Pension tension

Most people are baffled by the arithmetic of pensions. Consultants regularly report that people saving for their own retirement underestimate, routinely and massively, the amount of money they need to set aside. Meantime, those with company pensions rarely have any idea of the value of the benefit they hope to receive, or how big a potential burden it represents for their employer.

A few years ago, during one of General Motors' regular flirtations with bankruptcy, an intriguing story went across the Bloomberg wires. A GM pensioner, recently retired on his full salary, was fretting that the company's plight might deprive him of his entitlement. The retiree in question was, if memory serves, 40 years old and had been with the company for about 18 years. It did not seem to occur to him (or, it may be said, to the Bloomberg staffer on the story) that he just might be one of the reasons why GM was in financial trouble in the first place.

Which brings us, in a roundabout way, to the Hutton Report on UK public sector pensions*. Hutton wants to see public employees paying more into their pensions, retiring later and receiving benefits based on average earnings over their careers, rather than final salary as is currently the case. Recognising that this could look like a penny-pinching "race to the bottom" in terms of pension quality, he urges the government to ensure that the burden falls on the better paid, with the majority of people seeeing little change in their eventual pensions, though they will have to contribute more and work longer to get them.

Public sector unions are predictably up in arms and threatening strike action. (However, there are no reports that any of them have reacted quite as colourfully as Robert Peston: he says the proposals will seem "as attractive as a plate of cold sick" to union leaders). Like the GM retiree of a few years ago, today's public sector union leader seems to have no conception of just how expensive the existing package is, or who is paying for it; unlike that retiree, however, he presumably has little fear that the employer will go bankrupt and wipe out his pension altogether. As a result, the initial reaction from the unions is that the reforms proposed by Hutton amount to "workers paying the price for the banking crisis". This is patently untrue: governments have been trying to get the ravening beast under control for years. The most recent attempt was made by the Labour government when the economy was going great guns, though sadly, they flinched from making any really tough decisions.

There are misrepresentations on both sides of this issue. Talk in the right-wing media of "gold plated" public service pensions is offensive: the average annual payment is not far above £3000, reflecting the fact that a large number of public servants are low-paid. At the same time, the old union argument that public servants trade off lower earnings when they are in employment for better pensions when they retire no longer holds water. Public employees' average earnings are now on a par with those of the private sector, but they retire much sooner and get larger, inflation indexed pensions.

The average private retiree's pension "pot" used to buy a retirement annuity is apparently £32,000, which in today's low rate environment buys you a pension of a whole lot less than £3000 a year, and no inflation protection. You couldn't blame the unions for trying to hold on to what they've got, if the alternative was that sort of pittance. Hutton's proposals are designed to protect the lower paid from exactly that fate, but that may not be enough to stem the threat of strikes. History suggests this will be one of the toughest fights the coalition government faces.

* How unfortunate that this important report has been authored by the same man who prepared a risible whitewash of a report into the "dodgy dossier" during the 2003 Iraq war. His Lordship's name is not exactly a byword for rigorous and unbiased analysis.