PLC Pensions reports:
The Independent Public Service Pensions Commission’s Interim Report (Hutton) was published on 7 October 2010. Hutton summarises the broad points which will form the basis of the full report, due in the New Year, and parts of which will be included in the government’s Spending Review.
Scope of the report
Hutton’s brief was to deliver suggestions for short-term changes which could result in savings within the Spending Review period, which is from 2011/12 to 2014/15. As well as doing this, it sets out more long-term changes aimed at making the current public-sector pension system “fair and sustainable in the future”.
The report states that the current system, if left unchanged, will place an unacceptable burden on the UK economy in years to come. In 2008, the Government Actuary’s Department estimated the accrued liability for all unfunded public-service pension schemes at £770 billion. However, as Hutton confirms, this is a long term issue as “it is not a sum of money that will ever be needed at one time.”
The majority of public-sector pension schemes are unfunded which has heightened the media’s portrayal of public-sector pension schemes as “gold-plated”. Hutton expressly dismisses this presumption and states that the average pension paid is around £7,800 per year with about half of pensioners receiving less than £5,600 per year.
In addition, some schemes are currently not a burden on the taxpayer, for example, contributions to the NHS pension scheme in 2009-10 exceeded the cost of paying pension benefits by £2 billion.
For more information on the different types of public-sector pension schemes see our practice note.
Key findings of the report include:
- Future changes: benefits structures v increased contributions
The report is clear that changing benefit structures is not a viable solution for making short-term savings. Instead, its main recommendation is an increase in member contributions. It states that raising employee contribution rates by 1% across the unfunded schemes could raise around £1billion per year.
Another option is for public-sector pension schemes to contract into the State second pension. This would provide a short-term saving as the extra National Insurance Contributions from employers and employees would be payable to the government.
In the long term, benefit structure changes are envisaged, with a change from the current final salary benefits to a career average revalued earnings (CARE) scheme, being the most likely option for future accrual. Hutton is open to other options and some form of risk-sharing defined contribution arrangement is also mentioned.
- No change to Fair Deal
At present, when employees are transferred to non-public service bodies, the organisation they move to is required to ensure that there is ‘broadly comparable’ pension provision for future service, through the Fair Deal provisions, see Practice note, Public-sector pensions schemes: outsourcing.
The main areas of concern for contractors include:
- The cost of meeting higher employer contribution rates than in the private sector.
- The investment and demographic risks associated with final salary pension schemes.
While these may be manageable for large contractors, they can be deal-breakers for smaller firms and third sector organisations. For example, the exit charges for LGPS participating employers (known as admission bodies) require them to make good any deficit under a shorter timescale than that allowed to public service local government employers.
Hutton does not endorse extending the ability of contractors to participate in public-sector pension schemes, nor does it consider abolishing Fair Deal, a move that had been suggested by some industry commentators. Instead, Hutton refers the decision back to the government, suggesting long term changes to the schemes benefit structures as a way of reducing the risks for contractors.
The next step
The final version of the report will be published early in 2011, with some indication of the short-term steps expected when the spending review is announced on 20 October 2010. Authorities and contractors can expect, at the least, some increase in employee contributions. This will help deal with the most pressing problem, the shortfall between how much the government pays out in benefit payments for the unfunded public-sector pension schemes each year over and above the level of contributions coming in. This is estimated at £3.1 billion for 2009-10.
In the long-term, a change to the benefit structures seems inevitable with a switch to CARE as the most likely option. However, this will not affect benefits accrued up until the changes come in, so until then it is likely all avenues for reducing costs will be explored. Although Hutton has been fairly well received so far, it is likely that these changes will prove the most controversial, particularly with the unions.
However, without a change to Fair Deal, small contractors are still going to be exposed to significant financial risks when tendering, and with changes to the schemes’ benefit structures a long way off, they will look to the final form of Hutton to offer some hope for the future.