3 April 2009
‘Gold-plated’ public sector pensions stand accused of draining the public finances. But in the long term the state might have to step in to boost the relative paucity of their private sector equivalents
Over the past few months, the cost of public sector pensions has been the subject of intense debate. Pensions industry commentators, the CBI and the Institute of Directors have all drawn attention to the long-term financial implications of public sector pension liabilities. Picking up on this theme, the opposition parties have called for the government to review public sector pension arrangements. So far, the government has resisted this.
On reflection, this is perhaps for the best. The long-term cost of financing public sector pensions is a significant issue but an inquiry that focused only on this would be in danger of overlooking something equally important. It would not address the long-term implications for the public finances of the wider decline in occupational pensions provision.
We have become accustomed to seeing and hearing the phrase ‘gold-plated public sector pensions’. However, not so long ago final salary pension schemes for public sector workers were not so out of step with the private sector. It is only in recent years that this term has been used to highlight the widening gap between the pension benefits available to public and private sector workers.
However, this gap has not widened because public sector schemes have become more generous. In fact, in recent years, public sector schemes have been scaled back, with their average value to new entrants reduced by around 3% of salary, according to the Pensions Policy Institute. Rather, the gap has been created because of the significant decline in the provision of pension schemes in the private sector, particularly defined benefit schemes.
This decline, which began in earnest in the mid-1990s, has accelerated in recent years. In contrast, public sector pension scheme membership has risen during this period. This growing disparity has evolved to the point where the CBI, IoD and others have described a ‘pensions apartheid’ between public and private sector workers. Data from the Office for National Statistics reveals that, between 1991 and 2007, the active membership of public sector defined benefit pension schemes grew from 4.2 million to 5.2 million, a rise of 24%.
However, what is more telling is that, over the same period, active membership in private sector pension schemes fell from 6.5 million to 3.6 million, a decrease of some 45%. The vast majority of the lost 3 million members were in defined benefit schemes – ONS data shows that defined contribution scheme membership has remained relatively stable over this period.
So where have all these private sector pension scheme members gone? The latest ONS figures show that in the private sector there has been a massive rise in the number of preserved pensions (already-earned pension benefits now frozen and due to be paid on retirement), a direct consequence of the large numbers of scheme closures in recent years. What is less clear is how these missing millions are planning to make provision for their retirement.
As both the appetite for pensions and their availability through occupational schemes has decreased, many have sought to make their own arrangements for providing an income in retirement. Research by the Association of British Insurers shows that property, such as buy-to-let and speculative purchases, cash deposits and stock and shares are the most popular investment choices outside of pension schemes.
However, those relying on these alternative investments will likely face a shortfall against their expectations as rental income, dividend payouts, stock values and interest rates have all plummeted.
Even those in pension schemes might not receive the level of income they expected. The National Association of Pensions Funds 2008 pension scheme survey shows that the average defined contribution scheme is producing an annual pension of around £1,000. In the absence of any other income, and even with the basic state pension, this would still leave the recipient entitled to further state support.
If the numbers reported by the ONS to date showed the true extent of the problem, it might have been possible to ascertain the long-term implications for the public finances. However, since the ONS compiled the 2008 statistics (which were based on 2007 data), there have been more defined benefit scheme closures and switches into defined contribution schemes. We have also entered a recession, which is causing many scheme providers to look again at their pension arrangements. The NAPF believes this could seriously accelerate the decline in defined benefit schemes.
As little as seven months ago, research by consultancy Watson Wyatt found that more than 40% of defined benefit schemes could close to future accrual within the next ten years. Six months later, NAPF research now suggests that, with employers increasingly looking to reduce their costs by overhauling their pensions arrangements, more than 52% of (or over 1,000) occupational defined benefit schemes could close to new entrants within the next five years.
Even if many of these scheme members are moved into defined contribution arrangements, the low level of benefits that the latter pay out means that many more private sector workers might need state support in retirement.
The economic downturn is also affecting the way those in pension schemes are saving for their retirement. Recent research by the Prudential found that 18% of workers had already cut back on pension contributions. Another life company, Axa, has also suggested that 1.5 million people are on the verge of suspending their pension contributions altogether in response to the current economic conditions.
This points to an acceleration of the worrying trend for pensions underprovision highlighted by Lord (Adair) Turner’s 2005 Pension Commission report, which concluded that: ‘Voluntary private pension provision is not growing: rather it is in serious and probably irreversible decline. Employers’ willingness to voluntarily provide pensions is falling.’
All this leads to increasing uncertainty as to how much additional state finance will be required to support those whose income in retirement falls short of the government’s minimum income guarantee .
The decline of pensions in the private sector is not a zero-sum game. If the retired workers of this country are to enjoy their retirement free of poverty, it will fall upon the state, and by extension the taxpayer, in the form of increased income support and pension credit payments to make good the ‘pensions apartheid’.
So while the cost of public sector pensions might be the headline, the bigger story is the uncertain consequences for the public finances of the wider decline in private sector pension provision. Any review of pensions provision should therefore not limit itself to the public sector alone, but tackle the wider question of adequate income in retirement for all.
