Lord Hutton

Where there’s a Will (and John), by Jackie Ashley

The two Huttons’ proposals for reforming public sector pay and pensions tackle major areas that are in the government’s sights for cuts. But how fair are they?

Are you au fait with British public life? Then you don’t get your Huttons tangled. That’s Belfast Lord Hutton peering over his spectacles, who reported into Dr David Kelly’s death. Then there’s sharp-suited former Labour minister Lord (John) Hutton asked by the coalition to look into public sector pensions. And finally, there’s former newspaper editor, economist and ubiquitous commentator Will Hutton (not yet a Lord, outrageous!) who has been investigating public sector pay.

So what is a Hutton? A Hutton is admired for his flinty intellect and readiness to work for different political masters.

The original Lord Hutton had been brought in by Blair as a fierce figure nobody could dream of accusing of going soft on the government – although many thought he then did.

John and Will are men of the Left who took on tasks for the coalition. In each case the task they’d been given was big but thankless.

John Hutton was told to review public sector pensions, which (according to the Office for Budget Responsibility) would face a £9bn funding gap over the next four years alone. These are the pensions described by the politics-of-envy Tory tabloids as ‘gold plated’. Cutting back will cause real pain and anger and Tory ministers know it. All credit, you might say, to a Hutton for being prepared to pull on the rubber gloves.

Will Hutton’s task was to look at the gaps in public sector pay between those at the top, and those further down. The public sector has been infected by the boom years. If the bosses of FTSE companies could earn huge sums, why not the people running swathes of taxpayer-funded Britain? If you want the best, you have to compete. But whatever happened to fairness and the public service ethic? Another pair of rubber gloves, nurse – and fetch me a Hutton.

John Hutton’s remedy for pensions is radical surgery without much in the way of anaesthetic. Many public servants would have to work longer, pay more into their pensions and get less back in the end. Well, why should hard-pressed taxpayers have to keep shelling out for other people’s unaffordable pensions? Some people retiring expect to spend 40% of their adult life retired.

So he proposes that the uniformed services, such as the armed forces, firefighters and the police would have to work to 60, not 55, while others must wait until state pension age. That’s sensible. But then came the Treasury’s cash reductions, with pensions tagged to the CPI rather than the higher RPI.

Ouch. Hutton also proposes public sector workers move from final salary schemes to ones based on career average earnings – an idea, at best, ambiguous when it comes to the impact on low-paid public sector workers. The average pension paid to public servants is under £8,000 per year. About half get less than £5,600. ­­Gold-plated? Hardly.

So what about the other end of the scale? Will Hutton was expected to recommend a cap on top pay in the public service of 20 times the lowest pay. But he found that only 70 out of 6 million public sector workers earned more than that multiple. Instead, he has come up with plans for more transparency and performance bonuses.

He wants senior executives to have to earn at least a tenth of their salary for good performance – and lose it if performance targets are missed. It’s less simple than it seems. But it does introduce real incentives and some real sanctions.

Will Hutton deserves a thumbs up. The only problem is his managers with their performance targets might find many of their staff demoralised because of the pension proposals from John Hutton.

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How progressive are public sector pension reforms? By Carl Emmerson

Lord Hutton’s review of public service pensions contains a number of recommendations. Perhaps the three most important for both the taxpayer and the members of these schemes are:

  • Rights employees have already accrued should be honoured in full;
  • Future accrual should continue to operate on a defined benefit basis but this accrual should be based on the individual’s average earnings rather than their final salary;
  • The age at which a full pension should be paid (Normal Pension Age) should be equal to the State Pension Age, with the notable exception of the armed forces, police and fire fighters.

What would be the impact of a shift from final salary to career average and the planned increases to NPAs, and what would the whole package do to the overall generosity of public service pension schemes?

Much commentary on Hutton’s report has asserted that career average schemes are necessarily less generous than final salary schemes. But how the generosity of a career average scheme compares to a final salary scheme will depend on how that average is calculated. Hutton has proposed that earnings in each year of an individual’s active membership of a public service pension scheme should be revalued in line with average earnings growth. This reform certainly makes the scheme less generous than a final salary scheme to high flyers who would see their salaries increase by more than average earnings, but it will also make the scheme more generous than a final salary scheme to those whose salary grows by less than average earnings.

This change might well be deemed sensible: as Lord Hutton’s interim report showed, public sector workers who experience high salary growth can currently benefit from almost twice as much pension per £1 of pension contributions than those who experience low salary growth. Where these reforms would change the level of remuneration significantly the Pay Review Bodies should consider carefully whether offsetting changes in pay would be appropriate.

The proposal to set the NPA equal to the SPA for most public sector workers does reduce the generosity of the schemes: those affected would typically have to contribute for longer to receive the same pension for fewer years. There are at least two good arguments in favour of such an increase. First, many new members of public service pension schemes already have an NPA of 65, while those who were members of such schemes before the last set of reforms came into force often have an NPA of 60.

Aligning these would mean that individuals who were doing the same job, with the same pay, also accrued the same pension regardless of whether they happened to have joined the pension scheme before or after the cut-off date set out in the previous reforms.

