Lord Hutton report: Public sector final salary pensions should be replaced by career average schemes

Existing final salary public sector pensions schemes should be replaced by new career average schemes, says Lord Hutton in the final report of the Independent Public Services Pension Commission.

The final report follows a comprehensive nine-month review. It sets out a number of detailed recommendations to the government on how public service pensions can be made sustainable and affordable in the future, while providing an adequate level of retirement income.

The new schemes would see an employee’s pension entitlement still linked to their salary, a defined benefit (DB) scheme, but is related to their career average earnings, with appropriate adjustments in earlier years so that benefits maintain their value.

The report suggests that it should be possible to introduce these new schemes by 2015, while allowing a longer transition, where needed, for groups such as the armed forces and police.

Other key recommendations in the report include:
• Linking normal pension age (NPA) in most public service pension schemes to the state pension age;
• Introducing a normal pension age of 60 for those members of the uniformed services – armed forces, police and firefighters – who currently have a NPA of less than 60;
• Setting a clear cost ceiling for public service pension schemes – the proportion of pensionable pay that taxpayers will contribute to employees’ pensions – with automatic stabilisers to keep future costs under more effective control;
• Honouring, in full, the pension promises that have been earned by scheme members, their ‘accrued rights’, and maintaining the final salary link for past service for current members;
• Introducing more independent oversight and much stronger governance of all public service pension schemes;
• Encouraging greater member involvement in consultations about the setting up of new schemes, and in the running of schemes; and
• Overhauling the current legal framework for public service pensions to make it simpler.

Lord Hutton said: “These proposals aim to strike a balanced deal between public service workers and the taxpayer. They will ensure that public service workers continue to have access to good pensions, while taxpayers benefit from greater control over their costs.

“Pensions based on career average earnings will be fairer to the majority of members that do not have the high salary growth rewarded in final salary schemes.

“The current model of public service pension provision is clearly not tenable in the long-term. There is a clear need for reform.

“Getting the decisions right on the most appropriate structures and designs will be crucial to making any changes work in the future. This will only be achievable if there is effective dialogue between public service employers, employees and unions.”

Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), added: “Lord Hutton’s findings strike the right balance between fairness and cost, and have avoided a race to the bottom.

“Moving to a new career average scheme is a sensible approach that will help protect the lower paid. This could be a better deal than the current final salary arrangements for the lower paid and those whose earnings spike mid-career.

“It is an ambitious timetable to implement this by 2015, but it is important to crack on with these reforms.”

Malcolm Small, director of policy at Tax Incentivised Savings Association (Tisa), added: “Tisa broadly welcomes the recommendations of the Hutton Report. We all need to work for longer and contribute more to our pensions if we are going to stand any chance of a reasonable income in a retirement which, for many, will be over 25 years now and in future.

“The public sector is not immune from this; especially as so many of the pension promises made to them are supported by the tax payer. Hutton’s recommendations are well thought through, proportionate and balanced across the interests of all parties.

Kevin LeGrand, president of the society of pension consultants, added: “Thankfully today’s report acknowledges that the ‘race to the bottom’ is not sustainable in the long term, and that the right way forward sits somewhere between the current lowest levels of provision and the largely unaffordable final salary model.

“What happens in the public sector has implications for the private sector. Public sector schemes have in the past provided the benchmark for the private sector to follow; Hutton’s recommendations overall should create a sustainable and balanced framework, many of the features of which should once again provide models for the private sector.

“Crucially, it is essential for any scheme that costs are contained so that future arrangements remain sustainable, so we support the principle of defined cost limits being proposed. The same principles are essential for the private sector. We hope that recommendations will result in a review of existing legislation covering private sector arrangements, allowing similar review systems to be freely available. This would help encourage employers to feel comfortable with offering schemes once again where not all the risk lies with the member, where that would be appropriate for their employees.

“Cost containment requires accurate and consistent valuations of liabilities; Hutton’s recommendations in this area are a prerequisite to the success of any reforms.“

Charles Cotton, performance and reward advisor at the Chartered Institute of Personnel and Development (CIPD), added: “No matter how much more affordable new public sector pension arrangements are made, if employees don’t value and appreciate the employer investment then the money is simply being wasted. We understand Lord Hutton’s recommendation that the primary purpose of public service pensions should be to ensure adequate levels of retirement income for public service pensioners. However, we feel there is a danger he is too readily dismissing the role good pensions play in supporting the delivery of high quality public services. 

“We welcome Lord Hutton’s thorough and considered report. The challenge for government now is to ensure that the large cost of these pensions, even after the Hutton reforms are implemented, delivers value for money for the taxpayer. Meeting this challenge depends on their value to public sector workers being appreciated.

“Without this, they can’t effectively drive recruitment, retention and motivation of high performing employees, dedicated to consistent delivery and continuous improvement of high quality public services.”

Paul Middleman, a principal at Mercer, added: “This has the potential to be a good pragmatic approach combining modernisation with the preservation of good sustainable pension provision. We are pleased to see the close accord between the report and the contribution that Mercer has made to the debate.

“If appropriate design parameters are applied, career average (Care) schemes would strike the right balance between employee needs and taxpayer resources so its introduction is a welcome move. Care is more easily aligned with workforce management than final salary.

“It makes remuneration more transparent, as it reduces cross subsidy within the pension arrangement from low paid staff on flat careers to high paid, high potential staff.

“We also welcome the proposed tiered approach of member contributions and agree that some increases in contributions could make the cost of pensions clearer to members. However, we are concerned about a blanket increase in member contributions.

“Contribution levels for some parts of the public sector are already at high levels so a forced increase across the board would damage the enthusiasm for saving amongst members.”

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