Hutton Report – the Future of Public Sector Pensions

Introduction

In June 2010, John Hutton, the former Labour Secretary of State for Work and Pensions, was appointed to examine the future of public sector pensions as chair of the independent Public Service Pensions Commission. Today, the Commission has published its interim report.

The headline news is that there will be no structural change immediately but public sector workers will need to put their hands deeper into their pockets to pay for their benefits in the short term.

Key points

Public sector workers have had a short term reprieve – with structural changes to public sector schemes likely to be delayed for four years.
But any welcome (however muted) to this news is on hold until after the Spending Review on 20 October, when George Osborne is likely to tell public sector workers how much more they will have to pay in member contributions in the short term.
We have to wait until Spring 2011 to see what Hutton’s long term recommendations are, but reading between the lines, it looks like Career Average Revalued Earnings (CARE) is the front runner to replace final salary in the public sector.

No structural change immediately

There will be no immediate structural change – as Hutton concludes such amendments “will have little or no impact within the spending review period”. Although this may be perceived as a blow to a Government desperate to save money, in effect, by building in such a delay Hutton gives the Coalition Government a breathing space in which to negotiate reforms with public sector workers. This gives all parties a four year moratorium on change as the Spending Review due on 20 October this year will cover the period 2011/12 to 2014/15.

This blow will be softened by one of the Report’s key findings – liabilities will reduce in the public sector by as much as 15% as a result of the switch from RPI to CPI for increases to pensions in payment and in deferment. (No doubt this fact will also inform many private sector employer and trustee discussions in the next few months.)

Short term pain

In the short term, Hutton recommends both increasing member contributions and reviewing the discount rate in valuations. Hutton gives the Government a clear steer that the current discount rate is inappropriate, asking for it to be reviewed in time for the delivery of the final report.

On the issue of member contributions Hutton has handed the baton to his political masters, but has set parameters for change. The Commission recommends that as well as being staged to prevent an increase in opt-out rates, “increases should be managed to protect the low paid” suggesting higher paid workers are likely to bear the brunt of the increases. This is effectively what has already happened in the Local Government Pension Scheme.

If short term savings are to be made, the Chancellor will need to announce new member contribution rates at the Spending Review on 20 October. But this is a big ask as the different public sector schemes have different benefit levels and contribution requirements reflecting historic pay negotiations. Unwilling to face further political backlash, the Government is likely to pick up the Commission’s recommendation to spare the armed forces pension scheme members from this pain.

Fundamental reform on the cards

But the sword of Damocles still hangs over the public sector. Whilst accrued rights are to be protected, the report includes a set of general principles against which the options for more fundamental longer-term reform of future service rights will be tested. These are affordability and sustainability, adequacy and fairness, supporting productivity and transparency and simplicity.

Indeed, Hutton fired the first shot in the battle for hearts and minds this morning when he called final salary pensions “fundamentally unfair” in his Radio 4 interview on the Today programme. The report explains this by noting that in a final salary scheme “the promotion effect alone could mean that high flyers can receive almost twice as much in pension payments per pound of employee contribution than do low flyers”.

Bearing in mind the political need to retain value following the anticipated request for further contributions, in our view this makes CARE top of the list to replace final salary in the public sector.

Lessons for the private sector?

In the last few years the focus of industry commentators has been what the public sector can learn from the private sector, but Hutton makes out his case for turning that on its head. Hutton argues that the “substantial migration” from DB to DC in the private sector should not be seen as the last word.

Hutton rejects the public sector joining what he calls a “race to the bottom” – hoping, instead, that the public sector can provide a benchmark for private sector provision in the future.