Publications

Pensions Public Sector Update - Public Sector Pensions Commission – Final Report

11 March 2011

Hutton tells public sector workers they can keep defined benefits in return for later retirement, more affordability, greater scheme governance and tax payer accountability

Lord Hutton has now published the final version of his report on public sector pensions reform.

The report, which is in excess of 200 pages long, contains no fewer than 27 recommendations which build on the 4 principles of reform identified by the Commission in its interim report published in October 2010, that public service pensions must be affordable and sustainable, adequate and fair, they should support productivity, and they should be transparent and simple.

The report sets out details of a new "Deal" between public service workers and the taxpayer. In return for retaining the right to a defined benefit arrangement, public service workers will have to work longer. Also, the taxpayer must benefit from increased transparency and stability over scheme costs, and schemes should be subject to greater governance. Changes could be introduced by 2015.

Highlights

Highlights include the following:

• The entitlement of public sector employees to a defined benefit pension arrangement should continue but future service benefits should be valued on a career average basis. Existing final salary entitlements should be protected for benefits already accrued. The changes to future service benefits should be introduced as soon as practical.
• Normal retirement ages in public sector schemes should reflect and track planned increases in the State Pension Age which is rising to 66 for both sexes by 2020, although this is inappropriate for the armed forces who should not be required to retire later than 60.
• Ministers should set a clear cost ceiling on the new schemes to keep future costs under more effective control, possibly by introducing an employer contribution cap and increasing employee contributions.
• Scheme governance should be increased by the introduction of minimum scheme administration standards and increased information for Government and taxpayers on the financial health of public sector schemes.
• Hutton recommends that his proposals should be introduced over the lifetime of the current Parliament so that they are in place by 2015. Government should also introduce primary legislation to adopt a new common UK legal framework for public service schemes.
• Although the interim report did consider further extending access to public service schemes to non-public service employers to assist private sector employers to comply with their Fair Deal obligations, the final report considers that this would be undesirable, given the increased long-term risk this places on the Government and taxpayers.
• The Local Government Pension Scheme (LGPS) is not exempted from Hutton's proposals although he confirms it remains appropriate for the Government to maintain the different financing arrangements for the LGPS in future, so that the LGPS remains funded and the other major schemes remain unfunded.

Background

In his June 2010 Budget Chancellor of the Exchequer, George Osborne, commissioned Lord Hutton of Furness to undertake a review of public service pensions beginning with his interim report published in October 2010. Our summary of the key findings and recommendations of the interim report can be found here.

Hutton's final report was published on 10 March 2011. A copy of the full report can be found here. Below we summarise Hutton's key final recommendations to Government concerning public sector pension reform.

Key recommendations

The following are the key recommendations made to Government in Hutton's final report:

• As soon as practical, members of the current defined benefit public service pension schemes should be moved to the new schemes for future service, but the Government should continue to provide a form of defined benefit pension as the core design. A new career average revalued earnings (CARE) scheme should be adopted for general use in public service schemes.
• The Government must honour in full the pension promises that have been accrued by scheme members (their "accrued rights"). In doing so, the Commission recommends maintaining the final salary link for past service for current members.
• The Government should ensure that public service schemes, along with a full state pension, deliver at least adequate levels of income (as defined by the Turner Commission benchmark replacement rates) for scheme members who work full careers in public service. Employers should seek to maximise participation in the schemes where this is appropriate. Adequate incomes and good participation rates are particularly important below median income levels.
• A single benefit design should apply across the whole income range. The differing characteristics of higher and lower earners should be addressed through tiered contribution rates. The Government should consider the trade off between affordability and the impact of opt outs when setting member contribution levels.
• Members should have greater choice over when to start drawing their pension benefits. Therefore, they should be able to choose to retire earlier or later than their Normal Pension Age on the basis that their pension would be adjusted accordingly on an actuarially fair basis. Flexible retirement should be encouraged and abatement of pensions in its current form for those who return to work after drawing their pensions should be eliminated. In addition, caps on pension accrual should be removed or significantly lifted.
• All public service pension schemes should regularly publish data which, as far as possible, is produced to common standards and methodologies and is then collated centrally. This information should be of a quality that allows simple comparisons to be made across Government, between schemes and between individual LGPS Funds.
• Pension benefits should be uprated in line with average earnings during the accrual phase for active scheme members. Post-retirement, pensions in payment should be indexed in line with prices to maintain their purchasing power and adequacy during retirement.
• The Government should increase the Normal Pension Age in the new schemes so that it is in line with the State Pension Age. The link between the State Pension Age and Normal Pension Age should be regularly reviewed, to make sure it is still appropriate, with a preference for keeping the two pension ages linked. In the case of the uniformed services the Normal Pension Age should be set to reflect the unique characteristics of the work involved. Government should therefore consider setting a new Normal Pension Age of 60 across the uniformed services, and keep this under regular review.
• The Government, on behalf of the taxpayer, should set out a fixed cost ceiling for public service schemes: this is the proportion of pensionable pay that sponsoring public service employers will contribute, on average, to employees’ pensions over the long term. If this is exceeded then there should be a consultation process to bring costs back within the ceiling, with an automatic default change if agreement cannot be reached.
• The Commission is not proposing a single public service pension scheme, but over time public service pensions should move towards a common framework for scheme design as set out in this report. The key design features contained in this report should apply to all public service pension schemes. However, in some cases, for example, the uniformed services, there may need to be limited adaptations to this framework.
• Every public service pension scheme (and individual LGPS Fund) should have a properly constituted, trained and competent Pension Board, with member nominees, responsible for meeting good standards of governance including effective and efficient administration. There should also be a pension policy group for each scheme at national level for considering major changes to scheme rules.
• Governance and the availability and transparency of information would be improved by the Government establishing a framework that ensures independent oversight of the governance, administration and data transparency of public service pension schemes. The Government should consider which body or bodies (including possibly the Pensions Regulator) may be most suitable to undertake this role.
• The Commission’s view is that even allowing for the necessary processes it should be possible to introduce the new schemes before the end of this Parliament. The Government is encouraged to aim for implementation within this timeframe.

