There are many reasons to welcome the mood of fiscal probity that has permeated Whitehall, following the first report from Sir Alan Budd’s Office for Budget Responsibility (OBR) last week. Closing the deficit will require determined action in tomorrow’s Budget, and it is right that this is the government’s immediate focus.
But in making short-term savings we cannot neglect the longer-term sustainability of public finances. Nick Clegg pointed to the fact that few issues pose more headaches for future governments than the costs and risks associated with the pension schemes currently on offer to more than five million public sector employees. The OBR report only confirmed what we and others have been saying for many years – costs are spiralling without proper measurement or control.
And it’s high time to take action: earlier this year we calculated the total liability of the unfunded schemes to be at least £1 trillion. That’s why business warmly welcomes the announcement of a commission to investigate the costs of these schemes and set out a route to reform.
The journey should start by getting a grip on the scale of the problem, and end with ensuring that quality pensions are provided for staff, in line with good practice in the private sector. We think this can be delivered without taking big bets with future taxpayers’ money.
In the past decade, private sector pensions have undergone dramatic change. Firms have had to react quickly to the unsustainable costs and volatility associated with defined benefit schemes of the sort still widely available in the public sector, and only a couple of such schemes remain open to new members among FTSE 100 companies.
Over a decade, funding levels quadrupled and have shown little sign of slowing. While businesses have been forced to face these facts and make painful decisions about the future, equivalent changes have not yet been made in the public sector.
The private sector – by virtue of being subject to strict accounting and funding rules – knows what a weight these schemes can be. In the public sector transparency is far more limited, as our recent report Getting a Grip showed. This has allowed government, and those with an interest in ensuring the problem is ignored, to try to draw a veil over the real position.
The first goal of the commission has to be transparency on cost. We have already identified significant under-pricing of pension debt in the public sector. In 2007-08, for instance, £29bn was accrued in benefits by members, but only £19bn in contributions was collected from public sector employers and employees in contributions.
This funding gap hides £10bn of cost every year from public sector employers and staff – and the taxpayer. Is it any wonder that employees and employers in the public sector do not realise these schemes are unsustainably expensive, when neither of them see the real cost of the scheme, in the way that businesses do?
The independent commission will shine a long-overdue light on this conundrum. It can tell all of us – taxpayers, employers, employees and ministers – where we really stand. We hope to see them challenge all of the assumptions used in the public sector.
Once we know where we stand, we can then have the rational debate we need about what pension provision is sustainable. Of course it is essential for members to have confidence that their scheme is affordable and can be relied upon to see them through.
When major changes in longevity or the value of scheme benefits threaten that sustainability, it is far better to face up to the issue than to hide behind the long-term nature of the scheme and leave it to tomorrow’s leaders – in business or government – to sort out the problem. We can’t continue with our head in the sand.
Following their investigation into the true costs of current public sector schemes, the independent commission could usefully set out some principles for reform and broad parameters for future provision. Given the variety of public sector pension schemes and workforces, it would not be right for it to take on the task of detailed scheme design – that must rest with public sector employers themselves, working with employees. But the commission should establish the framework for rethinking public sector pensions over the course of this parliament.
The success of any pension scheme rests on a number of factors such as its design, its investment strategy and its contribution rates. Any company that has taken the tough step of making its pensions more affordable will tell you the process of reform will not be rapid or easy. But they will also tell you it makes their business stronger in the long-term.
Government is no different, and no matter how hard the journey, it is essential that it is started now. The sooner the commission gets to work, the better.
Katja Hall, director HR policy, CBI