Resource issue

Lord John Hutton has published the interim findings of the Independent Public Service Pension Commission's review, instigated by the Chancellor of the Exchequer in his Budget speech in June to consider the options for short and long-term reform of the "unsustainable" system.

Acknowledging the role of the public sector in performing functions that are "vital to the security of our country, the success of our economy and the health of our society", Lord Hutton stresses the importance of providing an effectively designed overall remuneration system which is fair and efficient in the use of scarce public resources.

Lord Hutton attempts to dispel the myths, bred by "misunderstandings and confusions", that commonly surround debate on public sector pensions, and dismisses the notion of "gold-plated" pensions being the norm in the public sector on the basis that the average pension paid out in the public sector is "fairly modest".

However, he expresses concern that "final salary schemes, which are the norm across much of the public sector, primarily reward high earners who progress rapidly through the salary scales", and no longer provide a robust and fair mechanism for the majority of the public service workforce.

Short-term savings

Taking account of increased longevity, the imbalance between employer and employee contributions, and the fact that total contributions may be too low if (as the committee suggests) the discount rate used to set the level of contribution is too high, a range of options is proposed that may provide short-term savings, pending long-term structural reform.

These include changes to the benefits structure, ceasing to contract out public service pension schemes from the State Second Pension, and increasing contribution rates. While Lord Hutton maintains that the most effective of these changes is to increase member contributions, he stresses that any such increases should protect the low paid and be managed in such a way as to prevent significant increase in opt-out rates.

Long-term reform

The report accepts that although the series of reforms introduced by the previous Government, the current pay freeze and planned workforce reductions will reduce the future cost of pensions, it will take many decades. In the longer term, reform is needed to enable the structure to respond flexibly to changes in modern working patterns and to demographic changes over the past few decades.

It is suggested that the traditional final salary defined benefit scheme cannot appropriately embrace these changes. But neither would a funded, individual account, defined contribution model, which would place a major financial burden on taxpayers, ignore the ability of Government to manage certain types of risk, and increase uncertainty of post-retirement income for scheme members, which is difficult in particular for the low paid to manage.

The final report will consider a wider range of radical solutions which Lord Hutton suggests might represent a better balance between the need for fairness between taxpayers and scheme members, allowing for longevity and the need to ensure adequate retirement incomes for those who have devoted some or all of their careers in the service of the wider community.

The solutions will be assessed against the general principles of affordability and sustainability, adequacy and fairness, supporting productivity, transparency and simplicity, which are highlighted in the report. These will include a career average alternative to the current final salary defined benefit scheme, alternatives such as Sweden's use of notional defined contribution schemes and the Netherlands' collective defined contribution schemes, and risk-sharing models, such as hybrid schemes that combine elements of defined benefit and defined contribution models.

It is expected that the final report will make recommendations on a range of options with a view to establishing a better framework for public service pensions going forward, and will be available in time for the 2011 Budget.

In his spending review published shortly after the report, Chancellor George Osborne confirmed that the Government had largely accepted Lord Hutton's recommendations, and an increase in the level of employee contributions equivalent to an average increase of 3% will be phased in from April 2012. A review of the discount rate used to set the level of contribution, which the commission suggests is at the high end of what is appropriate, will be commissioned alongside a review of the Government's "Fair Deal" requirement to provide comparable benefits for public sector outsourcing, which the commission regard as a barrier to non-public service providers.

Maureen McCarthy, solicitor, Pensions, Biggart Baillie LLP