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The Commons Public Accounts Committee publishes a report today which, on the basis of evidence from HM Treasury and the Department of Health, examines the cost of public service pensions and the impact of the 2007-08 changes.

The Rt Hon Margaret Hodge MP, Chair of the Committee of Public Accounts, today said:

"Government projections of the future cost of public service pensions suggest that the changes made in 2007-2008 will stabilise costs at around 1% of GDP, thereby bringing substantial savings to the taxpayer. This would be a significant achievement.

However, we are concerned that the Treasury has not tested the impact of the changes on some of the key assumptions underlying their cost projections.

We are also concerned that the Treasury has not set out clearly what level of spending it considers sustainable in the long term. Instead, officials appeared to define affordability on the basis of public perception.

The Treasury expects the majority of savings to come from cost sharing and capping, a reform designed to ensure that employees bear a greater share of future costs. However, implementation has been deferred because of the Treasury’s discount rate review, and remains on hold while the Government consults on the recommendations put forward by the Hutton Commission.

As soon as possible after the consultation, the Treasury needs to publish its timetable for implementing this mechanism or an alternative scheme, as well as the expected savings.

Employees currently lack the information they need to understand the value of their pensions and make rational decisions accordingly. The Treasury must work with employers and pension schemes to improve the quality of information provided to employees.

We are also concerned that the Treasury has not properly assessed how changes to public service pensions might lead to additional spending elsewhere, for example by increasing demand for means-tested benefits. Public service pensions policy must not be determined in isolation from other areas of public policy and spending."

Margaret Hodge was speaking as the Committee published its 38th Report of this Session which, on the basis of two reports from the Comptroller and Auditor General, examined the cost of public service pensions and the impact of the 2007-08 changes.

Background

In 2007-08, new pension schemes were introduced for civil servants, NHS staff and teachers. The changes were in response to Treasury requirements for savings in taxpayer costs to make public service pensions affordable.

Three main changes were made. First, the age at which a scheme member could draw a full pension was increased from 60 to 65 years for new members. Second, employee contributions were increased by 0.4% of pay for teachers and by up to 2.5% of pay for NHS staff. Third, a new cost sharing and capping mechanism was introduced to transfer, from employers to employees, extra costs that arise if pensioners live longer than previously expected. The Coalition Government announced additional changes in 2010, including indexing pensions to the Consumer Prices Index rather than the Retail Prices Index, which are expected to reduce costs further.

Projections

Government projections suggest that the 2007-08 changes are likely to reduce costs to taxpayers of the pension schemes by £67 billion over 50 years, with costs stabilising at around 1% of Gross Domestic Product (GDP) or 2% of public expenditure. This would be a significant achievement. We would, however, encourage the Treasury to publish a clear measure or benchmark of affordability which indicates the level of spending on public service pensions it considers sustainable. Officials appeared to define affordability on the basis of public perception rather than judgement on the cost in relation to either GDP or total public spending.

The committee's findings

The committee is concerned that the Treasury did not test the potential impact of changes in some of the key assumptions underpinning the long-term cost projections. These include assumptions about the rate of growth in GDP, the size of the public service workforce, and the wider impact of the 2007-08 changes on increased payments in means-tested benefits and reduced receipts from taxation and national insurance. In addition, the Treasury has not tested whether reducing the value of pensions would affect the public sector’s ability to recruit and retain high quality staff.

The committee heard concerns that the discount rate used to set pension contribution levels was too high. A lower discount rate leads to higher contributions from employees and employers, reducing the long-term cost of pension schemes to taxpayers. Following a Treasury review including a public consultation, the Government has now set a new, lower discount rate which was announced in the 2011 Budget. This has removed uncertainty about the appropriate level of the discount rate.

Three-fifths of the savings to the taxpayer were expected to come from the cost sharing and capping mechanism. Under this mechanism, employees would bear a greater share of costs, potentially paying 70% more for their pensions over the next 50 years if life expectancy continues to increase more than expected. However, implementation of the mechanism has been deferred, initially because of the Treasury's discount rate review. Implementation remains on hold while the Government decides how to respond to the Independent Public Service Pensions Commission (the Hutton Commission), which has recommended that cost sharing and capping be developed into a 'cost ceiling' that sets an upper limit on the amount the Government contributes to employees' pensions. An early decision to implement cost sharing and capping is important for providing certainty to both employees and employers.

Pensions form a substantial share of the total salary package received by public service employees. We are concerned that employees do not have a clear understanding of the value of their pensions because they are not provided with clear and intelligible information to enable them to make rational decisions. This may mean the benefits of public service employment are not fully appreciated by current and prospective employees, potentially diminishing the influence of pensions as a recruitment and retention tool.

Public service pensions policy is not joined up with planning in other areas of public policy and spending. Whilst this is not a new issue, we still found it concerning given the potential impact that pension changes could have on areas such as future demand for means-tested benefits. There is little evidence to judge whether wider pension policy measures are effective, including measures such as tax relief and other incentives to encourage people to save for their retirement.

Further changes to public service pensions are expected in the near future. In the 2011 Budget, the Government announced that it had accepted the Hutton Commission’s recommendations for long-term structural reform of public service pensions as the basis for consultation with public sector workers, unions and other interested parties. Following this consultation, it will set out proposals in autumn 2011. This provides the opportunity for the Government to develop a clear strategic direction for public service pensions. We look forward to the Government’s detailed proposals and, following their implementation, a period of much-needed stability and certainty for long-term public service pensions policy.