Brexit – what an opportunity

88300969_flagsI’ve always been pretty interested in politics and often stay up to watch the results come in on election night. This time was different though. The results wouldn’t get interesting for quite a while as there was no historic data to compare to and, frankly, I thought there was no chance of anything but remain being the result. I was sure that inertia would prevail. I went to bed fairly early for me but woke suddenly just after 4am feeling wide awake – almost like I sensed something was happening. Leave was winning and with every result that came in a vote for out looked more and more likely. Wow.

Hysteria

Facebook hysteria soon followed. I began to think I must have missed another announcement. Perhaps we’d also declared war on Russia? How else could such panic be justified? On the school run later that morning a friend of mine showed me the post of another parent who said their children were in tears that this had happened – what on earth had they been telling them?? Many others posted in a similar vein that they were deeply worried for the future of their children.

Project fear had clearly worked well and people were scared.

Lashing out

When the hysteria started to settle the lashing out started. Another animal instinct when scared or threatened.

  • “Thank you grandma” or how dare you almost dead old people vote against my young person view.
  • It was all racists and xenophobes.
  • It was the uneducated.

So there are 17 million racist uneducated old people out there apparently!

Denial

A day later came denial with a petition getting around 3m votes (interestingly from all over the world) demanding a 2nd referendum. Petitions quickly followed requesting second chances on all sorts of events from choosing lottery numbers to Stuart Pearce retaking his penalty in 1990.

The Liberal Anti-democrats and Labour MP David Lammy said the vote should be ignored.

The SNP confirmed they would take all steps to block it. To Nicola Sturgeon’s credit she had at least indicated this before the vote.

Pause for thought

What we did last Thursday was certainly momentous. But all we really did was vote to no longer be part ruled by an undemocratic bunch of bureaucrats in Brussels.

I am reminded of one of my favourite speeches from a New Zealand MP when they were voting on gay marriage. I commented to a friend that this would have been how I responded to the vote if I were PM. Something like:

“I give you this guarantee. The sun will still rise, your teenage children will still answer back, summer will still seem to last just 3 days, we will still be European and we will all still be friends. We now have an opportunity to shape a bright future.”

I was sad to see that David Cameron resigned after the vote. However, by doing so, he has also caused a pause for thought. A time to plan and a time to see how the rest of Europe responds. Many countries may decide to follow.

The opportunity

As a country we will be in control of our own destiny. That is a real opportunity.

The biggest opportunity though is social and political. The referendum has got people talking. It has got people voting and engaged who wouldn’t normally be. A referendum result has been campaigned for by (not my description) very right wing Tories and won with huge numbers of traditionally Labour voters voting for it – it has spanned the political divide.

There is surely now a chance to open people’s minds to a different form of politics and maybe some new parties too. One where the vocal left, a group I often refer to as champagne socialists, can reflect on whether they really are speaking for those they claim to care about any more, or just following their own herd driven moral hate crusade (See who you can hate). One where the Tory opposition isn’t referred to with disdain and an underlying assumption that all such politicians are only in it for money and power. One where the Tories winning this referendum can reflect on the needs of those poor communities that helped win this referendum and the social changes needed to make their lives better. One where we can debate ideas rather than throw insults.

Maybe I’m dreaming but it would be nice to think that all could reflect a bit on this result and work towards a bright future.

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Junior doctors strike action – is it justified?

In short, my opinion is it’s not. I’ll explain why…

Why is a new contract being proposed?

A new contract is being proposed to replace the current one that has some oddities to reflect a transition from an old era and is no longer fit for purpose. The stated aims for the junior doctor contract were:

image1

The government is also looking to use the new contract to reduce the cost impact of having more doctors working at the weekend.

Reviewing the current contract, whilst I can now understand how it came to pass, my initial reaction was one of surprise that: the current contract will allow someone working 41 hours a week to be paid the same as someone working 48 hours a week and anyone working illegal hours is paid more – an odd incentive system. Certainly there seemed good reason to consider something different.