Second, rising longevity led Lord Turner’s Pensions Commission to recommend that the SPA should increase in future from 65 to 68 and this proposal was accepted with cross-party support. Increasing the NPA in public service pension schemes would seem consistent with this decision, and there is also an attraction in aligning the ages at which an individual can start to receive their state pension and the age at which a full public service pension is available.

In addition a formal link between the NPA in public service pension schemes and the SPA would mean that were future governments to decide to increase the SPA further (presumably in the light of further increases in longevity) then the default would be that this led to an increase in the NPA in public service pensions.

Those in the uniformed services – the armed forces, police and fire fighters – are to have an NPA of 60 for future accrual rather than an NPA equal to the SPA. In some cases this also represents a substantial reduction in the generosity of these schemes (although not in the case of recent entrants to the fire fighters scheme who already face an NPA of 60) although significantly less than had their NPA been increased to the SPA. The desire to provide generous support to these individuals after they leave these careers – in particular where these careers typically can only be pursued up to a relatively young age – is understandable. What is less clear is whether more generous pensions, presumably with an expectation of early retirement, is the best way to provide such support.

An alternative that might be more attractive would be to increase the NPA to the SPA for all public sector workers including those in the uniformed services and instead offer some of those leaving the uniformed services specific payments to support a transition into alternative careers. Careful targeting of such payments – for example for retraining and relocation – could offer better value for money for the taxpayer than using universally more generous pension arrangements, and were it deemed appropriate, would also allow the payments to some individuals to be significantly more generous.

Overall many features of these reforms recommended by Lord Hutton are welcome. But what these reforms would do overall to the generosity of these schemes to public sector workers will not be known until a decision on other key parameters is announced. This will also affect the cost to the taxpayer of these schemes.

In particular, Hutton’s report leaves open the choice of accrual rate in these schemes and the level of employee contributions. Once these are known we will be able to assess the extent to which the reforms are leading to an average reduction in the generosity of public service pensions (if that is the case). In addition it will be possible to calculate whether there are likely to be any overall winners – such as low-flyers – from the reforms.

Carl Emmerson is deputy director of the Institute for Fiscal Studies. This post first appeared as an IFS Observation

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High-flyers and Hutton, by Andrew Cawley

It is very difficult to decide what is fair when it comes to public service pension reform, but fairness is the order of the day.  Following the publication of his final report by Lord Hutton yesterday, we still do not know what the new level of benefits will be as this is for the government to decide.

But what we do know is how the cake is to be shared.  This is because Hutton is very clear in his recommendations about the shape of the new pension schemes. There will be a shift of resources from ‘high-flyers’ to so-called ‘low-flyers’, in other words from those whose earnings increase faster than the national average to those whose earnings grow more slowly.

There will also be shift from current members with a Normal Pension Age of 60 to new members who currently have an NPA of 65.  So ‘up and coming’ employees such as a newly appointed hospital consultant in her mid 30s may be particularly affected.  She is far enough through her career to know that retirement is important, but not far enough through to bank the protection for older members.

So while it might be fair to provide a pension that is in proportion to the amount of contributions you pay throughout your career, it does not mean that it is an easy pill to swallow.

The government will want to make sure that pensions remain competitive for high-flyers and that these valuable future leaders don’t decide to leave the public sector.  Indeed, they may find that the pension provision in the private sector still falls short of what is on offer even post-Hutton but some may conclude that other benefits compensate for this.

Policy-makers will wish to avoid such a drain, so the government’s decision on the level of benefit is crucial.  One massive question is around the accruals level.  The Turner Commission suggested that a level of 1/90th would be adequate.  This would be an extreme move for the government given there are no immediate cash savings to be made and the many other (non-Hutton related) changes to pensions at the moment that are also hitting higher earners.

However, if accrual rates have to be reduced to cut costs, it would come as a big shock to the system.

Andrew Cawley is UK head of pensions at KPMG

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Pension proposals could destroy LGPS, by Mike Taylor

Treasury proposals to increase public sector workers pension contributions by 3% over the next three years (equating to £900m from the Local Government Pensions Scheme) could destroy the LGPS ahead of Lord Hutton’s final report on the future of public sector pensions.

To protect the low paid and phase in the additional contribution rates over the period 2012/13 to 2014/15 this implies significant increases for high and middle earners according to the Department for Communities and Local Government: 15% for those on £150,000 or more and 13% once you hit £42,000; a cliff edge at £24,001 where contribution rates jump from 6.5% to 9.7% and much higher rates in the LGPS than in many other public service schemes.

Such increases could lead to large numbers opting-out of the scheme; 40% according to the GMB, which would break the scheme before Lord Hutton gets the chance to fix it. And yet the Treasury has estimated that take up will be reduced by a mere 1%.

If significant numbers opt out-then not only will the government not get its £900m but funds will face increasing deficits and employers could end up having to put more money in than they do today resulting in a net loss to the public purse.

