Final Hutton report recommends switch to career-average benefits for all public-sector pension schemes | Practical Law

Final Hutton report recommends switch to career-average benefits for all public-sector pension schemes | Practical Law

On 10 March 2011, the Independent Public Service Pensions Commission headed by Lord Hutton of Furness published its final report.

Final Hutton report recommends switch to career-average benefits for all public-sector pension schemes

by PLC Pensions
Published on 10 Mar 2011
On 10 March 2011, the Independent Public Service Pensions Commission headed by Lord Hutton of Furness published its final report.
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Public-sector pension schemes should move to a career-average revalued earnings (CARE) benefit structure by 2015, with normal pension age rising in line with state pension age, under recommendations made by Lord Hutton in his final report to the Treasury. Tempering these proposals, the report also advises maintaining the link to members' final salaries for their accrued benefits and suggests CARE schemes should revalue active members' yearly accruals by earnings instead of prices.
Calling for a central oversight and governance framework across the public sector, Lord Hutton advises that the reforms should be implemented by primary legislation. Legislation would provide for a fixed cost ceiling limiting employer contributions to a specified level of pensionable earnings that public-sector employers contribute on average over the long term. A common amendment rule enacted for all schemes would enable further benefit adjustments to be implemented more easily.

Background

In June 2010, the coalition government announced its plans to set up an Independent Public Service Pensions Commission to examine reform of public-sector pension schemes, headed by former Secretary of State for Work and Pensions Lord Hutton of Furness.
The Commission published an interim report in October 2010. After reviewing the current pensions landscape and putting forward general ideas for reform, the report concluded that the Commission's final recommendations would be measured against four key benchmarks. Public-service pensions should:
  • Be affordable and sustainable.
  • Be adequate and fair.
  • Support productivity.
  • Be transparent and simple.
(See Legal update, Hutton: interim report published.)
For background about current pension arrangements in the public sector, see Practice note, Overview of pension schemes in the public sector.

Final report: key points

On 10 March 2011, the Commission published its final report. Its key recommendations to ministers are as follows:
  • Career-average benefits. Members of all public-sector schemes should move to accruing future benefits on a career-average revalued earnings (CARE) basis. There are no recommendations about specific accrual rates, which vary between schemes at the moment.
    Rejecting a switch to defined contribution options, the report said that public-sector workers should continue to have access to good quality defined benefit pensions, but these must be sustainable and fair. Between the two short-listed options, the Commission judged CARE schemes preferable to cash balance schemes on the grounds that while the latter provided greater flexibility for the government, they entailed an unacceptable degree of uncertainty about the level of benefits that members would receive at retirement.
  • Final salary link. Benefits that have already accrued on a final salary basis should be fully protected. In particular, all accrued service to the date of a future switch to CARE accrual should continue to be linked to members' final salaries at retirement.
  • Normal pension age. For most schemes, normal pension age (NPA) should rise in line with the planned increases to state pension age (SPA) being enacted under the Pensions Bill 2011 (see Practice note, Pensions Bill 2011: overview). So by 2010, SPA will be 66 for both men and women. This change should not apply in the case of the uniformed services (the armed forces, police and firefighters) where due to the nature of the work, NPA should be fixed at 60.
  • Indexation. Active members' accruals should be indexed by average earnings (without a cap being imposed). For deferred members, the government would have to decide whether to revalue by prices or earnings. Once in payment, pensions should be indexed by reference to the Consumer Prices Index as already implemented.
  • Member contributions. The existing plans across many schemes to increase member contributions should go ahead. For the future, standardised tiered contribution rates should be commonly used. There should not be a cap on contributions or accruals for high earners.
  • Flexible retirement. Partial retirement should be encouraged, with current abatements and caps on accrual abolished. Instead, actuarial adjustments should be applied to allow early or late flexible retirement.
  • Standardisation. The new benefit design should be introduced across all public-sector schemes by the end of the current Parliament (in other words 2015). There is no need to disturb the existing distinction between the LGPS as a funded scheme and other unfunded schemes in the public sector.
  • Fixed cost ceiling. Cost stabilisers should be built into the new framework to contain future risks, with employer contributions limited to the proportion of pensionable salary that public-sector employers contribute on average over the long term. Changes made to schemes' benefit structures to control costs would be subject to consultation with member representatives, but if agreement could not be reached an automatic default mechanism should provide for increased contributions or reductions in accrual rates.
  • Governance. An independent body should take charge of oversight of public-sector schemes, keeping government and members better informed about the financial health of schemes. Standards of scheme administration should be improved, with each scheme having a pensions board responsible for meeting governance standards (including administration). Each board should include member representatives.
  • Legislation. A common legal framework for public-service pension schemes should be put in place under primary legislation. The legislation should:
    • contain a common amendment rule (and detail consultation requirements about amendments);
    • confirm the extent of protection for members' accrued rights;
    • set out the core benefit design and scope for variation in individual schemes;
    • provide for the cost ceiling mechanism;
    • create a new independent oversight body (or provide for an existing body such as the Pensions Regulator to perform this role) and set out its powers and duties;
    • establish a scheme governance framework; and
    • provide for transitional measures while the new framework is being introduced.

Comment

The likelihood that the Commission would recommend a switch to CARE accrual for future service was widely predicted in advance of its final report. But some commentators wrongly suggested Lord Hutton would also recommend breaking the link with final salary for accrued rights. Certainly, this practice has been widespread in many scheme closures or benefit redesigns in the private-sector in recent years. The suggestion that yearly CARE accruals should be revalued by earnings will also soften the blow for many workers.
Assuming the government accepts the report's recommendations - far from certain at this stage - the key long-term reform arising from the report may be the concept of the fixed cost ceiling, where employers' long-term contributions will be capped to a yet-to-be-decided proportion of members' pensionable pay. In adverse economic conditions, this could lead to a pressing need to reduce benefits or increase member contributions. A standardised scheme amendment rule across the public sector would make implementing these benefit adjustments far easier to achieve than is currently the case.
An area that is only obliquely referred to in the report is the status of the Fair Deal policy, which the government has indicated it is inclined to reform or withdraw completely. Recommendation 16 is that in future non-public-sector workers should not be given access to public-sector schemes. For details about the recent consultation exercise on the future of Fair Deal and comments by David Gallagher, partner at Field Fisher Waterhouse, see Legal update, Consultation launched on the future of Fair Deal.

Sources

Independent Public Service Pensions Commission: final report (March 2011).
HM Treasury: Lord Hutton publishes his final report on the future of public service pensions (10 March 2011).