Why doctors say they’re striking

This can be summed up simply as: “Patient safety”. Do they have a point?

Doctors state that the key safeguards in place under the existing contract are being removed and that this makes the new contract unsafe.

The existing safeguards that they refer to relate to the requirement to pay extra “penalty” pay if doctors work illegal hours. The NHS Employers’ submission to the DDRB commented that this was often adversarial:

image2

It is easy to see how this could be the case as doctors are effectively “rewarded” or “compensated” for working illegal hours.

The proposed new contract has the stated intention of making working hours better:

image3.png

But doctors said this was meaningless as effective safeguards to enforce this weren’t in place.

After reading the documents and original proposals, this didn’t seem to be the case to me. There was a specific section on safeguards and it seemed to put the power to raise issues with doctors themselves. This all sounded ok.

But talking to some junior doctors I could understand why there were still problems. There were significant conflicts of interest around raising issues with working hours. One I spoke to told me the following:

“the process of reporting would be in the first instance to your educational supervisor and this is a serious problem.”

“Educational Supervisor’s role is to oversee your learning objectives for that job and check you are achieving them…It is also their job to write all of the reports that decide whether or not you ‘pass’ that year of training and write 3 references per 6 months that stay on your portfolio for every future employer to see forever. This is not a person you want to piss off!”

“There will always be the fear that if you are a conscientious stay later, that you will be thought of as slow and inefficient and that will reflect badly on your training report so you’ll not mention it, even feel guilty about it.”

“It would be entirely feasible to ruin your training year or even your future job prospects by ‘exception reporting’ honestly.”

This is clearly an issue but it was only after discussing things in detail that I got to this. All the articles, posts etc. that I read just talk about removal of existing safeguards being bad without talking about what is being added.

However, the January negotiations have recognised this issue and added a “Guardian of safe working”:

image4

The revised proposals also reinstate financial penalties. However, these penalties will now stay within the health service to help improve working conditions or provide further training rather than providing extra pay:

image5

This all sounds positive. Is the new contract unsafe? If it is, it doesn’t appear to be any less safe than the current one.

Why doctors are really striking

It’s not about the money but…

…is the way a lot of conversations go. But money is important. I don’t mind it being about the money but I do mind misinformation about the money.

We’ve had this on both sides with doctors talking about 30% pay cuts and government talking about 11% pay rises. Both are talking nonsense.

One of the key principles of the design of the new contract was that the cost of pay afterwards would be the same as the cost before i.e. no average pay cut and no average pay rise.

Most junior doctors currently work 40 to 48 hours a week and are paid a banding payment of 40% or 50% of basic pay in addition to their basic pay. The average pay of all junior doctors is quoted in the NHS Employers’ submission as 143.5% of basic pay.

Under the new system basic pay is quoted as 11% higher on average and there are then additional payments for hours worked over 40 hours per week, hours worked at night, on Sundays and Saturday evenings, and for working on call. Finally, there are additional incentive payments for some roles such as A&E and General Practice.

Depending on hours worked, some doctors would find themselves better or worse off than under the current system. But…crucially:

  • These differences are not as significant as made out
  • The average doctor is no worse off
  • The difference in payments reflects some doctors doing greater number of hours and/or unsociable hours than others

Even more crucially, those who would be worse off under the new system will have their pay protected for 3 years. The nature of pay progression as a trainee means this should be enough to mean no “actual” pay falls.

My analysis of the proposed new pay structure based on the sample rotas is as follows (click to see larger image):

image6

These are % changes so, taking into account that the £ amounts are much larger later on in a career, most are better off overall with the exceptions being rotas 3 and 4.

It is certainly not the case that the new contract is fundamentally offering pay cuts. And it is worth remembering that doctors are in the top 1.5% of earners in the country. Rightly so. But worth remembering.

