Pensions are pay
I received a very interesting press release the other day from my good friend Ros Altmann (Ros, if you remember, was a guest on one of our Pensions Radio podcasts last year (Ros Altmann on Pensions Radio)). The press release contains details of Ros’ latest work analysing public sector pension schemes and calls for an informed debate on the subject.
I have reprinted the text of the press release below (with Ros’ permission) as I thought you would all like to read it. Ros points out that she is not trying to argue the case that the pension benefits awarded to public sector employees are either wrong or right, but simply that there needs to be a better understanding of the real costs of such promises. I agree with that.
15 September 2008
This is the full text of the press release:
IMMEDIATE RELEASE Dr. Ros Altmann
Transparency urgently needed on public sector pensions
Since 1997, there has been a dramatic improvement in the fortunes of public sector employees. Without fanfare, they have achieved massive pay increases and retained hugely valuable pensions, while private sector pensions have been decimated. The tables below demonstrate some of the privileges that public workers enjoy. They earn more, pay lower national insurance, do not contribute to their state second pension and will receive much better pension benefits than private sector workers. They will still receive their pensions at age 60 while state pension age rises to 68 in coming years. Their pensions are fully inflation-linked and taxpayer guaranteed. Yet the costs of these superior pay and pension benefits are not transparent and are outside the Chancellor's fiscal rules. They are also not being factored into the current public sector pay negotiations. I am calling for proper transparency and an independent inquiry into all aspects of public sector remuneration. Abandoning contracting out would bring in up to £10billion in extra revenue to the Government each year.
Higher pay: It used to be that the very generous public sector pensions were justified because public sector workers earned less than their private sector counterparts. That is no longer the case. Since 1997, the public sector workforce has expanded significantly and pay has outstripped private sector earnings. Average public sector full-time weekly pay is now just under £500 compared with £440 a week for the private sector (Source: National Statistics).
Much better pensions: In addition to better pay, actuarial calculations show that the public sector government-guaranteed, fully inflation-linked pensions, paid from age 60 or even earlier, are worth at least 30% of each worker's salary, each week. That means a median public sector earner on £500 a week also earns another £150 every week in the form of pension accrual (deferred pay), making a total average full-time public sector worker's pay at least £650 per week.
Higher total remuneration: In contrast, an average private sector worker on £440 a week, with no private pension, effectively earns £210 less each week than the public employee, when today's pay plus deferred pay in promised pensions is considered.
Even assuming an average employer contribution to a private pension of around 6.8% of salary only adds £30pw which would boost private workers average pay to £470 a week. This is still £180 less each week in pay and pensions than public sector workers. This reality does not seem to be factored into the latest public sector threatened pay strikes.
Public vs. private sector pay and pensions
Public Sector Private Sector
% full-time workers in final salary scheme c.90% c.15%
Gross weekly pay (full-time workers) £500 £440
Value of average pension accrual (% of salary) >30% <7%
Value of pension accrual (£pw) £150 £30
Total pay - earnings plus pension contribution £650* £470
*in addition, the public worker pays 1.6% lower national insurance each week too!
Lower national insurance contributions: In addition to earning much more than private sector workers, public employees are also being allowed to pay lower national insurance. In particular, the 3.4 million employees in unfunded public sector pension schemes pay only 9.4% national insurance instead of 11% and public employers pay 9.1% instead of 12.8% of salary per worker. The lower national insurance payments are given legitimacy by calling them 'contracting out rebates' for pensions, but this is pushing billions of pounds worth of extra burden onto future taxpayers. (for explanation of contracting out see footnote below).
Public Sector contracting out in unfunded schemes - some statistics
Number of public workers in unfunded schemes 3.4 million
NI rate public sector worker: 9.4% of salary
NI rate private sector worker*: 11.0% of salary
NI rate public sector employer: 9.1% of salary
NI rate private sector employer*: 12.8% of salary
NI shortfall from workers: £ 1 billion each year
NI shortfall from employers: £ 2.5 billion each year
TOTAL SHORTFALL: £ 3.5 billion each year
* most private sector pensions are not contracted out
Contracting out in an unfunded scheme is a makes no sense: However, for public sector workers in unfunded public sector pension schemes, this contracting out is a nonsense. In an unfunded scheme, there is no fund building up to pay the workers' S2P in future. All the money will still have to be found by future taxpayers!
