The pensions apartheid � can it continue? | 43
THE KEY CHALLENGE:
TO MOVE TO FUNDED PROVISION
Ultimately, the only way to manage longevity risk is to move away
from the present state of affairs, where current contributions by
employees pay for current pensions paid to retirees, to funded
provision, where each scheme member's retirement pot grows
throughout his or her working life.
The local government pension scheme is a funded public
sector pension scheme, but it is hardly a model to follow. It is
based on final salary, has a fixed employee contribution rate16
and
leaves employers (ie. taxpayers) to make up the difference
between employee contributions and pension promises. Not
surprisingly, the employer (taxpayer) contribution rate in most
local authority schemes has increased rapidly in recent years.17
For new employees and future accrual of existing employees,
it would be possible to keep a lid on taxpayer exposure to public
sector pension costs by some combination of raising the public
sector retirement age, increasing employee contribution rates
and reducing accrual rates (eg. from 1/60th to 1/80th).
But in the long run, final salary pensions will always be
risky and expensive for taxpayers in an age of rising longevity.
It is no accident that the private sector is fast abandoning such
schemes and moving to defined contribution arrangements. It
is also no accident that individuals are increasingly saving in
more flexible arrangements such as Individual Savings
Accounts (ISAs). For example, in 2005, employees and
individuals saved �8.6bn in personal pensions, compared with
�31bn in ISAs.18
The main obstacle is that in moving from unfunded pension
schemes to funded arrangements, there will be a period of time
when payments have to be made twice. This is because at present,
current contributions pay for current pensions. Under reformed
arrangements, current contributions will go into a fund to be
built up for the member's future pension, meaning that current
pensions will have to be paid by some other means for several
decades. In the long run, such a shift will hugely reduce liabilities
and therefore taxpayer exposure, but the transition costs (which
are likely to fall on taxpayers) may be great.
There is a need for greater consideration of exactly how to
reform public sector pensions and how to manage transition
costs, but that should not deter pension reformers. The pensions
apartheid is real, unfair, unsustainable and urgently in need of
change.
16
Although the employee contribution rate is progressive ie. It increases for higher earnings.
17
Employer contribution rates vary by local authority, but to give some illustration, the employer contribution rate in Hounslow increased from 8.8 per cent of
pensionable pay in 1996 to 21.5 per cent of pensionable pay in 2006. Source: annual accounts of Hounslow council. Increases of similar magnitude have
occurred across local government, creating further pressure for council tax increases.
18
Office for National Statistics, Pension Trends, Table 8.12; HMRC, Table 9.4
The pensions
apartheid is real
and urgently in
need of change

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