There are some losers though. These are part-timers and those who don’t progress through training each year. This is because under the current contract pay progression is done purely on “time-served” rather than experience. This leads to the absurd position that under the current contract there are some levels of pay that can only be reached by those who progress more slowly!

Whilst this is a worse position for those affected, the new contract is a much fairer system. My only caveat would be that I think it would be reasonable to offer extended pay protection for part-time workers as part of the transition.

There is a lot of hot air about pay with politics being played on both sides. I also think there is a lot of misunderstanding because of this.

Unsociable hours

There is much misunderstanding on hours too and their interaction with pay. I’ve seen several comments talking about the extension of “plain-time hours” as if it was an increase in actual hours to be worked.

The rate of pay for any hours only really matters if the hours worked change. Otherwise the redistribution of pay is the same. For example, if I work Monday to Friday and am paid £10,000 a year for each day worked, it doesn’t really matter if I’m instead paid £14,000 a year for Mondays (because who likes Mondays?) and £9,000 a year for each of Tuesday to Friday. In both cases I would get £50,000 a year. It would only matter if I worked more or less Mondays.

The rise in basic pay compensates the loss of pay from the extension of plain-time hours. It will vary by individual rotas how well this works. However, the change in what hours attract a premium rate is only substantially important if shift patterns change.

The desire for a 7 day service means there is a presumption of more weekends being worked under the new contract. However, many doctors already work a lot of weekends. It would be good to see a clear question and answer for how many weekends it would be expected that junior doctors may work.

Potentially working more weekends is a valid concern. It is one that is also suggested as being part of why the new contract is unsafe. Of course, working Saturday instead of Monday is not less safe in itself. But doctors are concerned that extra weekend work will be covered by sacrificing cover Monday to Friday. On the presumption that there isn’t an oversupply of doctors in the week currently this concern is understandable. However, the government did make it clear in the parliamentary debate on this that the intention is to use the extra funding to recruit more doctors to provide this cover.

Doctors don’t trust government on this but it is very difficult to see how it can be addressed contractually.

Finally, whilst some doctors having to work more weekends is undoubtedly more inconvenient, it should perhaps be considered in the round with other measures that are being made to try and make life better and the trends in other jobs.

Politics, ideology, mistruths, misunderstanding and low morale

The handling of the contract dispute has been appalling. It has been appalling on both sides and I feel I should be able to expect more.

I’ve mentioned already the ridiculous claims on both sides about pay. But we’ve also had misrepresented statistics and childish name calling about who told who what via social media (again both sides!).

There are some clear underlying encamped views on each other’s ideologies and the poor handling by government has made it easy for a few that clearly have some political agenda to stoke the fire of a demoralised workforce. This is really why we have a strike today. There is no longer any trust.

When I talk to junior doctors about the issues they have they talk about the personal pressures they feel to work hours after their shift and through their breaks; because there are still sick people to treat and rotas aren’t adequate. They talk about the inability to get time off when they need it. Simple things that many of us take for granted like taking a day off for a family event or booking a holiday in advance before the best places are booked up. They talk about the problems of moving from one place to another and trying to have a relationship. They talk about not feeling valued with constant bad news stories in the press. They worry about the future and increased pressures as funding becomes more and more stretched.

They also talk about internal problems. Interestingly, in the same discussion I mentioned before I was also told:

“A lot of hierarchy and bullying still exists in medicine“
“some consultants are very aware of how working as a junior has changed and are very supportive, and others think we are lazy for not doing the 100+ hours that they used to do.”

This is an environment in which it is no surprise that they are demoralised and it is no wonder doctors feel the need to strike. But these issues exist under the current contract. They aren’t the reasons put forward for the strike action and they aren’t really part of the contract dispute.

In fact, if anything the proposed new contract is trying to address some of these things. Better yet talks are ongoing. There is time for more of these issues to be addressed. The contract dispute is a cover the real problems faced by junior doctors.

We should all support junior doctors but strikes about the new proposed contract are not the answer!!

