The New Public Sector Pensions offer – No-one is protecting taxpayers!! A critique: Public Service Pensions CM8214 – HM Treasury, November 2011
by Dr. Ros Altmann
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The revised offer to public service workers, outlined in the above document, is a substantially improved pension deal relative to that proposed by Lord Hutton. Of primary concern is that there is no proper protection for taxpayers built into this document. No cost estimates have been produced to explain how much this revised offer will cost future taxpayers. The offer seems to be designed to make sure workers receive much more generous benefits, while failing to adequately recognise the risks to taxpayers.
Do Ministers actually understand how generous this offer is? I am not sure whether they do or not, but I am sure that taxpayers are completely unaware of the extent of future costs and risks that this deal will impose on the private sector. We need to wake up to this danger before any new changes become even more difficult to make.
This deal offers neither certainty, nor fairness to taxpayers.
Danny Alexander concludes, in his Foreword that this is ‘a generous deal, offering certainty and fairness to both public service workers and other taxpayers’. There is no evidence that this offers either certainty or fairness to private sector taxpayers. Indeed, the only proper protection for taxpayers would be from an explicit contribution cap, but the details of this are being left for the future. They need to be agreed immediately as they are crucial to taxpayer protection.
One-way bet for workers
So, all in all, this latest offer is a one-way bet for workers. They are receiving a 25 year lock-in to benefits that are already better than they could get in the private sector – and will be even more so in future. And if today’s cost estimates are inaccurate, tomorrow’s taxpayers are being saddled with costs and risks they cannot protect themselves from, as workers’ terms are locked.
The Treasury’s conclusion is that the ‘offer is generous and reasonable both to public service workers and other taxpayers’. Unfortunately, there is no evidence at all in this paper that the offer is reasonable to private sector taxpayers.
Quite the contrary. In fact, the paper states that, in addition to public service workers earning over 7% more than their private sector counterparts in terms of their current pay, this deal means that their future pensions (i.e. deferred pay) will also be significantly better than private sector pensions. There are no cost estimates to show taxpayers what this will cost. There is no independent assessment of the details or assumptions. There is not even any certainty about the proposed cap on taxpayer contributions.
- A 25 year deal is a huge risk for taxpayers and will leave future Governments hamstrung if (when!) costs over-run. Taxpayers would have to bear all these costs.
- A long-term deal is also a risk ahead of changes to the state pension and likely ending of contracting-out. Scheme design currently includes replacement for state pensions and would not be able to change. The extra NI contributions may be resisted too and we should be having integrated negotiations alongside the forthcoming state pensions White Paper, rather than fixing a deal now.
- Cost ceiling is too vague and is not a real ceiling – we need more clarity for taxpayers
- Cost caps have not been worked out at all and will be left to future negotiation, yet this is the only proper mechanism for protecting future taxpayers. Caps must be agreed now.
- Higher accrual rates are an 8% improvement in pensions for public sector workers – at what cost?
- Protection for those within ten years of pension age is very expensive since these are likely to be the highest paid workers who will now still retire far earlier than private sector workers whose state pension age has been increased with only 6 or 7 years’ notice. This is clearly unfair to private sector workers, especially women.
- Low and middle earners will be protected – what is the definition of these groups?
- Final salary accrued benefits will be based on actual final salary at retirement, not salary when moving to new arrangements. This is very costly and very generous – how much will it cost?
- Individual schemes can still design different terms, and any cost over-runs only have to satisfy Government that they are reasonable protection for taxpayers, but there will be no independent assessment to better protect future taxpayers.
Hutton criticised the previous ‘cap and share’ deal for not specifying how cost savings would be made, nor how past longevity changes would be funded. The same applies to these new proposals! Taxpayers remain unprotected.
Lord Hutton pointed out that the 2007 and 2008 cap and share arrangements would limit future costs by either increasing employee contributions or reducing benefits (i.e. higher pension age). He argued this was not good enough. ‘Cap and share was designed to prevent further increases in costs to taxpayers. But it did not address the already significant cost increases from past improvements in life expectancy. Nor did it specify how these savings would be made.’ These same criticisms can be levelled at the current proposals – we do not know how the cap will work, or what will happen to future costs as a result of rising longevity of existing and future pensioners, nor any cost over-runs due to higher than forecast salary rises and inflation.
