Post war Britain developed a parallel system of pensions providing Final Salary schemes for the public sector and larger companies along with growing state provision.
It was a good system – if you worked for a large organisation. By the end of the 1960s 53% of the workforce was in an occupational pension scheme.
However, in 1961 life expectancy for men was 68 years and just under 72 years for women. Today life expectancy in the UK is 77.9 for men and 82 for women – and growing every year.
With retirement at 65, pension schemes could expect to provide retirement incomes for about 5 years, now with retirement ages at 60 schemes can expect to provide incomes for closer to 20 years!!
The fact that we are living longer is making pensions more and more expensive. There are other factors that make them too expensive such as salary growth and changing assumptions on long term inflation and investment growth, but increasing life expectancy is the root of the problem.
Private sector Final Salary pension schemes in the UK are therefore dead! They have been for the last 5 – 10 years. Companies can no longer afford them or bear benefits that are not only guaranteed but also an open ended commitment. They are no longer commercially tenable and are a risk to the business. That is why they are dead.
The simple fact is we will probably all have to spend a little less, save a little more and work a little longer to fund our retirements in future.
However, Final Salary pensions continue in the public sector – unfunded by investment and paid for by general taxation. Yes, their projected costs are currently set to fall with CPI replacing RPI indexation and with workers making contributions. They are still hugely expensive.
Pensions are in fact deferred pay. Because of the pensions position, it often now pays far more to work for the public sector than for the private sector – which is different to the common perception. This means the wider population are being asked to fund pensions which are far more generous than anything available to them. This means funding something akin to our entire defence spending budget. And no economy is going to last for very long where it becomes significantly more attractive to work for the public sector than for the private sector!
Of course the state can afford to pay whatever it wants for public sector pensions if the political will is there. However, the true costs of final salary schemes are unsustainable to fund – as the private sector has discovered. Employers can no longer underwrite these unquantifiable, open-ended commitments. Neither can the state or future tax payers – change is unavoidable.
What to do?
It seems to me that the real issue here is that our occupational pension infra-structure is broken – for both private and public sectors.
You see it is worse! New legislation aimed at widening pension provision just means a levelling down right across the private sector of what pensions are now provided!
The government is introducing something known as “auto enrolment” so that everyone in a job will have a modest occupational pension. This will help a little with people who have no pension at all. However, it is very modest provision.
With jobs for life gone and guaranteed final salary schemes for life also gone, companies don’t do social welfare anymore like they used to in the post war period. Unfortunately, many employers have been replacing old generous schemes with much less generous ‘money-purchase’ schemes with no guarantees for the employee. The new auto enrolment provisions, while welcome for some, is just accelerating this levelling down affect.
I’m told both the USA and Australia have been much more effective than the British at replacing old unsustainable pension schemes with new money purchase provision.
That is why I think the public sector unions have a real opportunity here. They need to be constructive. Accept the old pensions are unsustainable and come up with some good alternatives. If they are sustainable and something that provides decent pensions takes its place then market forces in the labour market could lead the way to improvements in the private sector as well.
The public sector could lead the way to a new pensions protocol which is desparately needed. Because we all need to save more for our retirements and we all need something that is much more sustainable than we have had in the past!