Some Background reading…

Original paper submitted by NHS Employers to DDRB: http://www.nhsemployers.org/~/media/Employers/Publications/NHSE-DDRB-submission-Dec-2014.pdf
DDRB recommendations: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/445742/50576_DDRB_report_2015_WEB_book.pdf
Offer made in November: http://www.nhsemployers.org/~/media/Employers/Documents/Need%20to%20know/JD%20A4%20booklet%20FINAL%20amends%2027%20Nov.pdf
Update on discussions in January: http://www.nhsemployers.org/~/media/Employers/Documents/Need%20to%20know/Letter%20from%20Danny%20Mortimer%20to%20SofS%20040116-Final.pdf
Letter to doctors setting out progress of discussions: http://www.nhsemployers.org/~/media/Employers/Publications/Junior%20doctors%20letter%2007%2001%2016%20final.pdf

Lower TVs and less DC saving…

…is perhaps an unlikely reaction to today’s budget consultation response. However, this could be the result of 2 of the measures announced today.

Locked away for too long

My first reaction following the budget this year was that DC might finally be something I have a real interest in saving money into. I am absolutely in favour of the reforms to give people more freedom with their pension savings. However, the reforms didn’t go far enough in my view. There was still the inflexibility of the money being tied up until 55, over 20 years away in my case. This is too long to tie my money up, there are so many scenarios I can think of in which I might need that money sooner whether it means I’m penniless in retirement or not.

Yet today it got worse still. Today it was determined that my money will be locked up until at least 58! That’s at least another 3 years before I can get at it and so another 3 years later before I START putting money into a DC pension. NISAs seem a much nicer way of doing things.

As an aside, the consultation response put “fairness” at it’s heart. It’s difficult to see why increasing the age at which you can access your own money is fair. Especially to the many people who don’t make it to retirement.

If all transfers are rational…

…then there’s some serious selection risk.

The area of most controversy in the consultation was on whether to ban transfers from DB schemes. Unsurprisingly following the reaction to this suggestion such a ban has not been implemented for all but unfunded public sector schemes. However, “safeguards” have been added such that independent advice must be obtained.

Given this, it perhaps reasonable to assume the majority of transfers will be rational decisions. But if this is the case then they must be better than average risks as far as the scheme is concerned. Should transfer values be reduced to take this into account?

Political football with pensions tax relief

Today’s FT Westminster blog states pensions tax relief is once gain going to be kicked around and become a key battleground as part of the election. Labour are proposing to reduce the relief to 20% for those paying 45% tax.

To me the whole concept of removing such relief is crazy. It will mean people are taxed twice on their money, 25% on the way into the pension and at least 15%, but for those in question likely 30%+, on the way out. This results in an overall tax rate of 55%! Of course the result should just be that no pension savings are made but this is an odd message to give. We already have both an annual and lifetime allowance for tax relief. Do we really need any more restrictions?

My tweet response to this was quickly followed up by Greg Kingston (@GregKingston) who summarised the political landscape well with:

@markjrowlinson @JosephineCumbo @ftwestminster always good to campaign on something most people don't understand. Lowest number will win.

It is this kind of politics that leads to division and the desire, from those that can, to look into ever more complicated tax avoidance schemes. I’m all for a progressive taxation system buts let’s keep it simple and be honest about it – that way we are all in it together.

It also reminded me of this little story who I have no idea who to credit to. There are many variants around but they are worth remembering from time to time. In particular the first part shows why it is only reasonable for the those paying more to gain more out of cuts and reliefs and the second why we should always avoid being too envious of those who earn more than us.

Let’s suppose 10 people who work together go to a restaurant after every payday, and at the end of the meal the bill comes to £100. They agree to cover the bill according to how much they earn.

The manager pays £55
The two supervisors pay £11 each
The four file staff pay £5 each
And the three junior staff pay £1 each

———————–

The regular meals continue for a few months and eventually they manage to convince the restaurant’s owner that, as they’ve been frequent and loyal customers and the restaurant is doing very well, he could give them a 20% discount. This leaves them with a £20 windfall to divide between them.

