Public sector pensions 'need radical reform'

7 July 2010

Public sector pensions are in need of urgent reform and are twice as valuable than originally thought, the Public Sector Pensions Commission has revealed.

The commission accuses the government of a lack of transparency over the cost of the pensions – which it puts at £35 billion a year - and suggests a series of reforms to ensure they can remain affordable in the future.

The report says the government has used artificially high discount rates in the past to calculate employer and employee contribution rates, which appear to lower the cost of providing these pensions.

Using the index-linked gilt yield, the commission - an independent body of pension experts - reveals that although the government claims the pensions are worth 20% of salary, they are actually worth around 40%.

Peter Tompkins, fellow of the Institute of Actuaries and chairman of the commission, says: "Increasing longevity means that pension provision has to be looked at again, and the public sector cannot continue to remain immune. The question of why the majority of the workforce should be expected to pay through their taxes to support pensions that they cannot afford for themselves must be raised."

The commission recommends several measures to reform public sector pensions. For example, raising the pension age to 65 for all members to save around £5 billion, and in the short term, increasing employee contribution rates by 2% to raise around £2 billion a year.

Other options include using a defined contribution or a hybrid scheme. This would reduce risk to the taxpayer. A reduction of accrual rate to 1/80 or a change to career average would also save around £10 billion per year.

The commission says reforms should apply to all current members of schemes and stressed the importance of protecting past accrual.

In the emergency Budget last month George Osborne said public sector pensions would be put under review in time for the next Budget. Former secretary of state for work and pensions Lord Hutton has been put in charge of how to reduce the cost of the final salary pensions.

Laith Khalaf, pensions analyst at Hargreaves Lansdown, says: "The government is taking some action already and after its own consultation is complete it is likely they will have two possible options: increasing contribution rates and reducing benefits, including raising the retirement age.

"People are now increasingly expected to build their own retirement pot and public sector workers now have more responsibility for their own pension arrangements."

However the TUC dismisses the report, saying private sector employers set up the commission to attack the public sector. "Of course all pensions need to change from time to time, but this report is from people who simply want to reduce taxes for business and the super-rich. They have nothing to say about top directors’ pensions, which have continued to go up during the recession and whose most common retirement age is 60," says Brendan Barber, TUC general secretary.

Pensions consultant Dr Ros Altmann believes public sector workers deserve good pensions because of the vital work they do for the country but points out there is a huge disparity between public and private pensions.

She says: "Public sector pay is already higher than equivalent private sector pay, except for the top ten per cent of earners. 

"The value of pensions on top of this higher pay today is equivalent to an extra 40% of salary for most public sector workers. This differential between public and private sectors is not admitted. The government has consistently hidden the true scale of this cost behind fiddled figures and fudged assumptions."

The Institute of Economic Affairs says the coalition government must act now to reduce the cost of the pension schemes and blasted previous governments for "avoiding this issue for far too long".

Altmann adds: "We must move public sector pension accounting into the real world. The longer we delay, the bigger the disparity becomes."

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