This new deal seems all about giving certainty to public sector workers and leaves taxpayers exposed to even more risk than before:
This Treasury paper is only seemingly concerned now to give certainty to workers, while leaving taxpayers with continued open-ended, potentially unbounded, commitments. The paper says that cap and share ‘left public service workers without certainty about the contributions they would pay or the benefits they would receive in future’. In particular the paper says that no increases in contribution levels or pension age were specified or agreed and the Government presumably now wants to do so. However, by removing the flexibility to change contribution levels, pension age and scheme design in future (which is the result of specifying that this will be a 25 year agreement) taxpayers are even more exposed to risk than they were under the old system!
Government aim is to give public sector workers significantly better pensions than private sector equivalent – on top of 7.5% higher pay as well!!
Indeed, Para 2.7 gives the whole game away. It states that, in return for paying a little bit more and working a bit longer, the Government wants to ensure ‘that they can continue to receive pensions that are significantly more generous than their private sector equivalents’. How is this fair to private sector taxpayers? Indeed, Para 2.11 shows that significantly more generous pensions will be on top of higher pay as well. The ONS study found that public sector pay was 7.8% higher than private sector pay in 2010 and IFS figures show it to be 7.5% higher in both 2009 and 2010.
The Government’s objectives are mutually exclusive – giving a 25 year deal for members means it is impossible to properly protect taxpayers.
Para 1.12 sets out the Governments objectives for reform. Taxpayer interests are not prioritised in these objectives. There is a statement that the reform should offer ‘fairness and certainty for public services workers and other taxpayers alike’ but then talks about no more reform for at least 25 years because the Government wants to give ‘public service workers the certainty they deserve’. These two objectives are incompatible. Taxpayers cannot be given certainty or protection if public service pension scheme members have a 25 year deal. All the costs of any cost over-runs will fall on future taxpayers.
Design of cost cap is the only real protection for taxpayers, but is being left for future discussion! There is therefore no actual protection in place at all.
Para 3.7 says that an employer contribution cap will operate following the introduction of new schemes to provide a backstop protection against unforeseen costs and risks. However, the design of the cost cap will only take place ‘in due course’. This is just not good enough! Once again, the Government is leaving the problem for a future Government to sort out, if things go wrong. However, by stating that this is a 25 year deal, future Governments will be very much more hamstrung in trying to deal with cost overruns. Taxpayers are being snookered.
The calculations of scheme costs should be done by independent Actuaries so that taxpayers have proper representation – Government Actuary’s Department is not independent!
In Chapter 2 and 3, the Treasury stresses the importance of transparency, consistent assumptions and methodology – but these are all to be controlled and compiled by the Government Actuary’s Department, whose staff are in the civil service pension scheme. This means there is an obvious conflict of interest – why are we not consulting independent actuaries to oversee these methodologies? Taxpayers need to be represented by their own experts. In Para 3.2, the Treasury says that the cost ceilings have been set based on advice from the Government Actuary’s Department – this advice may turn out to be wrong. There is no protection for taxpayers against this. Past cost estimates have always proved to be too optimistic.
No proper taxpayer protection in scheme design
Para 3.6 says that ‘final designs will also need to satisfy the Government that the taxpayer will be protected in the event that the cost of providing pensions increases’. But the ‘Government’ is being advised on this by civil servants who are not independent in this matter. Ministers have apparently been told that linking scheme pension age to state pension age is ‘the only way to achieve this for the taxpayer’. That is simply not the case!
Protection of those within 10 years of pension age – with no cost estimates provided
Para 3.8 does not explain how protecting those within ten years of pension age will affect the cost and merely asserts that the costs to the taxpayer should not exceed the OBR forecasts. But this is no comfort and no cost control, so taxpayers remain on the hook to cover any cost over-runs that result from this.
Worrying disregard for private sector taxpayers as state pension age rises with less than ten years notice.
In fact, private sector workers are furious that the recent Pensions Bill debate saw Government adamantly refuse to give state pension recipients ten years notice of significant pension delays on grounds of cost, whereas just two days later the Government – without any cost estimates at all being released – suggests that it is only fair that those within ten years of retirement in public sector schemes must have no change at all – even though they will retire well before state pension age. These double standards show a worrying disregard for the interests of private sector taxpayers.
Low and middle earners will receive better pensions than now, or at least as good – so where are the real taxpayer savings?
