Hutton recommends new career average scheme

Introduction

Lord Hutton’s Final Report (the “Report”) which sets out his proposals for the reform of public service pension schemes was published today. Although it contains few surprises, a new career average (CARE) scheme for the future and a rise in normal pension age (NPA), no doubt many public sector workers will be disappointed that, ultimately, they are likely to lose their final salary schemes.

Key recommendations

The public sector’s existing final salary schemes should be replaced with a new CARE scheme for the future.
Accrued rights in existing schemes should be protected and current members should retain their final salary link for past service.
NPA should be linked to SPA in most public service schemes, with a new NPA of 60 for the uniformed services (namely, the armed forces, police and firefighters).
The Government should set a “clear cost ceiling” for public service schemes with “automatic stablilisers” to keep future costs under more effective control.
The current legal framework for public service pensions should be simplified.

The design

The Report’s aim is to achieve a balanced deal between public service workers and the taxpayer. With this in mind, the Commission recommends a move away from final salary, which is seen as unfairly benefiting high earners, exposing taxpayers to salary risk and creating a barrier to employees switching from the public into the private sector. On balance, the Commission considers that the most suitable option going forward is CARE. (In a CARE scheme, an individual’s pension is based on the amount they earn each year during their career.)

As the actual accrual rates, indexation and contribution rates under a scheme all go to determining its ultimate cost, the Commission leaves these to the Government to decide. But, it recommends that benefits be uprated in line with average earnings during the accrual phase for active members.

Fixed cost ceiling

The Commission recommends that the Government sets out a “fixed cost ceiling”, making clear the proportion of pensionable pay that the taxpayer will contribute, on average, to employees’ pensions over the long-term. If this ceiling is exceeded “measures will need to be taken to bring costs back down below it”. Where no agreement between employers and scheme members can be reached as to what these measures should entail, the Report suggests that a “default stabilising mechanism” (such as an increase in employee contributions or decrease in accrual rates) should automatically take effect.

Changes to Fair Deal?

“Fair Deal” is a policy which applies to pension provision for public sector staff when they are compulsorily transferred to a private sector employer. It requires the new employer to provide a “broadly comparable” pension scheme for the transferred staff and bulk transfer arrangements for those staff who wish to transfer their public service pension benefits. It is currently possible for a private sector employer to become a participating employer of the Local Government Pension Scheme in respect of the transferring public sector workers.

Whilst recognising that providing access to public service pension schemes “helps to remove the pensions barrier for external contractors”, the Report states that there are “good reasons” for the Government to limit access. Indeed, the Report goes as far as saying that it is “in principle undesirable for future non-public service workers” to have access to public service pension schemes.

Presumably, the Government will now take this into account when considering the responses to its consultation on Fair Deal (issued on 3 March 2011).

Administration

Hutton considers that the governance and administration of public service schemes needs to be improved. He advises that each scheme should have a “properly constituted, trained and competent Pension Board, with member nominees”. The Government is tasked with setting good standards of administration and with establishing the framework for achieving this.

Hutton is also keen to achieve economies of scale and encourages the streamlining of administrative functions, and more shared arrangements, where this is appropriate.

What next?

Hutton’s recommendations are aimed at making public sector schemes sustainable and affordable for the long-term. It is now up to the Government to decide whether to accept and act on his proposals. If it does so, in the Commission’s opinion, it would be possible for the new schemes to be introduced before the end of this Parliament (2015).