Not least, a mass opt-out of the LGPS would make schemes much more mature, bringing forward the date when payments exceed contributions, requiring different investment strategies to match assets and liabilities. Funds would need to switch from investing in riskier assets such as equities to less risky assets such as bonds. For the LGPS with over £130bn invested, of which some £40bn is in UK equities, this would have a major impact on investment markets.

By virtue of being funded, the LGPS can raise £900m in more than one way. To achieve the correct balance between fairness and sustainability, there are more sensible options than merely increasing employees’ contribution rates. Options such as reducing accrual rates, increasing retirement ages or removing the final salary basis can more effectively generate the required reduction in employer contribution rates.

Mike Taylor is the chief executive of the London Pensions Fund Authority

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Taking care of pensions, by Mike Taylor

Lord Hutton has been charged by the government to explore how to make public sector pensions more affordable, yet still provide an adequate retirement income for Britain’s millions of public sector workers.

This is no easy task – affordability and adequacy are not easy bedfellows, nor is achieving a balance between risk and simplicity.

But an important step towards achieving these goals would be to move away from the current final salary structure and instead adopt a Career Average Revalued Earnings (Care) system.

There is a good case for employees to share more of the risks of pension provision in the public sector. Some media coverage has exaggerated the generosity of such schemes, with much ill-informed comment about so-called ‘gold plated pensions’.

In fact, the average pension in payment to members of the Local Government Pension Scheme is a far-from-gold-plated £4,000 a year. However, the burden of cost does currently fall unfairly on the employer (and therefore the taxpayer). Without reform, that burden of cost would rise significantly in the coming years and decades.

A Care system would not only mean a more equitable pension system but, just as importantly, it would also be seen to be fairer by the taxpayers who help to fund it.

In our submission to Lord Hutton, we have also proposed the creation of a ‘Pensions Chamber’, an independent body tasked with ensuring that the solvency levels of public sector schemes remain sustainable into the future.

Although answerable to ministers, such a body would effectively take the politics out of pensions, and help to ensure any reforms address long-term affordability and re-balance risk, while still offering members an adequate income in retirement.

Mike Taylor is the chief executive of the London Pensions Fund Authority

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Hutton: reality and rhetoric, by David Davison

The publication of Lord Hutton’s long-awaited interim report into the future of public sector pensions was met with comment bordering on hysteria in certain quarters and some degree of entrenchment as various parties sought to set out their stall for the future.

But Hutton’s report provides a balanced and well thought through assessment of the position we find ourselves in with public sector pension provision and an initial consideration of what options might exist to provide a more sustainable solution for the future. It needs to be viewed dispassionately and without the level of rhetoric that has already begun to appear.

How surprised can people be about the major thrust of the report that ultimately people will need to pay more, retire later or retire on less? This is a well-worn message common to all reviews of UK Pensions PLC over the past 10+ years. Lord Turner and Alan Pickering all reached the same inevitable conclusions in their reports. It’s all too easy to be distracted by vested interest or righteous indignation about how we got here and whose fault it is.

There is a degree of collective responsibility for the debt levels which have accumulated over the last decade. Deficit levels built up in schemes over recent years have in part been caused by the irresponsible use of early retirement provisions and an overly optimistic funding basis, where there has been a funding basis at all. The former has now been largely addressed and the latter being something Hutton has already commented on in a subsequent speech to the National Association of Pension Funds conference.

The facts however are inescapable:

* We are all living longer and therefore the cost of pension provision will be inevitably higher and that extra cost needs to be found from somewhere.

* Due to an unfortunate convergence of circumstances that extra money needs to be found at a time when there’s not really that much to go around, but the need for a more sustainable approach to public sector pensions is not something that can be laid at the feet of the banks or the recession.

* We are now in a low return economy at least for the foreseeable future.

* We are all taxpayers and the costs to the public purse need to be justified and balanced against other priorities – an increase in costs of one third in the past decade is unsustainable.

It was particularly interesting that Hutton described the final salary link in public service pensions as ‘inherently unfair’. Nine out of ten pensioners receive less than £17,000 per annum of pension, however that means one in ten exceed this figure and those with higher benefits disproportionately benefit from the final salary related scheme design.

Hutton also suggested that it was a myth that public sector workers are less well paid compared to the private sector undermining any argument that better pension benefits are somehow compensation of this non-existent inequity

There are those who will seek to portray this analysis as an attack on the public sector, but it needs to be borne in mind that a significant proportion of the private sector, particularly those in the third sector, also participate in these schemes and will have their benefits affected. Many charities are struggling to meet the rising costs of defined benefit pension provision for their staff, which directly impacts on their ability to perform the role that people subscribe to fund.

Clearly charities do not have the option of continually turning to the taxpayer for additional funding when needed. A more sustainable and fair solution needs to be arrived at for everyone’s benefit.

One of the difficulties is that a wider reform of the whole UK pension system is required that incorporates state pension benefits and how they integrate with private provision and how individuals can be encouraged to effectively save for their retirement. This requires wider thinking and integration but at least this report provides a good start.

David Davison is a director at Spence & Partners, independent actuaries and consultants

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