The CBI produced an interesting and timely report on public sector pensions today. It raises a number of important issues, but the solutions suggested could cause as many problems as they solve.
One very good point is that pension accrual should be recognised as part of the reward package as a whole. This would highlight the huge rise in overall remuneration that the public sector has seen over the last decade. Research has shown that people do not tend to correctly value their defined benefit (DB) pensions, underestimating just how valuable they are. However, whilst it is very easy to value defined contribution (DC) pension schemes – you just look at the size of your fund – it is also very easy to overestimate the pension that they will produce. The rise of DC pension schemes could well lead to an increase in the number of pensioners relying on State support in years to come. It is therefore worrying that one of the main recommendations of this report is that a new class of unfunded DC pension schemes should be set up.
In many parts of the report, the terms DB and final salary are used interchangeably, but these terms are not the same. A final salary pension schemes is a particular type of DB pension scheme, but DB schemes can be based on average earnings instead. This is mentioned in the report, in the context of the change in the Civil Service Pension Scheme from a final salary to career average revalued earnings (CARE) pension scheme, which links benefits to earnings over a full career rather than just in the final few years. The limited savings offered by this approach are rightly mentioned – if salary progressions are modest, then final salary and CARE schemes provide similar levels of benefits.
However, this does not mean that DC is the only answer. I talked about risk-sharing DB schemes in an earlier post as a good “third way”, and they could certainly offer a more attractive alternative to traditional DB pension schemes than DC would provide. The Association of Consulting Actuaries has also provided a great deal of research in this area.
Risk-sharing pension schemes might also provide a longer-term answer to the retirement age issue raised by the CBI. The paper rightly notes that the retirement ages in public sector schemes are too low, suggesting that they be aligned with State Pension Ages. Whilst this is a good first step retirement ages will need to rise further, even if life expectancy rises only in line with expectations. A well-designed risk-sharing pension scheme could allow for such changes.
The issue of public sector pensions will continue to attract headlines for as long as they are so much more generous than most private sector arrangements. Any changes will inevitably be met with resistance, as these changes will result in less valuable pensions. However, the issue must be addressed and anything that keeps it in the public eye – including this paper from the CBI – is to be welcomed.