Public sector pensions: The known unknowns

Public-sector staff do not yet know all the facts about the government's plans

One thing absent from the debate about public-sector pensions is just what, in detail, the government is planning to do.

So far the government has been having private negotiations with trade union leaders about its general plans but has not publicised some of the most important facts.

But it is these details which are vitally important to understanding how much worse off public servants might be under the suggested new arrangements.

The first point to grasp is that the government wants to change the current pension schemes in line with the recent suggestions of Lord Hutton.

That would mean many employees being evicted from their existing schemes (mainly final-salary-related) into career-average ones, which should be less generous.

They would also have to pay higher employee contributions.

The NHS, local government, civil service and teachers' schemes would also have later retirement ages of 65 (rising later to 66 or even more in line with the state pension) whereas many staff are still currently able to bail out at 60 on a full pension.

On the face of it, public servants are being invited to work longer, pay more but receive less.

Accrual rate

Actually, the government says its plans amount to working longer, paying more, but getting more or less the same as now.

How can that be? After all, career-average schemes appear designed precisely to produce lower pensions than their final-salary counterparts.

The first thing to note is that how much a career-average scheme pays out depends partly on just how fast pension builds up - the so-called accrual rate.

It could be 1% of salary a year, or 2%, or almost any other figure.

But the larger the number, the faster pension builds up, and thus contributions rates for both staff and employers have to be higher.

For instance, the current civil service Nuvos scheme, open to new entrants to the civil service since July 2007, has a generous accrual rate of 2.3%.

So someone who worked for 40 years before normal retirement, and whose salary never rose in that time, would accrue a pension worth 92% of their salary.

Inflation-proofing

It has been suggested that the government wants its new career-average schemes to have a much slower rate of accrual, possibly as low as 1% a year.

That is partly to offset the cost of one of Lord Hutton's other key recommendations.

He recommended that when staff in these schemes are building up pension, their accumulating pensions should be revalued each year in line with average earnings to protect them against inflation.

It is argued by economists that in the long term, earnings rise faster than prices, so this would be a very advantageous feature.

By contrast, annual revaluation in the Nuvos scheme is merely in line with the consumer prices index (CPI).

"If you have the same accrual rate but revalue accrued pensions in line with earnings, rather than prices, most people would be no worse off under a career-average scheme than they would be in their old final-salary one," said John Wright, an actuary with Hymans Robertson.

Final-salary link

This is not the only apparently generous detail among Lord Hutton's recommendations.

He also said - and the government has agreed - that when staff leave their final-salary scheme for a career-average version, they should still continue to build up pension in their old scheme, even though they are no longer paying in any money.

That is because Lord Hutton said that the eventual payout from the final-salary schemes should still continue to be related to that member's final salary on their eventual retirement.

Normally, people leaving pension schemes, but not actually retiring, become deferred (in the jargon of the pension industry).

This means their accumulated pension to date is calculated at the point of deferral. It is then uprated each year in line with inflation until they do retire, but crucially is no longer linked to their salary.

So Lord Hutton's suggestion for the design of his huge change to the public-sector pensions - that deferred pensions should in fact retain a link to final salary - incorporates another unusual extra cost for the government to digest.

Government contribution

It is only when current scheme members and their trade union negotiators see the fine details of the government's proposed new pension plans that they will be able to see what they are getting for their higher contributions.

They will need to examine not only the suggested accrual rates and the method of inflation-proofing during accrual, but also the level of inflation-proofing for pensions in payment, as well as the retirement age and early-retirement penalties.

Vitally, they will also need to see just how much the government plans to pay in as well.

All these figures will need to be published, and understood, before anyone can decide just how fair, or unfair, the government's intentions are.