Para 3.12 states that low and middle earners (this is not defined!) will get better pensions or at least as good as now. Therefore, the case that costs are being cut is being undermined and this scheme is likely to turn out to be even more expensive than the Hutton proposals – and possibly even more than Labour’s 2007-2008 proposals. We have no reliable cost estimates to assess these changes with and no independent assessment at all has been made.
It seems cost savings for the next decade will only be driven by the increase in state pension age.
The real change being made here is the increase in pension age, to bring it into line with state pension age. The rise in employee contributions does not even make up for past underpayments, so cost savings are derived from the pension age change. However, by protecting everyone within ten years of current pension age, as well as revaluing all final salary scheme accrued benefits in line with earnings or paying pensions based on the actual final salary at eventual retirement, the cost savings to taxpayers have been undone for this and the next Parliament.
Contracting out – the big hidden agenda?
Is this why the Treasury is suddenly being advised (by its civil servants!) to make a long-term agreement.
A 25 year deal may be designed to protect public service workers from the changes to scheme design that would normally accompany a move to end contracting out of the state second pension. At the moment, public service pensions are contracted out, so they have to replace the state second pension within their scheme design. If contracting out ends, then workers will transfer current rights to the state scheme and pay the full rate of National Insurance, instead of the lower rates as now. In private sector schemes, ending contracting out will be expected to lead to a reduction of scheme benefits, in order to recognise that the scheme no longer needs to replace state benefits, since they will be earned in the state scheme instead. Employer and employee national insurance contribution increases will be used to provide better state pensions. At the moment, public sector workers have been getting their second state pension effectively for free, because they pay the lower National Insurance rate, however the taxpayer is still providing the replacement for second state pension as well. In future, if workers still receive the equivalent of state second pension from their public sector pension scheme, but then also get extra rights to the state pension, they will be getting double the accrual.
It is of great concern that the current offer and negotiations are taking place before the Government’s White Paper on state pension reform is produced. If an agreement is reached now, it will be almost impossible to change the public sector scheme design to accommodate loss of state second pension rights and the higher National Insurance contributions may also be resisted by the public sector workforce. This extra National Insurance should be agreed as part of the contribution negotiations as a coherent package. It is most disconcerting that the timing of these changes is being rigged to the advantage of public sector workers.
Any private final salary schemes that remain in 2016 (the date when contracting out is due to end) will either have to close, or change benefits to reflect the ending of contracting out. But by agreeing such a long-term deal now, public sector schemes are going to immunise themselves against such changes.
If the Courts rule that Government is not entitled to uprate pensions in line with cpi in future and must stick to rpi, then the costs of these schemes will rise significantly again. This once more suggests that locking into a 25 year deal is most unwise. At the very least, no long-term agreements should be made before the outcome of the court case and the decisions about state pension reform are more certain.
Statements about spending on public service pensions falling are misleading:
In Paragraph 1.9 the Treasury states that spending on public service pensions has begun to fall. That is simply not true – these are forecasts of falls, not actual falls! Spending on public service pensions is still rising. Chart 1.A is a projection, but we do not know how reliable or realistic those projections are. Indeed, this Paragraph actually admits that the forecast spending reductions ‘includes unspecified cuts to the value of pensions from cap and share’. The costs of public service pensions have soared by one third in past ten years (over £32bn pa) due to previous cost underestimates (resulting from pay and longevity increases above forecast). We are still not given any clear indication of how this cost over-run will be funded.
Contribution rates for civil servants continue to be far lower than all others
Table 3.A shows that civil servants have taxpayer contributions (16.9% of salary) much higher than other schemes (NHS and Teachers 12.1%, LGPS 10.9%). The employee contributions for civil servants (5.6% of salary) are also much lower than for other public service workers (9.8% for NHS, 9.6% for teachers, 9.5% for LGPS).
There is no mention in the document of how much the contributions of public sector workers go towards a partner’s pension. In the current scheme, civil servants only contribute for their partner’s pension, they do not contribute to their own pension and if they reach pension age without a partner, they receive a refund of all their contributions. We do not know how much refund they receive, how those refunds are calculated, nor what the arrangements will be in the new schemes.
It is interesting that civil servants seem to have designed the best pension deal for themselves. And purely coincidental that GAD workers are in the particular scheme? Can taxpayers really rely on the independence of GAD – or should we demand an independent outside assessment?