The first idea the restaurant owner proposed was to split the savings evenly between them, so each gets £2 – leading to:

The manager paying £53
The two supervisors pay £9 each
The four file staff pay £3 each
And the three junior staff receive £1 on top of their (now) free meal

Obviously the 7 paying colleagues weren’t very happy with this arrangement – so the restaurant owner said “Fair enough, we’ll divide the windfall among you, proportional to how much you contributed to the original bill.”, leading to:

The manager paying £44
The two supervisors pay £8.80 each
The four file staff pay £4 each
And the three trainees pay 80p each

The trainees then complain that their share of the £20 windfall is 20p while the manager’s is £11 – how is this fair?!

———————–

Let’s see what happens if the situation was to be reversed: the restaurant hits on hard times and raises the prices by 20%, but nobody wants to simply order less food. The manager proposes everyone contributes an extra £2 each so:

The manager pays £57
The two supervisors pay £13 each
The four file staff pay £7 each
And the three junior staff pay £3 each

The junior staff are not happy at all – the cost of their meal has tripled! So, they suggest everyone just contributes 20% more than what they used to for the original bill:

The manager pays £66
The two supervisors pay £13.20 each
The four file staff pay £6 each
And the three junior staff pay £1.20 each

To which the manager says “Sorry, I’m not going to pay £66 for a meal – I’m already paying for much more than I get. In fact, if you’re going to insist, I’ll find some less demanding friends and go to a different restaurant with them.” – leaving the remaining colleagues to cover the (now £108) bill between the 9 of them.

The moral of the story?
Don’t go to restaurants you can’t afford… And if you do, don’t get greedy with other people’s money!

Reduction in the annual allowance – an opportunity

I read Josephine Cumbo ‘s article on pension tax relief being back on the agenda for Osbourne’s Autumn Statement in Sunday’s Financial Times with interest. The suggestion was that the annual allowance, the maximum amount you can put into a pension and claim tax relief on, may be reducing to as low as £30,000 a year.

I actually see this as an opportunity. I blogged just recently on my view on how long term savings can be improved and a reduction in the annual allowance for pensions makes such a scheme even easier to implement. Combine this fall in the pension annual allowance with an increase in the ISA allowance to same amount and you are well on the way to getting rid of pensions policies in place of flexible savings vehicles with incentives to keep money invested for retirement.

Industry interests

Someone commented earlier on a copy of my blog on Mallow Street that ISAs:

do not generate commission, and from the pensions industry point of view, this is a disadvantage. Indeed, they would compete for funds with conventional dc pensions.

Competing with conventional DC pensions is precisely the idea! This comment comes after comments from Michael Johnson that providers are holding back pensions reform. The pensions industry needs to stop worrying about change and have a good hard look at itself. It only has its self to blame for any industry wind-up.

Pensions, property and politicians

So last week we had suggestions that the flagship £140 a week state pension reform might not go ahead after all and this week we have the announcement of a policy that will allow pensions to be used as guarantees for mortgages. The calls are for the politicians to “stop using pensions as a political football” and those in the industry seem to wholeheartedly disagree with this latest suggestion. So is it really a bad idea?

What’s good about it?

From my perspective the basic idea of putting more flexibility into what you do with pension saving is a good one. Certainly when you think about defined contribution (DC)/money purchase pensions; these aren’t pensions so much as tax advantaged savings schemes with strings attached. Loosening one of those strings is therefore a good thing.

On the basis that the idea is the pension pot is used to provide a guarantee rather than actually provide cash, it also seems like good economics as it’s allowing money to be worked harder.

What’s bad about it?

The biggest thing that is wrong about this is what it is trying to achieve. The idea is to help house buyers get on the ladder at a time when house prices and deposits are high. Is it desirable to increase housing demand at a time when house prices are still vastly over valued and being propped up by artificially low interest rates? Policy should certainly try to ensure there isn’t a complete collapse of the property market but it certainly doesn’t need stimulating past this.