LGPS

The Commission concluded that the common design features laid out in its report should also apply to the LGPS. However, it remains appropriate for the Government to maintain the different financing arrangements for the LGPS in future. As a result the LGPS should retain its unique funded status, while the other major public service schemes will remain unfunded.

Centrally collated comprehensive data, covering all LGPS Funds, should be published including Fund comparisons. For example, this should clarify and compare key assumptions about investment growth and differences in deficit recovery plans.

Individual LGPS Funds should have a properly constituted, trained and competent Pension Board, with member nominees, responsible for meeting good standards of governance including effective and efficient administration. There should also be a pension policy group for each scheme at national level for considering major changes to scheme rules.

Central and local government should closely monitor the benefits associated with the current co-operative projects within the LGPS, with a view to encouraging the extension of this approach, if appropriate, across all local authorities. Government should also examine closely the potential for the unfunded public service schemes to realise greater efficiencies in the administration of pensions by sharing contracts and combining support services, including considering outsourcing.

Fair Deal

The interim report recognised that the cost and risk associated with providing a broadly comparable defined benefit scheme make it difficult for private sector or third sector organisations to comply with the Government's Fair Deal policy in connection with TUPE transfers affecting public sector employees. Subsequently, the Government launched a consultation on the future of Fair Deal on 3 March 2010, details of which can be found here in our previous pensions update.

As a solution, the interim report did consider further extending access to public service schemes to non-public service employers. However, the final report considers that in principle it is undesirable for future non-public service workers to have access to public service pension schemes, given the increased long-term risk this places on the Government and taxpayers.

Osborne Clarke commentary

While the initial reaction has been that Lord Hutton's final report is radical and likely to be difficult to implement owing to resistance from public service employees and their unions, for the most part the recommendations are as expected. It is a high quality report which reveals careful and balanced research of the key issues. It is commendable that it has been produced to such a standard against a tight deadline.

The report has delivered high level conclusions, leaving therefore the detail to be worked out by the Government with the relevant stakeholders. There will be some tough negotiations ahead (particularly as the Commission has recommended that there must be consultation with public sector employees over the changes), and it may be that the final outcome differs from the vision that Lord Hutton has laid out. However, it seems incontrovertible that we now know the key outcomes for public service pensions. In particular, it is clear that the future no longer lies with the traditional final salary pension scheme, which only a decade ago was the norm for most UK employees.

Finally, as noted above, the Government's current review of the Fair Deal policy remains at the consultation stage. While it may attract less media attention owing to its rather technical nature, the outcome of this review is likely to be a further significant event for public service employees, as well as for private sector providers of outsourced services. We will be watching developments closely over the coming months.

Advance notice – Osborne Clarke seminar

We will be sending out invitations to a client seminar event which will be timed to examine both the implications of Lord Hutton's final report and also the conclusions of the current consultation on Fair Deal. The Government is expected to report its conclusions on Fair Deal in the summer. The particular focus of this seminar will be on LPGS funds.

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These materials are written and provided for general information purposes only. They are not intended and should not be used as a substitute for taking legal advice. Specific legal advice should be taken before acting on any of the topics covered.