Lord Flight: We still need to do more to make public sector pensions affordable

Lord Flight was Shadow Chief Secretary to the Treasury from 2001-2004 and led for the Opposition on the FSMA.  He is now chairman of Flight & Partners Recovery Fund.

The Public Service Pensions Bill is currently going through its Committee Stage in the Lords.  Its content and arrangements reflect “the deal” done by Francis Maude with the Public Sector Unions, in turn based on the Hutton Report.  Given the long-term nature of pension arrangements, there is clearly a case for having cross-party agreement as far as possible and agreement with the Unions; and Lord Hutton’s Report was, in principle, balanced and reasonable.  The draft legislation also gives the Treasury large powers to intervene, going forward, where Clause 11 of the Bill provides a legal framework for the proposed system of cost control.

For most of the Public Sector — i.e. Health, Education, Civil Service (other than Local Government, academics and police) — Public Sector pensions remain unfunded, pay as you go, (PAYG) defined benefit schemes, with inflation indexed increases.  By contrast, in the private sector, most Defined Benefit Schemes have now been closed, on the grounds of costing too much, so placing the investment risk on the individual members, and without scope for automatic inflation indexation.  I believe it would be impossible, at least for the present, for PAYG public sector schemes to change to being funded largely because of the “pay twice” problem – contributions would be required both to meet pensions in payment and to credit employees’ funded personal accounts.

The fundamental issue, which I believe will make the Hutton framework unsustainable going forward, is the cash flow shortfall cost.  In 2005/06 the PAYG cash flow shortfall was a modest £200m but, since then, it has grown rapidly and is forecast by the OBR to reach £15.4bn by 2016/17.  This forecast, however, was before last December’s ONS Report on Mortality, to the effect that people are now living 6 years longer than pension, life expectancy projections.  If this is the case, it adds a further £7.2bn to the cash flow shortfall.  The Government has also now announced its Single Tier Pension proposals.  The key cost control/funding source for this is the abolition of the State second pension and, with it, the abolition of “Contracting Out”, - under which the relevant amounts of employer and employee National Insurance Contributions have been transferred to individuals’ occupational pension schemes.  For Public Sector Schemes, the ending of Contracting Out payments must, inevitably, increase the cash flow shortfall yet more, albeit that it is to be phased out over time.  The result of this, together with the additional cost of 6 years’ underestimated longevity, is a cash flow deficit not of £15.4bn p.a. but in excess of £25bn p.a. I simply do not believe the public finances can afford to finance an increase in the cash flow deficit of this order.  It is also manifestly unfair for the 23 million tax payers in the private sector, whose pension arrangements have mostly deteriorated dramatically, to be obliged to provide a subsidy of this size to sustain Public Sector, Defined Benefit Pensions.

There are 4 ways, or a mixture of them, which could, in principle, reduce or eliminate the cash flow deficit; - higher employee contributions but these would have to rise to some 35% of salaries if they were to cover the true economic cost of the pensions promised, which is clearly impractical:  the pensionable age could be increased, which is likely to happen; reducing accruing pension rights, which is provided for in Clause 11 of the Bill: but the Government has so far set its face against any measures to reduce pensions in payment, on the grounds that this would amount to breach of contract.

In the wider context, as and when QE is phased out because of its growing, future inflation risks, and the Government has to sell gilts (at a higher rate of interest than at present) to finance its large, on-going deficit, (rather than printing the money to do this, which is what QE amounts to), there is the catch-22 question as to whether or not it will be possible to sell £100bn-odd of gilts each year, without, at the least, a major rise in gilt yields and thus the cost of servicing the growing debt.  The pressure will then be to cut the huge on-going Government deficit, further and faster.  Against such a background, I do not see that a public sector pension cash flow deficit, increasing from £5.8bn last year to around £25bn in 4 or 5 years’ time, is politically or financially viable.