Another key criticism is that, at a time when we are talking about a pensions crisis, this scheme is likely to mean at least some people end up with lower pension benefits if the guarantee is called in.

As Ros Altman has said, those who have pensions pots large enough to take part in the scheme, almost certainly have better guarantees they could use such as their own property. Also, the scheme would need the buy in of lenders to accept such pension guarantees, and on what terms would it be offered? The money won’t be available until retirement and that date is unknown.

Looking at DC schemes the main other flaw is the potential complexity introduced for so little benefit. Comments on the Guardian’s Reality Check yesterday suggested that it is expected only 12,500 people would use the scheme. For this number the complexity really isn’t worthwhile.

For DB schemes the complexities are huge. For example, cash in DB schemes is often not taken at fair value and the benefit won’t be available on early death etc.

Summary

I think for DC only pensions the scheme could work in the future when there are more and bigger DC pots around and when the economy & property prices are more stable. However, introducing it now is bad timing and really not worth the complexity.

For DB schemes I cannot see how the policy could ever be workable. But then they’re being legislated out of existence anyway…

Fair and Sustainable Public Sector Pensions

Ahead of the planned strikes on Wednesday I thought I’d post a few thoughts on public sector pensions. I think of myself as being one of the few people that aren’t firmly on one side of the argument on this. I’m a taxpayer on one hand but defender of defined benefit pensions on the other. I’m therefore hoping that this post will perhaps dispel some of the various mistruths out there and perhaps get to the heart of the real dispute.

Why should the government provide good pensions to the public sector?

This seems a reasonable place to start in the debate. There are many shouting that they are too generous but is this just envy? The government should look to provide good pensions to those in the public sector for several reasons:

  • It is reasonable for a government to be paternal and want to look after the workforce in old age.
  • The government should lead by example, how can it expect others to provide if it doesn’t?
  • It reduces potential costs in means tested benefits.
  • Most importantly, it has a comparative example in doing so.

The government is much more able to take on the risk of defined benefit pensions than any other organisation. It can also provide them in a large scale efficient unfunded manner and is not subject to the horrendous number of legislative hoops that are in place for the private sector.

What is being provided? Isn’t it a gold plated benefit?

Public sector schemes generally provide benefits of either 1/80th of final salary for each year worked as a pension plus 3/80ths of final salary for each year worked as a lump sum OR 1/60th of final salary for each year worked as a pension. These benefits are generally payable at 60 or 65 with the majority currently still being payable at 60.

For example, if you joined at age 20 then retired at 60 you might get a pension of 40/80=half of your final salary plus a tax free cash sum of 1.5 times your final salary or, alternatively, a pension of 40/60=two thirds of your final salary but no lump sum.

Some schemes such as the police and armed forces are significantly different to reflect the nature of their roles.

Is this gold plated? Mostly it’s the same as what the private sector used to provide so arguably it’s not. However, retirement at age 60 without reduction is something that is very rare to see in the private sector and has been for some time. Arguably therefore the retirement age is the only thing that makes these schemes gold plated. It is often argued that the average pension is only £4,000 a year so how can they possibly be gold plated. The average pension is irrelevant. All it tells you is that there are quite a lot of low paid workers, quite a lot of part-time workers and quite a lot of people who don’t spend their entire career in the public sector.

What do these pensions cost?

Putting a value or cost on pensions is very difficult and there is no area in the pensions world that suffers quite as much in terms of bad calculations of cost as public sector pensions.

The “problem” with public sector pensions is that the majority of them are not funded. This means that the contributions paid just go to the treasury along with taxes raised and pensions are paid each year out of this pot as they fall due. This is instead of a funded scheme, which is the norm in the private sector, where contributions are paid into a pot that is invested and topped up as appropriate and pensions then paid out from this pot.

