Web exclusive: Who's going to tackle public sector pensions head-on?

10 July 2007

Will anyone take on the pensions battle on behalf of future generations of taxpayers? Professor Philip Booth asks the difficult questions

Tony Blair will move into early retirement while receiving a handsome pension. Members of Parliament receive one of the best pension packages available – financed by the taxpayer. Perhaps if MPs returned to the self- employed status they once had, without any pension provision that they had not made for themselves, they would better understand the problems that most of the rest of us have to face.

Though MP’s pension schemes stand out as being particularly “generous”, the cost of their scheme is small compared with the cost of providing pensions for other public sector workers – of course, there are only a few hundred MPs compared with a rapidly expanding public sector payroll in other sectors.

The best private sector pension schemes – those that pay pensions related to employees’ salary at retirement - have fallen like nine pins in recent years. Over two thirds are now closed to new entrants. The rest will probably close in the next five years. There are various reasons for this. One of the reasons is the increased level of regulation imposed by both Conservative and Labour governments over the past generation. Another reason is the increased cost of funding caused by Gordon Brown’s tax changes. Perhaps the main reason, however, is that companies have increasingly understood the risks that they face when guaranteeing pensions for life, related to a member’s salary at retirement.

Taxpayers have no choice but to bear those risks. Public sector final salary pension schemes remain open and unreformed, and many have earlier retirement ages than the average in the private sector. Furthermore, the government refuses to reveal their full cost in the national accounts. According to calculations undertaken by Neil Record for the Institute of Economic Affairs, the burden of public sector pension liabilities is estimated at over £1trillion in current value terms. This debt is only the debt accumulated in relation to pension promises made to date. Every year, the government promises new pension rights to public sector workers. The value of those pension rights is about £80billion each year.

Ill-health retirement rates in the public sector schemes are abysmal. Nearly a quarter of all teachers, civil servants and NHS workers retire due to ill health. This rises to 40% of all local government workers, 50% of police and over two-thirds of firemen. This is not good either for the taxpayer or for employees themselves. If employers had to pay the costs of early retirement pensions directly they would almost certainly manage employees’ health needs better.

The government does not seem to take public sector pension reform seriously. Why bother? Most MPs will be away from the scene before the costs become unbearable. Retirement ages are being raised for new members, but this will have little effect even in the medium term. By the time rises in retirement age show significant financial benefits, life expectancy will have improved further.

It is difficult to do anything about pensions that members have accrued to date – the promises have been made. Future taxpayers will just have to suffer. But radical solutions to the reform of these schemes should be possible. The cost of providing an NHS worker or teacher with their pension benefits is about 40% of salary. The cost of a policewoman’s pension is a staggering 72% of salary. There is plenty of scope here for negotiations between public sector unions and their employers to reach an acceptable solution. Elements of that solution could involve increasing employees’ pay significantly – in other words paying in cash what is currently paid in pension rights. At the same time, good quality defined contribution schemes could be developed with associated insurance arrangements. Unions could play a part in offering managed funds, financial advice and insurance products. They could return to their former, more glorious, role of being a prime provider of welfare for their members.

Is there any appetite on the political scene for such reforms? A Labour government could pull a rabbit out of the hat and the Liberal Democrats are certainly taking the issue seriously. As far as the Conservatives are concerned, pension reforms could be part of wider public sector reform that made education and health provision directly accountable to the users of the services – with individual providers, or groups of providers, taking total responsibility for setting pay and conditions for their employees. But it is increasingly unclear whether the Conservatives are in favour of reform or conservatism with regard to the public services. The real question is whether anybody has got the integrity to take on a battle on behalf of future generations of taxpayers. If they have, the results will be worth far more to them than Gordon Brown’s baby bond.

Professor Philip Booth is editorial and programme director at the Institute of Economic Affairs