Q&A on Public sector pensions

by Dr. Ros Altmann

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1. Why are public sector pensions so much more generous than private sector pensions?

   The original justification for better pensions was that public sector employees earned lower wages than private sector workers, but this was offset by higher ‘deferred pay’ in the form of better pensions on retirement.

2. What has happened in the last 10 years?

   Since 1997, public sector pay has risen sharply and is now higher than for private sector workers. Latest official statistics show the median public sector full-time worker earns £500 a week whereas median gross pay in the private sector is £440 a week. Also, the numbers of people employed in the public sector have risen substantially. The future pensions burden for taxpayers has soared. Meanwhile, in the past few years, private sector schemes have closed (latest figures show 83% are no longer open) but this trend has by-passed the public sector altogether.

3. But public sector workers contribute to their pensions, so what’s the fuss?

   Firstly, civil servants do not contribute to their pensions at all. The terms of their pension scheme are that they contribute either 1.5% or 3.5% of their salary but this is only to pay for a partner’s pension. On retirement, if civil servants are single, they get a full refund of all these contributions! Secondly, the contributions that are being made today by public sector workers, and their employers, are far less than the true cost of providing those pensions, so there is no proper budgeting or accounting for these liabilities. The notional contribution of under 20% of salary is much less than the true value of these pension promises, which far exceeds 30% of salary. Thirdly, most public sector workers are in unfunded pension arrangements, which means that no money is actually being set aside at all to cover the future costs of these pension commitments. Tomorrow’s taxpayers will have to somehow find the entire cost of supporting public sector workers when they retire, on pensions that are substantially more generous than the terms available in the private sector.

4. But the Government knows these costs are coming, so it must be putting money aside to pay for the costs as any prudent business manager would?

   Sadly not. The costs of public sector pensions are not being properly budgeted for at all. The Treasury simply says that the year by year costs are ‘fully affordable’ but it has used an incorrect discount rate to depress the true value of the pension promises. It also suggests that the pension payments could be cut in future, but that is illegal. If the Government does, indeed, intend to consider cutting future pensions, it must tell its workforce about this! There are no long term budgets that properly account for the rising numbers of public sector pensioners. They are totally excluded from the Treasury’s ‘fiscal rules’.

5. Wasn’t there a big renegotiation of public sector pensions in 2005?

   There was a huge row over proposed changes which were designed to reduce the future costs of these pension schemes, but unfortunately, the Government chickened out of radical change. In the face of union pressure and threatened industrial action, changes were only made for the future employees while keeping the current terms for existing workers and the costs of those changes have not been properly accounted for. The Treasury has used an incorrect discount rate to value the future liabilities which makes them look artificially low.

6. Why shouldn’t public sector workers be allowed to contract out of the state second pension?

   Contracting out in an unfunded scheme is an economic nonsense. The purpose of contracting is that the NI contributions for your additional state pension (S2P – the part above the basic state pension) are put into a private pension scheme instead, so the state will save money when you retire by not having to pay any S2P. The NI ‘rebate’ is supposed to be put into a private pension scheme to pay a replacement for the state pension that taxpayers will not have to pay in future. However, with an ‘unfunded’ pension scheme, this simply does not work. There is no ‘fund’ building up to replace the state pension. Public sector workers and employers just pay less NI each week now, but future taxpayers will have to fund both the replacement for S2P and the rest of the public sector pension. The concept of contracting out does not work.

7. What about our armed forces and security services – there is so much public support for them and don’t they deserve decent pensions?

   Unfunded public sector pension schemes do not all have to be the same. Special arrangements can be made for certain groups of public sector workers. The key is to make all the arrangements transparent. At the moment, the Government hides away the costs and is leaving everything to future Governments and taxpayers to sort out. We need to be open and honest about the costs and values of pensions. Currently, pension accruals are treated almost as if they do not exist. This means that neither the workers themselves, nor the rest of the country, really understand the true costs building up.

8. What can we do?

   Transparency is essential. I am not saying whether these arrangements are right or wrong, but we need a properly informed debate. Public sector workers to a marvelous job and the country could not run without them. But hiding away the costs of employing them is not fair between generations. We should at the very least be budgeting for these upcoming expenses which cannot be altered. Even the state pension can be cut in future, but public sector occupational pensions cannot be reduced. We need an independent inquiry into this issue. We should also consider whether unfunded public sector schemes should remain contracted out of the state second pension.