Speech by John Hutton at the National Association of Pension Funds

07 October 2010

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1. When I took on the job of leading a review into public service pensions, I was clear about the important role these pensions play in the lives of millions of our fellow citizens. They are a vital part of our national retirement savings system for two reasons. First, up to 12 million people are depending on them for their retirement. Second, over 85% of public sector employees are saving for their retirement in employer-sponsored schemes– more than twice as many as in the private sector. And in an age increasingly characterised by doubt and uncertainty about the future, the knowledge that you have made proper financial provision for your retirement can provide enormous peace of mind and re-assurance. But I took on this role because it was also clear to me from my time in Government that it was time to ask ourselves some important questions about how public sector pensions were structured, how they were being administered and whether the design was sustainable over the long term.

2. Today I have published my interim report. It sets out the facts in order to allow us all to be clear about the present situation and where we are heading. I hope it destroys some of the myths. It makes it clear that there is a case for reform. But this does not have to be a race to the bottom. There are sensible options for addressing the problems I have identified, based on good sound principles, which we should now explore in more detail. Any alternative to the present arrangements must be fairer to all concerned, deliver decent retirement incomes for low paid public sector employees and be sustainable for future generations. My hope is that it will be possible to build a consensus for reform. That is certainly my intention. If I am to succeed in doing this, then I accept there is a need for objectivity and balance. That is how I intend to proceed.

3. What do the facts tell us? First, that the costs of providing public sector pensions have risen sharply in the last ten years – up by a third. Payments are now over £32 billions a year: almost two thirds the total amount paid out through the State Pension. Second, that we have consistently under-estimated the increase in longevity and therefore may have underestimated the cost of benefits being accrued. Third, that the costs of this increase in the value of public sector pensions have not been shared fairly between employees and taxpayers – it has been paid for by taxpayers. Fourth, that the final salary schemes that form the vast majority of public service pensions favour the high flyers at the expense of the low-paid – the high flyer can get twice the pension benefit for the same pension contributions. And finally, that there is a danger of pensions forming an iron curtain between the private and public sectors, restricting labour market mobility and therefore productivity in the economy as a whole.

4. And what are the myths? There is for example a lot of talk of gold plating. The truth is rather different because the facts tell a rather different story. The average pension paid to pensioner members is about £7,800 a year. About half of all public sector pensioners receive less than £5,600 per year. And 90% of pensioners receive less than £17,000 a year. These are not huge pensions. It is true that some of these figures can be partly accounted for by interrupted careers or part-time working. But overall, they provide a modest – not excessive – level of retirement income. We should all be clear about this.

5. Many commentators have also drawn comparisons with private sector pensions; and there is a large gap between provision in the public and private sectors. This is something we should be concerned about. And whilst virtually all of this provision is defined benefit provision in the public sector, only 40% is in the private sector.

6. My own very strong view is that we should be celebrating the high level of participation in pension schemes in the public sector, not seeking to follow the downward drift of pension savings in the private sector. Public sector pension reform must not become a race to the bottom. There would be hidden costs to the taxpayer in taking this course. It is equally clear to me that we cannot just carry on as we are – because this option presents serious issues of fairness, sustainability and value for money.

7. So what are the options? The current status quo of final salary defined benefit schemes does not deal with the fundamental problem. But neither would a swing to a funded individual account defined contribution model, which would:

place a major financing burden on taxpayers;
ignore the ability of Government as a large employer to manage certain types of risk; and
increase the uncertainty of post-retirement income for scheme members – which is difficult for the low paid in particular to manage.

8. Instead, in going forward to my final report, I will be examining a range of alternative models.

9. First, the more traditional options, such as career average schemes and capped defined benefit schemes.

10. Second, more radical options, including drawing on international example. So, for example, I will consider the notional defined contribution model, such as they have in Sweden and the related cash balance model that is seen in the UK. I will also look at collective defined contribution schemes, such as those found in the Netherlands.

11. Third, I will consider hybrid models that can help us to share the risks inherent in pension provision. For example, sequential hybrids, where a member can earn both a defined contribution and a defined benefit pension during their time with an employer, but only earn one type of benefit at any time. Or combination hybrids, for example, a capped defined benefit scheme with a defined contribution top-up, where both types of benefit can be earned simultaneously.

12. As well as looking at the fundamental structure of public service pension schemes I will also be looking at other elements of scheme design. Including how to ensure that normal pension ages are in line with the latest developments in longevity.

13. To assist me in my analysis of these options I have identified four principles that I feel go to the heart of the issues that public service pensions should address.

14. First, public service pensions should be affordable and sustainable. What pension cost is affordable is, in the end, a matter for the Government to decide. But I am clear that affordability and sustainability are not, given the nature of pensions, a short-term issue and must not be considered in that light.

15. Second, public service pensions should be adequate and fair. Public service workers should be able to expect to retire on an adequate income. But in ensuring this we also need to be fair – not just between and to members, but also between taxpayers and public service employees. We must never forget who picks up most of the bill.

16. Third, public service pensions should support productivity. Public service pensions should give value for money through an efficient labour market for employees. They should also not be an unnecessary barrier to future reforms of the delivery of public services.

17. Fourth, public service pensions should be transparent and simple. They need to be understood by both members and the taxpayer. And they should be able to withstand robust scrutiny. I think there is room for considerable improvement here.

18. It is unlikely that any one option will fit all of the principles perfectly. But by using this framework the trade-offs inherent in this process will be at least made explicit allowing a proper balance to be struck.

19. Any long-term options will have to deal with the issues I have outlined:

rising benefits due to increasing life expectancy;
unfair sharing of the costs between the employee, employer and taxpayers;
unequal treatment of pension scheme members; and
the potential barrier to optimal labour market productivity and future reforms to the delivery of public services.

20. This will not be an easy task. But I intend that the recommendations I put forward in my final report will provide the basis for a new long term pensions deal for the public service, not just a way of getting through the next few difficult years. I am not interested in quick fixes.

21. I would like to conclude my remarks this afternoon with a request to all of you. I know you share my determination to get this right. I hope therefore that you will all feel able to contribute to the next phase of my work, which I want to be as inclusive as possible. It is an open invitation. I need your views on the best way forward. Thank you for listening.

Speech by John Hutton at the National Association of Pension Funds

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