Final salary is being replaced by career average (CARE). Is that better or worse?
The answer is not necessarily better or worse; it all depends on the detail that the Government now needs to decide through the consultations it has promised. In a CARE schemes compared with a Final Salary scheme, typically high flyers do less well and steady stayers do better. A CARE scheme will also often be better for those with non-continuous careers and could facilitate and easier Fair Deal when work transfers out of the public sector.
Lord Hutton's key recommendation is that public sector pensions should deliver an adequate level of income, Current evidence suggests that current levels of pension provision in the public sector are broadly only at, or marginally above, what the Turner Pensions commission stated as adequate. Those with a broken career may well be behind the benchmark. So it seems there is no Hutton agenda here for future benefit levels to be slashed, indeed he talks about avoiding a "race to the bottom".
On that basis, the main areas for cost savings, as demanded by the Government, will be from later retirement ages and increased employee contribution.
So employees have to pay more - how much?
The increase in staff contributions is going to be left for government to decide when it responds to the report. Of course, members and unions will want to minimise any increases but indications are that a 3% increase is likely, which will be a bitter pill for many employees to swallow at the current time. Hutton recognises, however, that there is wide variation in the levels of existing contributions, so an across the board increase is not likely to be equitable. In addition, the report warns that sizeable contribution increases may force members to opt out completely on affordability grounds. The key Hutton recommendation here is that pensions and pension contributions must be taken into account by pay review bodies in considering total reward.
And what about retirement ages?
The report also suggested increasing retirement ages to 65 and then beyond in line with the state pension age (SPA). Some of the schemes already have a retirement age of 65 so the impact is by no means uniform. Employers need to consider the impacts of this in conjunction with the abolition of default enforced retirement ages; something already implemented in the Civil Service. Later working is now genuinely a reality, with all the HR challenges as well as opportunities that brings.
Hutton recommends flexible retirement ages should allow an employee options for earlier or later retirement. The Hutton report specifies that benefits would be reduced for those choosing to retire early and increased for those retiring later. Although the report recommends that ancillary benefits such as death in service and ill health retirement should be retained, there is no mention of the current common practice of paying a pension, with no reduction in value, in the case of redundancy. This may therefore require new workforce management approaches to be adopted by employers.
How will existing benefits be protected, and how will the transition work?
In spite of the move to CARE, final salary is to be retained for all existing accrued service. This perpetuates the old rules, and requires benefits to be calculated in separate "tranches", old and new. It makes for complication in administration and in communication. But the Hutton report seems to regard this as a necessary transitional feature to honour the spirit as well as the letter of accrued pension promises. It does mean though that the legacy benefit terms will need to be maintained in the future for some time yet.
Also it preserves for many years still the inequalities between high flyers and steady stayers, these inequalities being those that Hutton cites as the driver for moving to the CARE system. An alternative approach that would strip these concerns away would have been to protect accrued rights on current pay, and then continue to index that going forward in line with nation average earnings increases. This would have had the following key benefits:
- No "tranching" of benefits due to retaining old as well as new benefit rules
- Still keeps earnings linking protection, but now just on an average basis
- Removes the stated inequalities from high flyers to steady stayers completely and immediately
It would also still provide a much improved level of protection for accrued rights over and above the minimum often provided for schemes discontinuing final salary plans in the private sector. Whether the Government therefore accepts this particular Hutton recommendation remains to be seen.
Delivery of public services via outsourcing - how will pensions be dealt with in future?
The future pension requirements where services are outsourced to the private sector remain up in the air. Hutton says that it is undesirable for future non-public service workers to have access to public service schemes, but doesn't comment on what the arrangements should be for those employees working for private sector organisations contracted to central or local government. This is left firmly in the government's hands with the recently instigated review of "Fair Deal".
So what has Hutton achieved?
The critics out there might well say he's achieved little, citing retention of indexed "gold-plated" pensions, and with the cost cutting decisions ducked as a matter for the government to negotiate.
This is not a fair analysis. Hutton has completed a detailed, thorough and thoughtful review concluding what we at Mercer have always held as a truism - good quality worthwhile and well communicated pension benefits are a powerful and effective tool in rewarding and managing a business's most important asset - its people. We therefore welcome the report as an essential step in moving ahead with the modernisation of the current public sector pension arrangements: it strikes a good balance between the needs of employees and the ability of the taxpayer to fund.
The challenge for employers and in particular HR professionals is to keep their businesses on track and staff motivated through a period of rapid and difficult change. A key element of this must be to help employees get beyond what can so often be sensationalist media reporting, and get to the key message of what Hutton is saying: good pensions are here to stay, and what's more, they're worth waiting for, and worth paying for.
Paul Middleman and Chris Hull, public sector pension scheme specialists from Mercer
