Speech by John Hutton at the National Association of Pension Funds conference

11 March 2011

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Yesterday, I published my final report on the reform of public service pensions. The big changes that are affecting our society are requiring companies, individuals and governments across the developed world to re-think their approach to pensions. Three issues stand out to me.

First, the large increases in life expectancies that we have seen in recent decades. And which look certain to continue. Second, that these, welcome, increases in life expectancies have driven up the cost of providing pensions. In the case of the public service pension schemes this has driven up costs by about a third since the 1950s. Third, given the uncertainty around future longevity, and cost, our current defined benefit schemes may not be sustainable if we just carry on along the current path.

It’s therefore not a question of whether we need reform - it’s a question of what reforms we need to make to ensure the sustainability of good quality public service pension schemes. And this is reform for the long-term, not in response to the fiscal pressures currently facing the country, but in response to the pressures on these schemes that have built up over decades.

I hope it is clear to everyone that I am not advocating a ‘race to the bottom’ in public service pensions. I would regard this as a counsel of despair. And the fact is that public service pensions are not ‘gold-plated’ - around half of public service pensioners receive less than £6,000 a year. And public service pensions are a vital part of our national savings system – with about one in five UK citizens having some entitlement to a public service pension. We have to build on this solid platform of engagement, not undermine the current high level of participation in these schemes.

But the current final salary schemes are not suitable for a modern workforce for three reasons. First, they unfairly benefit high flyers, who can receive up to twice as much in pension payments per £100 of contributions. Second, they expose the taxpayer to the risk that salaries will rise more quickly than expected, which would increase the cost of providing these pensions. Third, they create a barrier to employees moving from the public to the private sector.

So, I have recommended a comprehensive package of reform, which deals with these issues. First, I am recommending that the current defined benefit schemes are replaced by new career average schemes. Members would build up a slice of pension each year based on their salary, which should, in my view, be increased in line with average earnings. This design provides a fairer outcome than those seen in the current final salary schemes – and fairness is at the heart of the reforms I am proposing. In an equal-value career average scheme, the bottom tenth of pension payments would be almost 90 per cent higher than those from a final salary scheme. The top tenth of pension payments would be about 6 per cent lower. I am proposing a switch to career average schemes because they are simpler and easier to understand and to implement than the other scheme designs I considered.

Second, I have recommended that the pension ages in most of these schemes is linked to the State pension Age, to reflect the changes in life expectancies that we have seen in recent decades. On current projections this would bring the proportion of adult life in retirement back to around a third; roughly where it was in the 1980s. The only exception to this would be for the armed forces, police and firefighters, where the unique nature of their work, and the toll this takes on them, means that a pension age of 60 would be more appropriate.

Third, I have recommended that a clear cost ceiling is set for these schemes going forward - I have suggested basing this on the percentage of pensionable pay paid by the taxpayer. And these ceilings would have an automatic stabiliser built in to their designs to make sure that future costs to the taxpayer are more effectively controlled.

This should provide a balanced deal for public service pension members and taxpayers for the future. Public service pension scheme members will receive a good quality, defined benefit pension – providing them with an adequate retirement income. While taxpayers can have confidence that the schemes provide value for money and their costs are controlled.

It is important that current, as well as new, members are placed into these schemes. Previous reforms have been mostly confined to new entrants, but this has created unfairness across the generations. It is not fair for the current members to pass on all the cost of change to others.

But in return for this, I am recommending retaining the final salary link for current members for their past service. This will make sure that current members are treated fairly. And those closest to retirement, perhaps in their 50s today, who have less time to adjust will be least affected.

I have also recommended more independent oversight and much stronger governance of all the public service pension schemes. It is only right that government, taxpayers and members are better informed about the financial health of these schemes and that they can have confidence that they are being run correctly.

There is also a strong case for introducing new, overarching, primary legislation to establish the new public service pension framework that I have described here. This will provide greater transparency, simplicity and certainty over the reforms.

These changes will also need to apply to the Local Government Pension Scheme. Yes, the LGPS does have a higher proportion of part-time, lower earning members than in most schemes, but there are also many members in schemes such as the NHS and civil service schemes. And generally the LGPS shares many features with other schemes. But it also makes sense for the LGPS to continue on a funded basis, contributing to a mixed approach to funding for the public service pension schemes.

If the Government accepts my package of reforms it will then need to be implemented fairly and effectively. This is key. Reform will only be successful if my recommendations are capable of being implemented in a practical way. I believe they are. And the process will need to include a proper period of discussion between employers, employees and their representatives.

Change on this scale cannot be achieved overnight and the journey to full implementation may well be a difficult one. But I believe that the package of reforms I have recommended is the best chance we have of achieving a sustainable public service pensions system that delivers a good deal for both scheme members and taxpayers.

It recognises the changes that are taking place in wider society – the increasing costs of pensions, that people are starting to work longer and that the State Pension Age is increasing – without creating an inevitable downward spiral in pension provision for the millions of public service workers who serve this country well. This is the most sensible and rational path for us to follow. I hope we take it.

Speech by John Hutton at the National Association of Pension Funds conference

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