This “problem” leads to some horribly bad numbers being produced on the cost of public sector pensions.

The first is that the cost is often given as the pension outgo this year less contribution income this year. This tells us very little if anything about “cost”. If this was how we calculated cost then it would be more expensive to remove all public sector pension accrual than doubling their benefit accruals as the contribution income would fall to zero if accrual ceased.

The other awful number often quoted is when an attempt is made to “capitalise” into one number all future public sector pension promises. As it is an unfunded scheme this number is utterly meaningless. It’s as silly a number as putting a single figure on what we will spend on healthcare in the next 80 years! However, it is made even more meaningless by assuming that, if it were funded, the money would be invested in government debt i.e. the government would issue debt only to buy it back and that therefore the way to value the benefits is by using index linked gilt yields – nonsense!

Of course cost is also very difficult in the private sector. The problem with pensions in general is that they are paid a long time into the future, a future we know nothing about. Because of this, to determine the cost of benefits accruing we need to use a discount factor so that we can compare the value of money today vs money tomorrow.

Up until now this has been done for public sector pensions in the same way as would be done when evaluating any government capital project (e.g. building a bridge) by using a Social Time Preference Rate or, more specifically for pensions, the SCAPE (Superannuation Contributions Adjusted for Past Experience) approach (see here appendix D for more on this). This is a real (i.e. above inflation) discount rate of 3.5% pa. Following the Hutton Review it has been agreed to use a rate in line with expected economic growth agreed at 2% pa real. This drop in discount rate leads to a significant increase in the perceived cost of public sector pensions (see below).

In the private sector there are a myriad of different approaches used but the 3 main approaches are that: the actual expected cost is determined using rates in line with the expected return on the assets held; the funding cost is determined using a prudent expectation of the return on the assets held; and the accounting cost is determined using a corporate bond yield.

When considering the private sector we should also include defined contribution (DC) schemes as the majority of private sector pensions are now DC. A DC scheme being little more than a tax advantaged savings scheme with strings attached. In determining the cost to an individual of replicating a DB pension in one of these schemes we can again use the expected return on the assets likely to be held but also need to factor in the fact that they will need to buy an annuity from an insurer at retirement.

The chart below shows an approximate comparison of the cost as a percentage of salary of providing a pension of 1/60th of final salary payable from age 60 in the public sector and private sector (including an individual in the form of a DC scheme). It allows for above RPI inflation salary rises of 1% pa, CPI inflation increases in payment and makes many other assumptions (available on request) – it is not designed to be definitive. It does however potentially under rather than overstate the private sector costs (particularly at the moment with bond yields so low).

pension cost comparison
[Click to see a larger version]

The chart clearly shows the “comparative advantage” I mentioned earlier that the government had over the private sector in providing pensions with the SCAPE method discount rate. However, it also shows that this has largely been eroded when compared with private sector DB with the discount rate change. Finally, it shows where the problems stem from as the costs, on a DC basis which is the setup of most private sector schemes now, are substantially higher. This is an even bigger problem because the contributions being made to DC schemes are substantially less than were/are made to DB schemes. Workers in the private sector doing similar jobs to public sector counterparts on similar salaries are therefore looking across with some envy about where they perceive their taxes are being spent.

The change in public sector discount rate will increase the cost of benefits by around 50%! But private sector funding costs in the short term are around 10% higher still and for an individual in DC the cost is about 25% higher on average. When people talk about pension apartheid this is what they mean.

What’s proposed to change?

Very broadly:

  • Contributions are to increase by 3% (but with little or no impact on lower earners)
  • The accrual rate will be set at 60ths
  • The new scheme will be based on average salary earned increased by average national earnings rather than final salary
  • Retirement age will be linked to state pension age (65-68 depending on date of birth) rather than 60

However, a transition period is to apply such that those within 10 years of retirement at April 2012 will not be impacted and those within 14 years will have a lesser impact.

Additionally, this is a cost envelope only and benefits can be amended for each scheme provided the revised benefit is no more costly.

