Reform of Public Sector pensions
by Dr. Ros Altmann
(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)
It must be a rather worrying time for public workers, who have recently begun to better appreciate the true value represented by a Government-guaranteed pension. The landscape ahead looks distinctly hostile to the indefinite continuation of extremely generous public sector pension arrangements. As private sector employers are cutting back on defined benefit pensions and contributions to money purchase schemes are relatively low, the open-ended generosity of public sector schemes – especially those which are unfunded – will be a potential cause for social unease. On present estimates, the costs of unfunded public sector pension provision will double over the next 30 years (from 1.15% of GDP to 2.3%). Many commentators believe that the real increase could be substantially higher. The implications for future taxpayers have begun to be better appreciated and this is likely to become a hot political issue.
What will the new Prime Minister do? It is not clear precisely what Gordon Brown’s agenda on pensions will be, but there have been rumours that he was not entirely comfortable with the Government’s 2005 deal with the unions to allow current public sector workers to continue to retire at 60. Lord Turner has recently called for a rethink and Opposition parties have also suggested they favour amending the agreement
The long-term continuation of public sector pensions, in their current form, seems to me to be highly unlikely. The real question is how they will change, rather than whether they will change.
There are three major questions. Firstly, what will be the normal pension age? Secondly, will they remain as final salary schemes? Thirdly, what will contribution levels be?
After 2005’s failed attempt to raise normal pension age from 60 to 65, the Government may try another initiative, but this time with better consultation. It seems most likely that normal pension age for public sector workers will increase in line with the state pension age in future decades, but that, as now, the age of retirement will not necessarily coincide with pension age, thus catering for individual differences. The notion of one age beyond which people are expected to stop working, is outdated.
There are, in fact, many advantages in raising normal pension ages. Indeed, I believe part of the solution to the global pensions crisis has to include longer working lives. This does not need to be full-time work, but could encompass a new phase of life with part-time working for 10 or 15 years after age 60. 2 or 3 days a week work, 4 or 5 days a week free to pursue other interests, but more money to spend overall. As this becomes more common in the private sector, public sector workers are likely to follow.
UK public sector pensions are, without doubt, some of the most generous pension arrangements in the world. As longevity rises and private sector final salary schemes decline, it is inevitable that such generous schemes will come under pressure. A move to career average revalued earnings pension arrangements, away from final salary, is the most likely reform. This type of arrangement would fit in much better with flexible and gradual retirement. It could also benefit many workers. Women in particular are less likely to have their highest earnings just before retirement. Those who will lose out most in such arrangements are the most senior public sector workers, whose average salary will be lower than their final salary. Perhaps interim arrangements could be made for such employees.
On the question of contributions, most estimates suggest that the value of a typical public sector final salary pension is now worth 25%-30% of salary. The original rationale for exceptionally generous public sector pension arrangements was that public servants’ wages were lower than private sector employees, so this was compensated for by better pensions (deferred pay).
This rationale has disappeared. Median public sector pay is now higher than private sector pay. Coupled with much more generous pension provision, total remuneration in the public sector has risen significantly. This is likely to increase pressure on the Government to raise contribution levels paid by public sector employees, to better reflect the value of their pension benefits. Perhaps the Government will offer public sector workers the opportunity to retain generous pensions only if they are willing to substantially increase their contributions, but to be transferred into a less generous scheme if they are unwilling to pay more themselves.
A really modern approach could even see pensions forming part of a flexible benefits package, offering public sector workers a monetary value that they can choose to spend on various benefits. One option would be a pension, but they could also use the money for repaying student loans when young, a mortgage, travel, education and so on. After the recent pension reforms, the need to contribute as early as possible has diminished, since contributions can be made up later in life. Paying back debt may be better for younger workers than saving for their pension until they are older. This would fundamentally change public sector pension provision but may actually prove popular with many. Do you think public servants are ready for such radical thinking?