The government is right to address the huge unfunded liability that public sector pensions represent.
Unlike registered occupational pension schemes in the private sector, all the main public sector pension schemes – with the exception of that of local government – are unfunded. In 2008/09, the shortfall between the liabilities accrued for the four largest public sector pension schemes and the contributions collected was £10bn.
Population ageing will push this liability up considerably – and not in the distant future either. The Reform report Old and broke found that between 2011 and 2016 the number of people aged 65 and over will rise by 1.4 million, while the number of people of working age funding government expenditure will fall. As a result, by 2041, for every retired person there will be just 2.5 people of working age able to support them, down from almost four now.
This is unsustainable. But when it comes to public sector pensions there is also an underlying question of fairness. It is often argued that public sector wages are lower than private sector salaries and hence public sector workers need to be ‘compensated’ with larger pensions.
However, evidence shows that this is not the case. Research by PricewaterhouseCoopers estimated that the average annual post-tax income of a retired public sector employee was more than two and a half times that of someone in the private sector with an equivalent working life.
Previous governments have attempted to address these disparities. The Labour government outlined significant reforms in the 2002 pensions green paper, but these proposals failed to fully address the question of sustainability in public service pension policy.
The interim report of Lord Hutton’s review, published last October, moved things a big step forward. It identified the right issues for public sector pension reforms – the inadequate level of contributions paid by employees and the difficulty this poses to independent sector organisations that wish to take on the provision of public services.
The final report, published in March, recommended that the contributions and entitlements to public sector pensions should be brought into line, limiting the cost to the taxpayer.
This is the right principle to underpin fair changes to public sector pensions, and it largely informed the government’s proposals for public sector workers to contribute more into their pensions, work for longer and accept a pension based on a ‘career average’ salary, rather than the current final salary arrangement.
As the strikes by public sector workers in response to these proposals showed, the political challenge in dealing with the impact of population ageing is great. The influence of the grey vote in elections means that politicians are always wary of reducing age-related entitlements.
The government is right to be tackling this issue, in order to create a fairer system of entitlements and expectations and to help put the public finances back on to a sustainable footing.
But the rising costs of public sector pensions and of long-term care – highlighted by the recent Dilnot report – are dwarfed by projected increases in spending on state pensions and health care. It is in these expenditures that the big impact of population ageing will be felt, and where the government has yet to show that it has the mettle to make the necessary reforms.
Lucy Parsons is research director at Reform and co-author of the report Old and broke, published on June 29