Public Sector Pension Schemes

Introduction

Public sector pensions are firmly in the spotlight this summer, with the Hutton Commission charged by the Government with reviewing public sector pension provision.1

In this alert we focus on two other recent developments – the announcement in the Coalition Government’s first Budget on 22 June 2010 that public sector pensions will increase in line with CPI (rather than RPI), and the publication on 7 July 2010 of a report by the independent Public Sector Pension Commission on options for reforming public sector pension arrangements.

In this Alert:

• The Budget: Pension increases in line with CPI rather than RPI
• The Public Sector Pensions Commission Report
• What’s next?

The Budget: Pension increases in line with CPI rather than RPI

• The Coalition’s programme for government published in May announced the review of public sector pensions but promised that existing pension rights would be protected.
• This statement is at odds with the Chancellor’s Budget statement that the majority of state benefits, including the State Second Pension (S2P), would be increased in line with CPI rather than RPI from April 2011.
• This change will impact on many public sector workers because their pensions increase at the same time and by the same percentage as the increase in S2P. Current legislation only refers to a right to have pension uprated in line with S2P, not by a particular index.
• The impact of this change is thought to be significant as historically CPI has been between about half and a full percent less than RPI.

The Public Sector Pensions Commission Report

• The Public Sector Pensions Commission was set up as a result of an initiative of interested parties including the Institute of Directors. The terms of reference for its report were to improve transparency and public understanding of public sector pension costs, and to present to government a realistic set of options for reform.
• The report concludes that there is a lack of transparency on the cost of public sector pensions and the official statistics do not reflect the true cost of pension provision in unfunded pension schemes. It likens the current public sector pensions arrangements to “an unstable Ponzi scheme”!
• Three options for reform are costed by the Commission – reformed DB, funded DC and notional DC.
• The reformed DB option would maintain the existing shape of the unfunded public sector pension scheme, but reduce costs to tax payers for all future accrual. Proposals include a higher pension age, lower accrual rate, a move to career average and a ceiling on pensionable pay.
• In its review of a funded DC arrangement, the Commission notes that combined employer and employee cash contributions in the public sector DB schemes are generally at least 20 per cent of salary, and that a total contribution into a DC scheme of this amount would be very generous compared with private sector arrangements.
• The Commission recognises that a move to notional DC may, however, be more practical than a switch to funded DC due to the current unfunded nature of many public sector schemes.
• The Commission concludes that there is no single “correct” way to reform public sector pensions, with all three main approaches having their pros and cons.

What’s next?

Whilst the Hutton Commission has yet to report, it is clear that the starting gun on public sector pension reform has already been fired by the Government, with interested parties paving the way with suggested reforms.

1 An interim report is anticipated in September 2010, with the Commission’s final report comprising a fundamental structural review, due in time for the 2011 Budget