HUTTON REPORT

NUT BRIEFING

OCTOBER 2010

BACKGROUND

The Government asked John Hutton’s Public Service Pension Commission to look at the cost of public service pensions. The Government is concerned that public service pensions are too expensive for the country and that the long term cost of the current system is unsustainable.

John Hutton’s interim report was published on 7 October. It will be followed by a further report early in 2011. The interim report examines the costs of public sector pensions and discusses a range of possible options for reform. Hutton has clearly indicated some of these will be put forward as firm proposals in his final report.

NUT POSITION

The Union has always believed that further change to public sector pensions is unnecessary. The agreements already concluded with the Government and employers led to changes which have made pensions sustainable for the long term. From January 2007, the contribution rate for all teachers increased from 6 to 6.4%, the normal pension age for new teachers was increased to 65, and a cost-sharing agreement was introduced to allocate any future increases in costs. These changes will reduce the cost of our pensions in the long term and should be given a chance to work.

HUTTON’S INTERIM REPORT - KEY POINTS

Hutton's report rules nothing in and nothing out. He raises possibilities and expresses preferences but emphasises that the final decisions are for the Government.

There are some good points from the report. Hutton recognises that public service pensions are not ‘gold-plated’. The average public service pension in payment is £7,800 a year, and half of pensioners receive less than £5,600 a year. As Lord Hutton says, these pensions ‘provide a modest – not an excessive – level of retirement income’.

Hutton says that he does not want a “race to the bottom” mirroring what has happened in the private sector. Many of his favoured proposals would, however, ensure this.

The possible changes discussed fall into three broad categories: pay more, work longer and get less.

PAY MORE

Higher contributions

Hutton was asked to examine the case for short-term savings within the period of the Comprehensive Spending Review. He has examined the potential impact of changing the benefit structure of schemes, contracting back into the state second pension; and higher employee contribution rates.

Unsurprisingly he has concluded that the most effective way to make short-term savings is to increase member contributions ‘and there is also a clear rationale for doing so’. The ‘clear rationale’ is that when set up, public service pension schemes had a more or less equal division of costs between the employer and the employee. With the Teachers’ Pension Scheme in the 1920s, contribution rates were 5% from the employer and 5% cent from the employee. Employees in public service schemes now pay between a fifth and a third of the total contribution. For teachers, the current employee contribution is 6.4% compared with the 14.1% employer contribution.

Higher contributions: example

A teacher earns £36,000 a year. Under the current 6.4% contribution rate she pays £2,304 a year in pension contributions. With a 8.4% contribution rate, this would rise to £3,024 a year. Once the effect of tax relief is removed, she will be £576 a year worse off, or £48 a month. A teacher starting on M1 will be £29 a month worse off.

Over a lifetime, a teacher who starts at M1 and reaches UPS3, will pay over £20,000 extra over a working lifetime if the employee contribution rate rises by 2%.

Tiered contributions

Hutton argues that those promoted during their careers gain greater benefits from their pension schemes and also live longer than low earners. He also believes any contribution increases should protect the low paid.

Hutton therefore suggests targeting contribution increases at high earners through tiered contribution levels as already happens in the NHS Scheme and the Local Government Pension Scheme.

Review of discount rate

Although the Teachers’ Pension Scheme is an unfunded scheme, the Government Actuary’s Department periodically assesses notional assets and liabilities of the scheme to analyse the full cost of the scheme.

The "discount rate" (notional rate of return) used is RPI inflation plus 3.5%. Hutton asks the Government to review this rate of return, suggesting that while he does not oppose it, it is at the high end of what is acceptable.

He estimates that a 0.5% reduction in the discount rate would increase the total contribution rate required by 3%. This could clearly have a major effect on the employee contribution rate.

WORK LONGER

Higher normal pension ages

Hutton notes that workers retiring today at 60 will spend around 40% of their adult lives in retirement, compared to 28% in 1955.

Hutton has said that schemes should ensure that ‘normal pension ages are in line with developments in longevity’. This is a clear indication that he will propose increases in NPA to 65 or higher or even to a variable age increasing in line with future increases in longevity. Existing members of schemes would almost certainly be affected. Hutton has publicly stated his distaste for the differential normal pension ages introduced in 2007.

Higher normal pension ages: example

A teacher is aged 40 when switched over to a final salary scheme with 1/60 accrual and a normal pension age of 65, but she still wants to retire at 60. The teacher earns £36,000 a year throughout the period.