In effect, public sector workers in unfunded public sector pension schemes (such as civil service, NHS, teachers etc) are not paying anything for their state second pension. They will get it for free. Furthermore, they start receiving pensions at age 60 as part of the public sector pension scheme, whereas state pension age will rise to 68 in the future.
So contracting out amounts to a hidden pay boost for public workers and hidden subsidy for public sector employers today, which will have to be made up by taxpayers in future.
Hidden costs: None of the costs of public sector pensions are included in the Chancellor's 'fiscal rules' - they are hidden away as if they do not exist. But there are nearly 6 million public sector workers altogether - one-fifth of the entire labour force, who are being paid more today and will also be paid better pensions in future.
It is not the fault of the public sector unions that they are demanding better pay and conditions for their workers. That is their job. But it is surely the job of Government to behave responsibly with our money. At the very least, the public should be told the truth about the future build up of liabilities.
Private sector pension provision has collapsed, as final salary schemes have closed and employer contributions are cut, but public sector schemes remain unaffected. Hiding the true costs off balance sheet does not fit with transparent and open Government. It is time for proper openness about all aspects of public sector pensions. An independent inquiry into the costs, both now and into the future, is long overdue.
Dr. Ros Altmann
NOTES FOR EDITORS:
We have a two-tier workforce in the UK. Public workers are earning more and also earning much better pensions than private sector workers. Public sector pension schemes have all kinds of benefits that are no longer available in the private sector - including far more generous inflation-linking and better revaluation terms.
Public sector workers are being allowed to pay lower national insurance than they should. All the employees in unfunded public sector pension schemes pay only 9.4% national insurance instead of 11%. Their take-home pay is therefore higher than other workers paying the full rate, as shown in the table below.
NATIONAL INSURANCE - PUBLIC AND PRIVATE SECTOR WORKERS
NI paid by public sector employee per week
NI paid by private sector employee* per week
Extra take-home pay for public sector employee per week
£20,000 £26.33 £31.20 £4.87 £25,000 £35.37 £41.39 £6.02 £30,000 £44.41 £51.96 £7.55 £40,000 £62.50 £73.12 £10.63
* assumes not contracted out of state second pension
In addition, public sector employers pay only 9.1% national insurance per worker instead of 12.8%. The total annual underpayments, per worker, by public sector employees and their employing Government departments, at different salary levels, are shown below.
ANNUAL AMOUNT SAVED BY PAYING LOWER NATIONAL INSURANCE
NI saving for public sector employees*
NI saving for public sector employers
£20,000 £253 £539 £25,000 £313 £724 £30,000 £393 £909 £40,000 £553 £1088
The total shortfall in employer contributions for the 3.4 million workers in unfunded public sector schemes amounts to at least £2.5 billion a year, in addition to the £1 billion of employee contributions that are not being paid. So this hidden subsidy is costing at least £3.5 billion a year - money not being paid today which will have to be found by future taxpayers when public sector workers retire.
Most public sector workers themselves do not even seem to realise they are paying less national insurance and that that they will effectively receive their state second pension for free. If they are getting this huge benefit they should at least be aware of it.
Contracting out is the most complex part of our pension system - which is itself the most complex system in the world. It is not working well and costs billions of pounds each year. Of course, ending contracting out would mean public workers suddenly having to pay higher NI contributions, so there has been some resistance to abolishing the system, but I am calling for this to be stopped as soon as possible. This will bring in billions of pounds a year in extra Government revenue and also allow substantial simplification of our ludicrously complex pension system.
  Contracting out of the state pension: The national insurance state pension is based on national insurance contributions made while working. Employees usually pay 11% and employers pay 12.8% of salary (total of 23.8%) each week in NI contributions, which helps pay for state pensions. State pensions have two parts:
1. The Basic State Pension (BSP)
2. The State Second Pension (S2P)
Both of these are paid by the Government at state pension age and the amount paid depends on people's contribution records. At the moment, pension age is 60 for women and 65 for men. From 2010 onwards, women's pension age will increase to age 65. After 2020 the state pension age will start rising to age 68 for both men and women.
Uniquely in the UK (no other country does this) the Government allows people to 'contract out' of the second part of the state pension, paying lower national insurance now and forfeiting the right to a second state pension on retirement. The workers pay 5.3% lower national insurance (1.6% lower for employee and 3.7% lower for employer) and the money is supposed to be paid into an approved occupational or personal pension scheme invested over time which will then replace the S2P part of the state pension that would otherwise be paid by future taxpayers. The Pensions Commission showed that contracting out costs today's taxpayers over £10billion a year.