Impact assessment shows public sector pension reform will reduce the average value by more than a third

The Government’s proposed reforms to the four largest public service pension schemes will reduce the average value of the pension benefit for members of these schemes by more than a third, and reduce long-term government expenditure on unfunded public service schemes by around a quarter, says Pensions Policy Institute.

The Pensions Policy Institute (PPI) has published an independent assessment of the impact of the Coalition Government’s proposed reforms to the four largest public service pension schemes: the NHS, Teachers, Local Government and Civil Service pension schemes. The analysis has been funded by the Nuffield Foundation and covers the potential impact of the Government’s proposed reforms on the pension benefit offered to members of schemes and on the affordability and sustainability of the schemes.

Under the Government’s proposed reforms to the largest four public service pension schemes the pension benefit will be linked to the member’s average salary, the Normal Pension Age is due to increase in line with the State Pension Age and member contributions are set to increase.

Niki Cleal, PPI Director, said: “The PPI’s analysis suggests that the combined impact of the Coalition Government’s proposed reforms is to reduce the average value of the pension benefit for all members of the NHS, Teachers, Local Government and Civil Service pension schemes from 23% of a member’s salary before the Coalition Government’s reforms, to 15% of a member’s salary after the Coalition Government’s reforms, a reduction in the average value of the pension benefit for members of these four schemes of more than a third.”

“Nevertheless, even after the Coalition’s proposed reforms the benefit offered by all four of the largest public service pension schemes remains more valuable, on average, than the pension benefit offered by Defined Contribution (DC) schemes that are now most commonly offered to employees in the private sector, into which employers typically contribute around 7% of a DC scheme member’s salary.”

Chris Curry, PPI Research Director, added: “The impact of the Government’s reforms on members of the public service pension schemes will vary for scheme members with different characteristics. High-flyers with fast salary progression may see a larger reduction in the value of their public service pension under the Government’s proposed reforms than scheme members with more modest salary progression.”

“The reforms will also reduce net government expenditure on unfunded public service schemes from around 1.1% of GDP by 2065 under the current system to around 0.8% of GDP in the reformed system – a reduction of around a quarter.”

Notes for editors

1. This report updates a previous report published on 23 October 2012. The new report includes an analysis of the impact of the Government’s proposed reforms on the affordability and sustainability of public service pension schemes.

2. The report published on 23 October 2012 estimated the value of a private sector DC scheme to be worth around 10% of salary. This included an allowance for eligibility to the State Second Pension (S2P). The Coalition Government has announced its intention to introduce a Single Tier Pension from 2016, in effect abolishing the S2P. Therefore, the EEBR comparator for a member of a DC scheme used in this report does not take into account the value of the S2P. As a consequence, the overall value of a typical Defined Contribution scheme is now estimated as the average employer contribution rate of around 7% of a private sector worker’s salary.

3. The Coalition Government’s proposed reforms to the public service pensions as set out in the proposed final agreements include:

Ending the link between pension benefits and final salary. Instead the Government proposes to link pension benefits to the average salary of public sector employees over the course of their careers revalued by an index;
Linking the Normal Pension Age to the State Pension Age for members of the four largest schemes and increasing the Normal Pension Age to 60 for members of the uniformed services;
Increasing the rate of members own contributions to the schemes, with higher earners seeing the most significant increases in contribution levels.

The tables in Annex 1 of the report published today summarise the main elements of the four largest public service pension schemes and the Government’s proposed reforms. The Government has also proposed reforms to the uniformed service schemes: Policy, Fire and Armed Forces but the PPI has not analysed the impact of those reforms.

4. The Effective Employee Benefit Rate (EEBR) calculations measure the value of the pension being built up each year to an ‘average’ scheme member expressed as percentage of the scheme member’s salary. The calculations take account of the main features of the schemes’ design, including the structure of the benefit, the Normal Pension Age, accrual rate, survivors’ benefits, ill-health benefits, and death-in-service benefits. Member contributions have been deducted, to show the notional amount that is contributed by the employer and the effective benefit of the pension to the employee as a % of their salary. So if a scheme has a benefit structure that would be worth 20% of the member’s salary, but the member is contributing 5% themselves in member contributions, then the EEBR would be 15%. The discount rate used in the PPI’s calculations is CPI + 3% – the same discount rate that the Government uses to calculate contribution rates to the public service schemes.

5. One feature of the Coalition Government’s proposed reforms to the four largest public service pension schemes is that the Normal Pension Age (NPA) has been set to increase in line with future changes to the State Pension Age (SPA) for men. The modelling in this project assumes increases in SPA approximating a combination of current legislation and announced Government policy. Since April 2010 women’s State Pension Age has been increasing in a series of steps to equalise with men’s SPA, and will reach age 65 by November 2018 when SPA will be equal for men and women. According to current legislation, both men and women’s SPA will then rise to 66 by 2020. The NPA for each scheme under the Government’s proposed reforms is therefore 65 until 2018 (which is consistent with the current SPA for men), increasing to 66 by 2020. Scheme NPAs are then assumed to increase in line with the Government’s announced intention that SPA for both men and women will rise to 67 between 2026 and 2028. In the longer term, SPA and NPA are then modelled as increasing to 68 between 2044 and 2046 as stipulated in current legislation.