If the teacher had stayed in the existing 1/80 pension 3/80 cash, her final pension from the period to NPA 60 would give a pension of £9,000 + £27,000 lump sum. In the new scheme, he has earned a pension of £12,000 by age 60. If she retires, the actuarial reduction brings this down to £9,036. If she then commutes £27,000 tax free cash, she is left with a pension of £6,786, a loss of £2,214 compared with the existing scheme.

GET LESS

Changing pensions indexation from RPI to CPI

The Government has already announced that the indexation of public sector pensions in payment and deferred pensions will switch from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI) from April 2011.

Hutton quantifies the effect of this proposal - it is expected to reduce the value of current benefits on average by around 15%, making schemes around 25% less generous than the pre-reform schemes.

RPI to CPI: example

The Union has calculated that an individual with the average £10,000 pension would lose £35,000 over the course of their retirement because of the switch from RPI to CPI – a severe loss of purchasing power in retirement.

"Career average" and other changes to scheme structures

Hutton clearly opposes final salary schemes. He cites the unequal treatment of members within the same professional group, in particular the disproportionate benefits earned by high flyers in final salary defined benefit schemes when compared with low flyers.

Hutton appears to favour a move to career average schemes that give a pension based on service and salary earned over the whole career remain the most likely possibility. The entitlement built up during each period of service (usually a year) is revalued at retirement and totalled to produce the final pension entitlement. Much depends upon the chosen evaluation factor and also the chosen accrual rate which is usually higher in such schemes in order to offset the effect of moving to a career average.

Huttondoes not favour a move to individual funded defined contribution accounts but has said that he will consider a range of overseas pension schemes which sit between final salary and defined contribution arrangements.

Hutton also proposes a review of private sector participation in public sector pension schemes and in particular of the “Fair Deal” arrangements which protect employees’ pension entitlements when transferred to the employment of private sector providers. He argues that these may obstruct mobility between the private and public sector and obstruct private sector companies’ involvement in providing public services. This will have implications for NUT members transferred to providers of LA services and potentially may also extend to teachers working in independent schools and academies.

Career average: example

The Union has estimated that if the Government introduces a career average pension, with a 1/60 accrual per year of service and each year revalued to retirement in line with CPI then teachers face huge losses.

A teacher who starts at M1 and reaches UPS3 will get a pension at 68% of the former level. A Secondary Head may get a pension that is half of their pension under the current final salary scheme.

COST OF TEACHERS’ PENSION SCHEME (% OF SALARY)

Hutton’s report sets out updated projections on the gross cost of paying unfunded public service pensions. These showthat the total cost (1.7% of GDP at the time of the 2005 PSF agreement) is currently 1.9% of GDP and will fall to 1.4% of GDP by 2060, assuming the switch from RPI to CPI takes place. This shows that there is no affordability problem with public service pensions. Any attempt to cut public sector pensions is a political choice not an economic necessity.

Hutton’s report also shows the extent of the RPI to CPI switch. This is expected to cut the cost of public sector pensions by 15%, compared to the 10% saving achieved by the scheme changes made recently. He estimates that the pension entitlement for pre-2007 members was worth 23% of the total pay package under RPI indexation. CPI indexation reduces that to 19$% of pay. For post-2007 scheme members, the figures are 20% and 17% respectively.

ACCRUED RIGHTS

Hutton’s interim report makes it clear that pension rights accrued to the date of any changes will be protected. This is not largesse. It would be very difficult for the Government to reduce pension rights that have already been accrued.

Retired teachers and teachers with deferred rights in the scheme should therefore see no change to their pension rights other than the change to the indexation of pensions.

Serving teachers’ pension rights built up to date will also be protected. A teacher aged 40 with 15 years’ scheme membership has a normal pension age of 60. That teacher will be able to take that part of their pension in full at 60. It is, however, possible for the Government to change the terms for future service, so that any pension rights built up by that teacher after a change to a normal pension age of 65 could only be taken in full at 65 and would be subject to actuarial reduction if taken at 60.

The Union has argued that the protection of accrued rights should include continued indexation of pensions in line with the Retail Price Index on the longstanding basis. The Union has asked Hutton to comment on the merits and propriety of this change as it clear to us that accrued rights are not being properly protected.

NEXT STEPS

Hutton will produce his second report, concentrating on the long-term structure and funding of public service pensions in time for the 2010 Budget. The Government would then have to decide whether to accept Hutton’s recommendations in whole or in part. It is unclear whether the Government will respond to Hutton’s interim report during, for example, the Comprehensive Spending Review announcements.

Any changes to the Teachers’ Pension Scheme would require legislation. The NUT would expect consultation and negotiation on any changes through the Teachers’ Superannuation Working Party as happened in 2005-6. Any changes should also reflect the Scheme’s own actuarial valuation process which is currently overdue.

SSEE Department

October 2010