David Roache: Public Sector Pensions – let’s have the facts

David Roache is from Warwickshire and Group Finance Director in several listed businesses and writes here a second response to Lord Hutton's report on pensions. Read his first here.

Headlines such as “the death knell for final salary pensions” miss the point in this debate entirely - and  the facts remain shrouded in uncertainty, at best, or secrecy, at worst, the choice about which course of action to take cannot be soundly made.

The decision regarding what to do about the cost of public sector pensions has to be made with the facts about the associated debt fully exposed. That debt is the unfunded liability for the total pension promises made to all public sector employees. So, for each category of public sector employee (i.e. MPs, the judiciary, armed forces, NHS, Civil Service, teachers, police, fire service, local government employees etc.) we need to know the current cost of the future liability for the pension promise, calculated using assumptions that the Pension Regulator would approve for such calculations in the private sector (i.e. inflation rates, mortality rates, asset returns etc.) and we need to know the value of any assets properly set aside to fund this liability.

The difference between the two (the liability and the assets) is the deficit which will have to be funded by tax payers in the future. My guess is that, properly calculated, this deficit will be many billions of pounds. For a start the liability has not in the past been calculated using acceptable assumptions. Those imposed on private sector pension schemes by the Pension Regulator are far more conservative than assumptions that have been used in calculating public sector pension liabilities. Also, I suspect that much of the liability for pensions is totally unfunded by properly segregated assets, again, something that would simply not be tenable in the private sector.

Exposing that unfunded debt to public scrutiny is the first step to having a proper debate about public sector pensions and identifying which category of public “servant” is causing the problem. The second step needs to be the modelling of the various means of controlling or reducing the level of growth in this debt in the future. Until MPs and the public at large have seen the results of such modelling, there is no way that they can come to an informed conclusion about the right way to go.

The unfortunate fact is that this deficit cannot easily be reduced. The pension benefit that an individual employee has earned in his career to date cannot be reduced (except in the private sector by a pension scheme being taken into the Pension Protection Fund – an unlikely scenario in the public sector).

Therefore you can only work on the pension benefit that individuals will earn in the future. The problem is exacerbated by the fact that people are living longer and therefore the liability even for the pension benefit earned to date, let alone that earned on future service, will continue to rise because it will have to be paid for a longer period of time. This will happen whatever future decision is made because public sector pensions, unlike many private sector pensions today, are Defined Benefit schemes, these have an open ended liability to continue paying benefits for the employee’s life and often the life of his/her spouse and often with annual inflators built in.

There is also an indisputable correlation between the level of someone’s pension and their life expectancy –  the longer they live the higher the pension. Don’t forget, an increase in life expectancy by one year, which has happened over the last ten years or so, represents a 5% increase in the liability for future pension payments under a Defined Benefit scheme whether calculated on final salary or average earnings. It would have no effect on a Defined Contribution scheme.

If MPs have not seen these facts (the size of such a deficit and the modelled options for managing it into the future) then they are not in a position to decide whether or not to adopt Hutton’s recommendations. Do MPs know by how much the properly calculated deficit will be reduced by Hutton’s recommendations? Do they know what the impact of alternatives would be? If they don’t then on what grounds are they to make a decision. More importantly, if the general public, who will have to fund this massive debt, aren’t privy to the facts then how will we know that MPs have made the right decision.

Any change to public sector pension arrangements is going to cause a massive battle with the unions – see Bob Crow’s comments already. Surely therefore it is better to have this battle over something worthwhile rather that the tinkering that Lord Hutton is recommending.

The point is not whether Hutton’s recommendations are the death knell of final salary pensions, it is whether they should be the death knell of defined denefit pensions (something far more fundamental), for until this is sounded, as it surely has been in the private sector, no real progress will have been made and the battle with the unions will have been fought on the wrong ground.

So do MPs and the public have the facts by which to measure the problem? No, they don’t. Should they have the facts? They absolutely must if the right decision is to be made. Is the Government frightened about the reaction of the public and of the international debt and money markets to exposing the level of unfunded debt represented by this issue? Yes, it probably is: that must surely be why it has not revealed the properly calculated value of this debt. Until it does so, this issue will not be resolved and we will carry the debt forward, undiminished, to future generations.