Wednesday, July 07, 2010

Public Sector Pensions Crisis

It's the same all over

Right across Europe public sector pensions are in crisis. For years, successive governments have made outlandish pension promises to their employees that their taxpayers were never ever going to be able to afford. And les poulets are now well and truly coming home to roost.

This morning sees the publication of an excellent new report on our own crisis. The Public Sector Pensions Commission (PSPC) confirms the harsh reality - public sector pensions are far too expensive and we simply can't afford to continue with them on the current basis.

First, debt. As we've blogged many times, the vast majority of public sector pensions are unfunded - ie there are no assets to back the liability, which therefore represents a pure debt we owe to public pensioners. Realistic assessments of this debt put it at well over £1 trillion, dwarfing our official national debt. Naturally HMG's own estimates understate the total - mainly because they overstate the discount rate applied to future payments - but the PSPC report provides this handy summary of all the latest estimates:

As we can see, Towers Watson - one of the world's leading independent actuarial firms - now put the true debt at an eye-watering £1.2 trillion, or £45 grand per household.

That's bad enough, but unfortunately the debt is still accumulating at an alarming rate. The best independent estimate (from Policy Exchange) says that the annual cost of the pension entitlement being accrued by current public employees is running at £34bn pa (2007-08). True, that's partly offset by the annual payments to existing pensioners (which reduce the outstanding liability), but shelling out £25bn pa on pensions is not what you'd really call comfort.

The second point is that public sector pensions are now miles better than those on offer in the private sector, and it simply isn't fair to expect hard-pressed workers in the private sector to pay higher taxes to featherbed public employees.

Of course, the public sector unions and their media supporters argue that these pensions form a perfectly fair and above board part of overall public sector remuneration. They say that they have accepted lower pay today against the promise of a better pension tomorrow.

But the truth is that overall public sector pay is not low relative to private sector. As we blogged here all the mainstream public sector groups (those famous teachers'n'nurses) currently do pretty well relative to the wider economy.

And when it comes to pension provision, the public sector advantage is huge. In the private sector - even if you're one of the mere 11% now in a defined benefit pension scheme - the total benefit to you averages around 19% of salary (and you'll likely have to contribute to that).

In the public sector, the benefit is much higher. Although the employers and employees are together only contributing around 20% of salary, even after Labour's modest reforms for new members, the benefit to employees averages 44% of salary, increasing to an extraordinary 71% for the uniformed services:

So the average policeman gets a total remuneration package that's 71% higher than what it says on his pay slip. No wonder we can't afford to employ them any more.

What's to be done?

Obviously there needs to be a drastic pruning of benefits. And the PSPC offers a menu, including:
  • Increase the pension age - most existing members of public sector schemes can still draw a pension at 60 (the police get it at 50, and firefighters at 55); with our vastly increased life expectancy, that has to increase.
  • Reduce benefit accrual rates - ie cut the amount of extra pension each employee earns for each year of work from its current average of around 1/60th of final salary
  • Move to career averaging - ie instead of basing an individual's pension on his final salary in his final year of employment, base it on his average salary over his whole career
They provide this handy table comparing the effects of the three options. They ask how far we'd have to go with each of the options separtately to bring the average overall cost of public sector pensions down from their current 40-70% of salary to the c20% actually being contributed by employers and employees together:

The choices are stark: either the pension age will have to be increased to around 80, or the accrual rate will have to fall from 1/60th of final salary for each year's service down to around 1/100th, or 1/80th if career averaging is introduced.

But however stark the choices, and however much resistance the unions put up, change has to come. All sensible commentators are agreed on that.

Labour already had one fumbled attempt at reform. But with the unions as their paymaster, they were never going to push it through. As the PSPC points out, not only did they leave entitlement rules for existing employees untouched, even for new employees what they took away with one hand they gave back with the other. So that was a flop.

Cam has to do much better. He may have appointed Hutton to take the initial flak, but it's Cam himself who will have to push it through to a final conclusion. Half-measures are not going to do it and he must steel himself for a long and bloody battle.

PS So why has Sir Alan Budd quit so soon? The left are naturally slavering, but there's no getting away from the fact that it is very troubling. We knew he was only there to get the thing up and running, but we'd all assumed he'd stay until the OBR had been put onto a permanent NAO-type footing - reporting to Parliament - and his successor was known. Replacement? It seems unlikely that Robert Chote would want to leave the IFS to take this role, but he's being touted by many. The other name being pushed by the left is the dreaded Blanchflower, but that would kill the OBR stone dead. Very tricky, although it does underline one point - no matter who produces the public finance forecasts, they will always be subject to a wide margin of dispute and disagreement. Which is why an OBR is no substitute for a properly articulated set of fiscal rules - see many previous blogs.


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