report from the Office of Budget Responsibility (OBR), outlining the economic forecasts to be used in the Budget, also highlighted the rapidly rising costs of public sector pension payments. The Report shows that net spending on public sector pensions will more than double over the next five years and it also highlighted that the annual costs of new pension commitments building up each year are £26billion. But this Report used the Government's own flawed assumptions, which are not supported by independent studies. When assessed using an appropriate discount rate, the actual costs of these pensions is double the official estimate - well over £50billion a year according to Philip Booth of the Institute of Economic Affairs.

Given the furore over the Government's plans to shave just £6billion off public spending, the idea that we are actually committing a whopping £30billion extra each year into the future, that has not even been accounted for, is alarming. Apart from local authority workers and MPs, no money has been set aside to pay for these public sector pensions in future. As we struggle to cut public spending, the money will still have to be found.

How did we get into this position? There are many reasons, but the most important is that Government has consistently failed to provide proper transparency about the costs and pretended for years that these commitments are 'fully affordable', without doing its sums properly. The costs of public sector pensions are not included in the official 'fiscal rules' and have been hidden off balance sheet. That may be about to change.

The new Government has now admitted that, not only are these pensions not affordable any longer, they are also grossly unfair. The debate, therefore, has moved on from whether these pensions need reforming, to asking what reforms will be introduced.

Of course, part of the reason for the surge in costs is due to people living longer - which is pretty good news. It is also because public sector salaries have risen far faster than forecast - which is also good news for public sector workers. In fact, it used to be the case that public sector salaries were lower than equivalent private sector pay, but the generous pension benefits made up for that. However, since 1997, public sector unions have done a tremendous job in improving salaries. Official statistics reveal that pay in the public sector is now higher than in the private sector. So, public sector workers have better pay and pensions than comparable private sector workers.

That is not to say that public sector workers will all be receiving huge pensions. Some highly paid public employees will receive enormous pensions, but the average is perhaps around £6,000 a year or so. But this is far better than will be paid to most private sector workers. In addition, it is taxpayer-guaranteed, and paid from a much younger age than state pensions. Even when state pension age rises to 68 in future, most of today's public sector workers will still get their pensions at 60.

The OBR report also shows that net public sector pension spending, even on the Government's own figures, will increase by an average of 20 per cent every year over the next five years. In the current climate of cost cutting, this hardly seems sustainable. Private pensions have been hit hard by the credit crisis, with falling interest rates, rising annuity rates and disappointing stock markets. None of this has affected public sector pensions. Can the Government justify asking taxpayers whose own pensions are falling, to continue to fund ever-rising costs for public workers' pensions. Independent estimates show that most of these public sector pensions are worth around 40% of each year's salary. Yet the Government's assumptions value them at only 20% - in other words the true costs are double what we are being told.

There are many ways in which things could change. It is not easy and no doubt public workers will resist. There may be industrial unrest. Quite rightly, public sector unions will fight hard to protect their members' terms and conditions - that is their job. But the reality is that taxpayers cannot be expected to provide much better pensions to one group of workers, while they themselves head for a miserable retirement.

The situation is complex and the Government is expected to announce an independent inquiry into the costs, fairness and sustainability of public sector pensions. This should, at last, give an honest assessment of the situation - with figures produced by private sector experts who do not have a vested interest in hiding the true costs.

What might change? The first thing to say is that pension rights which public workers have already accrued should not be affected. We are talking about changes for future rights, not past entitlements. Therefore, those closest to retirement will be least affected.

Perhaps workers will be asked to contribute more to their pensions. Perhaps the pension age will be increased. Inflation linking could be cut, or the generosity of each year's pension building up might be reduced. Schemes may change to provide average salary pensions, rather than final salary. More radically, there have been calls to scrap these guaranteed pensions and for public sector workers to be moved onto the kind of pensions that most private sector employers now offer. These are defined contribution schemes, which do not promise to pay any specified level of pension. The employer merely puts in contributions each year, alongside workers, and the ultimate pension paid out will depend on investment returns, fees charged and any annuity that is purchased on retirement. This puts all the risks on the worker, rather than the employer, and is far less secure.

All these options will be on the table, but the most important starting point is to understand the costs and then decide what taxpayer burdens are acceptable, how much workers themselves may have to pay for their pensions and what changes can be made that are both fair and affordable in the future. At last politicians have woken up to the problem, now let's try to find the best solution.


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