Yesterday (7 October 2010), Lord Hutton of Furness published his interim report setting out progress to date in relation to his structural review of public service pensions.

Lord Hutton chairs the Independent Public Services Pensions Commission. His remit is to make, by Budget 2012, recommendations on how public service pensions can be made sustainable and affordable in the long-term, while at the same time being fair to both the public service workforce and the tax payer.

Overview

In broad terms, Lord Hutton has concluded that the current regime is not tenable. He considers a more prudent approach to meeting the cost of public service pensions is required to strike the right balance between the competing interests of current taxpayers and public service employees, and between current and future generations.

Increased longevity; the fact that pensions are generally linked to final salary (meaning that "high-flyers" can receive almost twice as much in pension payments for every pound they pay, compared with "low flyers"); and the imbalance of risk between taxpayers and the public service workforce all point to the need for change.

Lord Hutton also found that the differences in pension provision between the private and public sectors were a barrier to non-public service providers. This difference could potentially reduce the efficiencies and innovation in public service delivery that could be achieved.

But Lord Hutton is equally clear that a "downward drift" in pension provision in the private sector should not result in a drift in the same direction in the public sector. Indeed, his hope is that the reformed public service pensions should provide a benchmark for pension provision in the private sector too.

So, what to do about it all?

The Commission has identified the following principles against which long-term options for reform should be judged, namely

  • Affordability and sustainability (though Lord Hutton notes that what level of pension cost is affordable is a political decision for the Government, rather than the Commission)
  • Adequacy and fairness
  • Supporting productivity
  • Transparency and simplicity

Lord Hutton recognises that issues around these principles mean there is a need to consider long-term structural reform of public service pensions, such that the traditional final salary defined benefit scheme is not the way forward. The Commission will therefore consider a range of alternative structures.

These will include a career-average scheme, as well as alternative schemes such as Sweden's notional defined contribution scheme and the Netherlands' collective defined contribution schemes, along with risk-sharing models like hybrid schemes. The Commission will also consider elements of scheme design such as ensuring normal pension ages are in line with changes in longevity.

In the short-term, the imbalance between employer and employee contributions and the fact that people are living longer merit, in Lord Hutton's view, short-term changes. The Commission considers that the most effective way to make short-term savings is to increase member contributions.

It does, however, acknowledge the need to protect the low paid and phase in contributions as far as possible in order to prevent a significant proportion of the public service workforce opting out. It also recommends excluding the armed forces from any increased contributions at this time. Lord Hutton states that it is for the Government to decide the manner and level of any such increase.

So, what's the next step?

The Commission now has to make a recommendation on a range of options for the Government in its final report. It will therefore be issuing a second call for evidence later this month, asking for contributions by the end of December.

Given that structural reform is on the cards, it's time for interested parties to make representations to Lord Hutton. The Commission needs to have as much evidence as possible in order to be able to make a recommendation with the best chance of producing a fair and sustainable system for us all.

All manner of matters will need to be addressed. There's a lot to think about and we'll be reviewing the Interim Report and our response to it over the next few weeks.