The end is high

The Government faces a tough sell in trying to navigate a reduction in the local government pension scheme through a union minefield. By Jane Marshall and Wendy Hunter

No reader of the financial press can have escaped the topic of pensions over recent months. There have been failures of company schemes without enough money in them to pay members’ pensions, the political quick-fix of complex legislation and the appointment of a new pensions regulator. Pensions issues now have to be considered and planned for in any corporate transaction, reconstruction or reorganisation. From being a Cinderella subject, pensions are now at the top of the corporate agenda.

The possibility of seeking deal clearances from the new regulator, the extension of protection to pensions on Transfer of Undertakings (Protection of Employment) transfers and increased governance requirements all mean more work for pensions lawyers. It seems inevitable that this will also feed through into increased contentious work given the radical nature of the current changes. There is no perfect solution to the various problems facing UK pension schemes.

Perhaps less well known, but potentially even more difficult, are the problems surrounding public service pensions. Public service pensions are typically very generous. They are based on the final salary model, which is disappearing fast from the private sector. In addition to full, guaranteed indexation, pensions are typically paid earlier than the usual private sector retirement age of 65; many public service schemes have a retirement age of 60. Public service schemes generally give advantageous early retirement terms, particularly under so-called ‘rule of 85’ provisions, which allow a member to retire early on full pension if the appropriate combination of years of service and age is reached.

There are also likely to be enhanced provisions if the member is made redundant or is subject to ‘efficiency’ reorganisation. One of the features of New Labour has been an increase in public sector recruitment on the same generous terms, exacerbating the position. The result is that public sector pensions are very, very expensive. Although most of the same factors that have hit private sector schemes apply – such as increasing life expectancy – the cost is hidden. Members typically contribute 5 per cent or 6 per cent of pay, which is nowhere near the true cost of the benefits. The employer, backed by the general taxpayer or council taxpayer, pays the balance, but this is not usually funded up front, as in the case in the private sector.

The Government has recognised that the burden of public sector pensions is too high; identifying what action to take, though, is more difficult. There were some grounds for optimism when changes to the local government pension scheme (LGPS) were introduced, with effect from 1 April 2005. The purpose of the changes was to start a process of modernisation and to reduce pension costs. Their key feature was an increase in the retirement age, from 60 to 65, and greater restrictions on access to early retirement, particularly by removing rule of 85 retirements. The latter was widely thought to be necessary to avoid falling foul of the forthcoming age discrimination legislation. These changes were supposed to provide the groundwork for even more radical changes in 2008. Even so, the annual savings from the 2005 changes were estimated at between £10m (the figure estimated by Unison) and £400m by the actuaries, who handle much of the work for the LGPS. The local government employers’ own estimate was £200m. These figures are staggering. If similar changes were made in other public sector schemes, some of which are much larger, from the NHS to the police, fire-fighters and teachers, then the cost savings would be enormous.

Politically, this is a very hot potato. John Prescott bowed to union opposition just before the general election and issued draft regulations that would, if implemented, retrospectively revoke the April 2005 changes to the LGPS. But this would mean local authorities would not secure savings they have already factored into this year’s budget. At the same time, the Government is unwilling to compensate local authorities. An increase in council tax or cost-cutting (ie job losses) appear to be the only alternatives, but are equally unpalatable. Meanwhile, the unions continue their opposition to any change to pensionable age. At its conference, Unison delegates agreed that their opposition to the change was non-negotiable. In the draft revocation regulations, the Government trailed the possibility of alternative cost-cutting changes to the LGPS. But are the unions any more likely to accept such alternatives?

And this is not simply a political hot potato within local government. At the British Medical Association conference last week, doctors voted in favour of a strike action ballot. Industrial disputes in local government nationwide would be politically damaging, but how much worse a strike by NHS doctors?

It is perfectly understandable that members will fight to keep generous pension arrangements, but only now is the general public becoming aware of just how generous these arrangements are. A report by Pensions Commissioner Adair Turner is due out later this year dealing with the sustainability of retirement provisions generally. It is expected to recommend a combination of later retirement, higher contributions and lower benefits. As council tax bills or general taxation rise to pay for public sector pension costs, particularly at a time when many other employees are having their pension provisions cut and employers are having to pay a high price for greater regulation, it could be a very rough political ride.

But delay is not an option for the Government – it will simply compound the legal problems. Three months after the intention to revoke the 2005 changes to the LGPS was announced, it has yet to be implemented. The uncertainty means it is increasingly difficult for local authorities to administer the LGPS. Disputes will surely follow. And what about the removal of rule of 85 early retirement provisions? The age discrimination requirements could make it unlawful by October 2006.

One way or another, it seems likely that public sector pensions are going to become an even bigger headache for the politicians, but as a source of work, they could be the fulfilment of the pensions lawyer’s dream.

Jane Marshall heads the international benefits practice and Wendy Hunter heads the public sector pensions group at Hammonds