Switch to Swedish model to trim £10 billion UK public sector pension deficit, says CBI

Pensions in the public sector must shift from unsustainable 'final salary' models to a more affordable system, if we are to contain a trillion pound burden on the taxpayer, the CBI said today.

Its latest research claims that, because these pensions include an unpredictable guarantee from employers, and staff contributions are out of kilter with payout levels, the financial 'black hole' for unfunded public sector pensions is £10 billion every year. The total overall liability for these schemes has mushroomed to one trillion pounds, or £40,400 for every UK household, says the CBI.

The employers’ organization concedes that the picture is complicated because public sector pensions vary greatly in size and structure depending on the employer. Some, such as the local government scheme, have more transparent arrangements and are funded schemes, albeit often carrying large deficits. The civil service pension scheme, by contrast, is a completely unfunded pay-as-you-go scheme. However, the CBI believes that, taken as a whole, the current approach to public sector retirement is simply not sustainable.

The CBI claims that public sector pension benefits are on average worth 26% of salary every year, which is far higher than private sector norms - and the total cost will increase as people live longer. To compound the situation, the state workforce has grown by almost 1m in the past decade to hit 6.1million, or one in five workers.

The CBI today urged the next government to set up an independent commission within weeks of taking office to fully investigate pensions costs.

Today’s CBI report, Getting a grip: the route to reform of public sector pensions sets out some of the key issues the commission should consider.

The CBI believes the public sector needs to 'pay its way' for their pensions, so that pensions are fully linked to the contributions made by staff and their employer, with no hidden taxpayer subsidy. Importantly, pension rights and pots which have already been accrued must be protected, so staff will not lose whatever they have accumulated.

Going forward, all public sector staff should be moved off guaranteed 'defined benefit' schemes, which include final salary and career average pensions, says the CBI. How this happens may differ between public sector employers, continues the CBI, and it adds that schemes that are in a 'funded' position, such as local government, may wish to pursue a different route.

But for unfunded schemes, including the NHS, teachers and civil service, the CBI thinks staff should migrate to pensions based on the Swedish model of 'notional defined contribution', which will provide guaranteed pensions without an unpredictable taxpayer liability. This scheme would offer a risk-free pension that is more sustainable and secures transparency for employers, staff and taxpayers.

Also, retirement ages for existing and new public sector workers must be raised to match the state pension age, continues the CBI. Presently there will be state workers who retire in the 2040s at the age of 60 on a full pension, when the state pension age will be at least 68. Those due to retire in the next few years should not be affected, and lower ages could be kept in certain frontline roles, such as the police, armed forces and fire service.

"This is a difficult and emotive area, and not one that should be rushed,” said John Cridland, CBI Deputy Director-General. “Public sector workers deserve a good retirement, but they and their employers should pay their own way. The pensions black hole is over one trillion pounds and rising, and taxpayers cannot be left to make up the difference. Guaranteed final salary pensions have entered the history books in the private sector, but the state has not squared up to the issue for its own workers. Countries like Sweden and Holland reformed their systems some 15 years ago. A new government needs to acknowledge the problem, establish the true costs and let the taxpaying public decide what they are prepared to pay for. Public sector workers cannot lose the pensions pot they have accrued so far, but they will have to adapt in the future. We think that, for many public sector employers, shifting to a notional defined contribution pension could be the best way forward. It would ease the burden on taxpayers and offer public sector workers a secure and sustainable pension."

Under Notional Defined Contribution (NDC) schemes, members and their employers pay contributions calculated on pensionable earnings, and these are put in personal accounts. This money is not exposed to financial markets, but is directed to independently-managed, ring-fenced funds, separate from general public funds and budgets. These funds are then drawn on to provide benefits for current pensioners, which in the UK's case would be retired public sector workers.

With an NDC, the value of employees’ personal accounts increases over time in line with selected economic benchmarks – such as average earnings or inflation – using an independently determined rate of return. On retirement the accumulated value of the personal account is taken out of the ring-fenced funds and used to buy an annuity, either from the scheme itself or on the open market. A similar system was implemented in Sweden in the mid 1990s and has proved very successful.

The CBI recognises that some changes have been made to public sector schemes over the past decade, particularly in raising retirement ages for new joiners and moving some final salary pensions to a career average model. But the CBI has calculated that these steps, although welcome, will make very little difference to the headline issue.

The CBI says it does not believe that better pensions in the public sector 'make up' for lower pay, as some have argued. The ONS shows the average public sector salary is £23,660, compared to £21,528 in the private sector – the biggest gap on record. Furthermore, the IFS has calculated that factoring in pensions would add 12% to public sector pay packages, and only 5% to private sector pay.

And although the average public sector pension is over £7,000 per annum, the CBI considers this a misleading figure because the very large number of people with only one or two years’ service pulls the average down.

Tags: PensionsCBI