Peter Tompkins: Public sector pensions cost a lot more than people think
Peter Tompkins is a Member of the Council of the Institute of Actuaries and a former Chairman of its Pensions Board. He is the chairman of the non-government independent Public Sector Pensions Commission, which is publishing its report this morning.
Public sector pensions cost a lot more than people think: that is one of the main conclusions of a six-month study carried out by the independent Public Sector Pensions Commission*, which I chair. Our group had the support of a number of policy bodies like the Institute of Economic Affairs, the Institute of Directors and Policy Exchange.
When it comes to pensions, figures are everywhere, confusing even seasoned experts like me. Private sector pensions are valued regularly – and have shown some shocking levels of deficit in recent times. The deficit is the difference between the funds they have invested and the liabilities to pay pensions in future – discounted to the present time at the rate of interest that they expect to earn on their investments. One reason why pension deficits abound is that returns on investments have been steadily falling but the main one is that people are living longer and longer, far more than most actuaries expected ten or twenty years ago.
In the public sector, you may expect, the sums might be different. As these schemes are “pay as you go” where pensions are paid with today’s pension contributions, there are generally no funds put away and invested, so you would not expect the future payments to be discounted at the rate of interest they can earn on the funds they don’t have. But if you thought that you would be wrong. The Government does still discount future payments at a rate of discount 3.5 per cent higher than inflation (similar to what private sector funded schemes do), even though its own promises to pay inflation-linked payments to government bondholders now earn only 0.8% above inflation.
Typically, the Government says that if employees pay in 6% (say) to the NHS scheme, then the employers need to pay in 14% and that’s it. Current pensioners are paid out of the combined 20% and all is well. But it isn’t. A shortfall has grown up between the 20% paid in and the true cost of providing pensions, which we have calculated are worth around 45% of salary. Hiding the true cost distorts the market for a number of reasons:
- employees don’t appreciate the full worth of their benefit package
- employers don’t pay in the full value of what they are providing and are at risk of future large increases in contributions
- contractors cannot compete on an even playing-field for outsourced public sector contracts
- future generations of taxpayers will have to pick up the pieces for the balance of cost of paying out the pensions which employers are promising today; and
- maybe most importantly of all, the public can’t make a proper judgment of what the right level of pension should be.
Our commission recommends full transparency of costings so we can make proper decisions and choose how to reform public sector pensions at a time of rising life expectancy and costs. Some of the choices we investigate include:
- upping member contributions by 2% to bring in an extra £2 billion a year
- increasing retirement ages for all staff, not just new joiners as the Labour Government changes in 2005 did – that would save around £5 billion a year
- changing from a final salary scheme to one where your pension is based on your average salary over your lifetime. This would hit high flyers hard and be fairer to the average worker and could save £10 billion a year
- lower the benefit accrual rate from 1/60th to 1/80th of salary for every year of service. This would also save £10 billion a year
We also look at radical changes such as setting up a defined contribution scheme where employees and their employers pay in to a fund which is then used for buying a pension at retirement. This would be a fairer regime but the problem with it is that we would be paying in to people’s pension funds straight away, whilst we still have to pay for all the pensions we have been promising in the past. In other words, today’s taxpayer might end up paying twice.
A new commission has been set up by the Government with John Hutton leading it and we welcome this move. We expect the solution to be a combination of changes but hope that it includes:
- a fairer transparent assessment of pensions in future
- higher employee and employer contributions
- bringing all staff onto the new pensions terms introduced in 2005
- long-term cost sharing between employees and employers if life expectancy carries on growing
* The Commission is comprised of:
- Peter Tompkins, Fellow of the Institute of Actuaries, Chairman
- Philip Booth, Institute of Economic Affairs, Vice Chairman
- David Acland CBE DL, CHK Charities Ltd
- Ros Altmann
- Andrew Lilico, Policy Exchange
- Neil Record, Institute of Economic Affairs
- Malcolm Small, Tax Incentivised Savings Association
- Corin Taylor, Institute of Directors, Secretary