Why is this happening?

There is much talk about fair and sustainable pensions. Both fair and sustainable are pretty difficult concepts though when it comes to pensions.

I think there are 3 points to address separately about why this is happening: the contributions rise, the benefit changes and the transition period.

Transition

I’ll deal with the latter of these first as it’s easiest. The transition has been offered as members do not understand the proposed reforms/how they will operate and the government has inadequately communicated this. In my eyes they’ve taken something that had an automatic in built simple transition and suggested a complicated “transition” that has introduced potential cliff edges.

So if you are due to retire before 1 April 2022 you no longer need to worry about your benefits provided agreement is reached before the year end and the deal isn’t revoked. (So no need to strike!)

Even if the transition weren’t in place if you only had e.g. 5 years until retirement then you will only have 5 years on the new benefit structure. Your old benefits would be protected on the old structure! For example if the new benefits were worth 20% less (not necessarily the case) and you already have 20 years service then you’d still get 96% of your original entitlement. If you are 1 year away then you’d get 99% and 10 years away 93%. Automatic transition!

Conclusion: The transition period offered is a bad idea and the money would be better spent elsewhere.

Benefit changes

When considering sustainability we need to note that the current benefits are sustainable – particularly as “cap and share” that was introduced following the last set of changes means members could expect to have to increase contributions in the future if the cost rose. However, what we really mean when we talk about sustainability is what level of benefit are we prepared to sustain?

What do we mean by fairness? Well the definition being applied seems to have 2 parts attached to it. Firstly that for it to be fair the changes should have greater impact on the higher rather than lower paid and secondly that pension benefits accruing should be fair to the tax payer. The first aim is I think achieved by the career average structure which for a given total cost should ensure greater benefits for the lower paid who generally don’t have such high salary growth. The second is much more subjective but it’s worth referring to notes on costs above noting just because it costs the government less doesn’t mean it should provide more as it should be using the comparative advantage to reduce costs.

One point that has clear sustainability merits is linking retirement age to state pension age as this should help ensure stability of cost going forward. I think it’s also reasonable to suggest that taxpayers aren’t getting the best value out of providing pension benefits as they stand. The number of opt outs suggested due to contribution rises shows that member value is nowhere near as high as cost on any measure. This is partly due to the mistrust members have with pensions and governments.

Conclusion: much of what is proposed is perfectly reasonable but much work needs to be done on communicating the value of benefits to members.

Contribution rises

There is an element in this that is about fairness and attempting to address the fact that the perceived total reward in the public sector is too high. Increasing member contributions has the effect of addressing the balance without talking about salary cuts. By ensuring the lower paid are affected less, the approach to increasing contributions is also arguably fair. However, I get the feeling that the increase in contributions is probably the overwhelming problem with the proposed reforms. This is the one that hits members pockets directly today and, assuming the government does want to encourage membership, is exactly the same as a pay cut.

However, we are in a financial black hole. As well as being the only thing that hits member’s pockets today, it’s also the only think that provides extra income to the government today. This is why it is being done. The contribution rises have very little to do with fairness and sustainability but everything to do with the deficit that exists in public finances. There is nothing wrong with this but it needs to be communicated as such.

Higher contributions or lower salaries
or
Higher contributions or redundancies

If the contribution rise doesn’t go ahead then the finances need to be filled by something else. This is why this area of change is not negotiable. This message has not been communicated though.

Conclusion: it’s going to happen but needs to be communicated why.

Other points of note

  • Just because your normal retirement age is 68 doesn’t mean that’s when you have to retire.
  • After the changes public sector schemes will still be very good and the envy of private sector workers.
  • We need to think hard about our ageing workforce. Some jobs just can’t be done at 68. Is it time to introduce positive age discrimination to get older workers into jobs they can do?
  • We need to attack things from the other angle and remove the barriers to private provision so that DB schemes can once again exist for private sector workers – much of the problem is due to bad regulation.