Stewart Ritchie: MPs must set an example on public sector pensions

LAST month, for the first time ever, I e-mailed Gordon Brown to congratulate him. The reason was that he has taken the first brave step to sort out MPs' pensions. He has asked the Chairman of the Senior Salaries Review Board to look at the possibility of removing the taxpayer guarantee on MPs' pensions earned in future.

In other words, once the taxpayer has contributed a fixed percentage of the MP's salary, the MP's pension pot is on its own, just like the most of taxpayers' private pensions now. This is called defined contribution, or money purchase.

MPs' pensions are just about the most generous around, and MSPs' pensions are similar. MPs can make a personal contribution of 10% of earnings to get a pension of one 40th of earnings for each year of service. Taxpayers foot the bill in two ways. They pay the balance of the contribution rate, and are on the hook if contributions prove inadequate, because, for example, the MP lives longer than expected. Based on realistic assumptions, the taxpayer contribution could approach 50% of earnings.

None of this is new. It is five years since MPs last improved their pensions. What is new is what has been going on in the private sector. Employer-guaranteed schemes which pay a pension linked to your final salary – or defined benefit schemes to give them their proper title – have been closing to new entrants and are now increasingly stopping any more pension building up for existing members.

Figures published by the Pension Protection Fund suggest that these private sector schemes were in total only 62% solvent in March 2008, and that solvency is likely to have worsened since then. In other words, there is roughly half the money in these schemes that would be necessary to buy on the open market the pension already earned. The employer is liable for any shortfall. Yet the ability of private sector employers to meet large pension black holes is impaired by what Ed Balls has suggested is the worst economic situation in the past 100 years.

The reality is that the world has changed dramatically. The private sector has been impacted badly, and the true horror for members of private sector pension schemes across the board will be revealed in the coming months. Yet public sector pensions have been largely immune to this because of the taxpayer guarantee. The country cannot afford to continue for the future the pension generosity which public servants have enjoyed in the past. It is MPs who will have to pass legislation to radically reform public sector pensions, but how can they credibly do that while they themselves continue to earn the best public sector pensions of all?

We will see vested interests mobilised to 'protect' public sector pensions. All kinds of smokescreens will be thrown up. One is that public sector workers accept less pay in exchange for better pensions. This might have been true once, but is unlikely to be so today. Another is that the state is uniquely well placed to offer long-term guarantees, and should use that for the benefit of its employees. To the extent that that is true, it should be applied to all citizens through the state pension system, and not reserved for a privileged minority.

A further smokescreen is that we can have the best of all worlds by 'risk sharing', whereby we keep defined benefits but, for example, raise the pension age for them if people are living longer than expected. Problems with this approach include increased complexity and the scope for taxpayers to continue finding themselves with future large bills for past service which they thought they had already paid for.

A real problem of shifting future public sector pensions to defined contribution is cash flow. Taxpayers will still have to pay for unfunded pensions earned in the past while making contributions for pensions currently being earned. This may require notional defined contribution accounts to be created for public servants whose pension is currently unfunded, and only as the economy improves can this be gradually moved to a real money basis.

It is time for MPs to set an example. Gordon Brown is effectively challenging them to do so. The damage done to our democratic system by rows over MPs' expenses may be chickenfeed compared with what will happen if they fail to respond effectively to Brown's challenge.