The Hutton Report is lacking in some areas, says David Davison, but there are observations of importance for civil society organisations.

Following on from the interim report in October 2010 the Independent Public Service Pensions Commission, led by Lord Hutton, published its eagerly awaited final report on 10th March 2011. Now the dust has settled I thought it would be useful to review the major findings and consider how they might impact on charity employers.

The major findings of the report were:-

• Public service pensions had not been able to respond flexibly to workforce and demographic changes over the past few decades. Benefits had risen in value due to increased longevity, there was an unequal treatment of members within the same profession, there was an unfair sharing of cost between employees, the employer and the tax payer and barriers to increasing the range of providers of public services.
• A growing gap between the amounts being paid to public service schemes in employer and employee contributions and the amounts paid out by the tax-payer – increasing from £4bn in 2010 to more than £10bn in 2015. A 1 per cent increase in contributions equated to about £1bn so an attempt to balance the books is likely to result in higher employee contributions.
• The report rejected the idea of a wholesale switch to defined contribution as this would be likely to result in “a race to the bottom” in terms of quality.
• An acceptance that the final salary link was “inherently unfair” as current contribution rates did not reflect the value of benefits and their structure unfairly rewarded high-fliers who could potentially benefit by more than double those on modest earnings.
• A recognition of the need for “inter-generational fairness” which would lead to an increase in retirement ages to more closely match state pension age.

The publication of the final report was set against a background where Consumer Prices Index (“CPI”) is now the measure of inflation, a rise in employee contributions is imminent and reviews of contracting-out and ‘Fair Deal’ are on-going.

Omissions and concerns

Whilst the report is well written and concise there are however some omissions and potential concerns. Of the 27 recommendations made by the report some will have more relevance to civil society employers than others.

The proposal that the existing final salary pension schemes should be replaced with a new career average (‘CARE’) scheme with existing members eventually moving to that should mean that organisations competing for staff with public service bodies may not have to provide pension benefits at the same level as currently, or if they do they will have a positive advantage. The difficulty is that it is by no means clear that the move to CARE will reduce costs, or indeed even reduce benefits for many.

The proposed move to CARE is understandable, and indeed was well trailed in advance of the publication of the report, however, there is no comment on the accrual rate proposed as part of the move. In addition the recommendation to up-rate benefits for active members in line with average earnings is a bit surprising given the recent change from RPI to CPI. This linkage of CARE to average earnings raises the possibility that many lower earners in lower grade jobs could actually be better off, potentially exactly the type of staff engaged by many civil society organisations.

The retention of the final salary link for benefits already built up and any change being applicable for future benefits only will mean that the deficit legacy already built up will remain intact (save for a slight reduction if a move from RPI to CPI is applicable) and take many years to resolve. Future service cost may be lower but that is unclear as there is also no comment on the future contribution amounts included.

The report interestingly also proposes that it is in principle undesirable for future non-public service workers to have access to public service schemes. The detail on this is limited although I’m not sure about how significant this actually is, more a way of formalising existing practice. It has become increasingly difficult for voluntary organisations to join public service schemes as schemes begin to recognise the risk they pose. Tightening eligibility and the requirement for guarantors has made it all but impossible for organisations to gain access so the future problem has been significantly limited. However this does little to address the major issue of the legacy debt.

The report was silent on issues where third sector employers have assumed responsibility for many years of historic debt within schemes helpfully relieving local authorities of much of this burden. There is also limited information on how this will impact on out-sourced public sector work as presumably this is linked to the on-going review of Fair Deal.  

The report also does nothing to address the issue of augmented benefits granted on early retirement following redundancy, where the benefits are based on prospective service and are paid without actuarial reduction, or indeed the above average use of ill-health retirement provisions in certain sectors. This is a big issue for voluntary sector employers as they are in the catch-22 position of not being able to afford staff salaries but unable to make them redundant because of the associated pension cost.

Underplayed risks

Hutton seems to have also underplayed the investment risk relating to local government pensions schemes with more emphasis on risks associates with longevity. The investment impact is much more transparent for organisations who disclose under FRS17 and can have a direct impact on organisations income and trading position. 

The report needs to be viewed in the wider context of political and pension reform and will undoubtedly have planning and funding implications for many organisations:

• There will be a need to manage change and communicate this change effectively to affected employees.
• Organisations will need to ensure a consistent and coherent pension policy across staff participating in the LGPS and private schemes.
• There will be a need to budget for and effectively implement any changes to the cost of benefits and also to link these with the implementation of NEST.
• Any reform of the ‘Fair Deal’ provisions could potentially open up out-sourcing opportunities.
• The report promotes the use of flexible retirement and indeed any link of normal retirement date to a flexible state retirement age could produce uncertainty about when staff would be able to retire. This also has to be viewed in the context of the EU judgement on flexible retirement.

The chancellor George Osborne in his budget was supportive of the proposals in their entirety confirming that the government would not be selective about which elements to implement. However, in the face of mounting opposition to change, it will be interesting to see the detail and if the government has the political will to implement the radical change necessary to balance the books.