Treasury’s ‘£17bn mistake’ that will take “generations to resolve” only part of “perfect storm” brewing in public pension costs, says PAC

In a report published today the House of Commons Public Accounts Committee says HM Treasury has “done little to identify and manage the stark differences in average pensions between genders and other groups” and “should have foreseen the age discrimination issue that gave rise to the 2018 McCloud judgment”.

In 2011 and 2015 the Treasury introduced reforms aimed at making public service pensions more sustainable and affordable, but a 2018 Court of Appeal judgement (the McCloud judgement) ruled parts of the reforms unlawful. The Treasury now wants pension scheme members to pay the estimated £17 billion cost to put that right, despite the unlawful reform having been “its own mistake - a mistake which could have been avoided by listening to advice and which will take many decades to resolve.”

Around 25% of pensioners and 16% of the working-age population are members of one of the four largest public service pension schemes covering the armed forces, civil service, NHS and teachers. The schemes are almost all unfunded, meaning retirees’ pension benefits are paid out of current workforce contributions.

The Committee saw “evidence of public service pensions issues affecting delivery of frontline services, and independent schools opting out of pension schemes because of increasing costs”. It says HM Treasury doesn’t have the data it needs nor evaluated the impact of its reforms, or whether they are achieving its pension policy objectives - the PAC is “not convinced it is on track”.

The Treasury also seems “unconcerned about the drop in enrolment by some workers”. The Committee warns on the “a danger of a perfect storm where some young people believe they cannot afford pension contributions because of high costs of living and retire with a reduced public sector pension as a result. Many younger workers will continue to pay rent in retirement because they cannot afford to buy a home and the cost of supporting this generation will fall on future taxpayers”.

Meg Hillier MP, Chair of the Public Accounts Committee, said “The Treasury’s £17 billion mistake on pensions reform is a ripple compared to the tsunami of costs to the public purse if Government fails to address the growing number of young people unable to afford to plan for a proper pension.

“It’s lack of curiosity about why nearly a quarter of a million workers are not joining these pension schemes is a concern. Pension planning must be long term; mistakes and poor planning have an impact for decades. Short term cost savings can become long term costs to individuals with lower retirement incomes and the taxpayer who may end up supporting them.”

PAC report conclusions and recommendations

5. HM Treasury focuses on affordability to the taxpayer, but this is often at the expense of its other objectives. HM Treasury’s policy for public service pensions seeks to balance three important objectives: ensuring a decent income in retirement to public sector workers; ensuring pensions play a key role in good recruitment and retention of high-quality workers; and doing that in a framework that is affordable for the taxpayer. HM Treasury says it does not think there are significant trade-offs to be made, as affordability is necessary for good levels of overall remuneration and retirement income. However, there are clearly signs that in some cases the balance is not correct and that pensions are not working as well as they could for employers and employees. The focus on affordability means that HM Treasury has lost sight of the potential for public service pensions to support employers in recruiting and retaining the staff they need to deliver public services.

Recommendation: HM Treasury should set out explicitly in its Treasury Minute response how it makes trade-offs between its objectives for public service pensions, for example, when evaluating proposals for additional flexibilities in the public service pension system.

6. It is becoming clear that public service pension policy is affecting the delivery of frontline services in some areas, such as education and health. In 2019-20, a substantial increase in employers’ pension contributions – which was not fully funded by HM Treasury – has directly impacted on employer budgets. As a result of concerns about these increasing contributions, around 200 independent schools are set to withdraw from the Teachers’ Pension Scheme, and we are concerned more may follow. This may put further pressure on the remaining schools, who may not be unable to withdraw from the scheme despite others in the sector viewing it as increasingly unaffordable. At least one higher education institution has had to make redundancies in response to the 2019-20 increase in costs. The employer contribution rate is next due to be reviewed in 2023, where it may change again. Both the SCAPE rate – which is used to help set the employer contribution rate and caused the 2019-20 increase in employer contributions – and its methodology will be reviewed prior to 2023. There is also evidence that pensions can affect staff choices about their work, which impacts frontline services. For example, the interaction between the NHS Pension Scheme rules and the tax system means a large number of doctors have reduced their working hours, opted out of the scheme, or retired early.

Recommendation: HM Treasury should regularly set out the likely impact on employers’ budgets of employer contribution rate changes in advance of their implementation. By giving employers plenty of notice and offering wider support, it can help minimising the impact on frontline services. HM Treasury should also consult widely on the SCAPE discount rate and its methodology, well in advance of any changes.

7. HM Treasury has not done enough to ensure people understand the value of their pensions. This Committee previously recommended, in 2011, that HM Treasury should work with employers and pension schemes to ensure that clear and relevant information is provided to employees on the value of their pensions. But limited progress has been made and more needs to be done to improve employees’ understanding. The problem has been exacerbated with further complexities being introduced as a result of government’s response to the McCloud judgment. HM Treasury provided us with data that implies that over 238,000 employees have opted out of their pensions, but it does not have a clear understanding of why they do so and whether some groups are more likely to opt out – it is particularly concerning if younger and lower paid employees are more likely to opt out. There are understandable reasons why people may choose to opt out of pension schemes for example, owing to short-term spending priorities, but inadequate pensions are likely to cause issues in the future and push costs into other policy areas, such as if people are more likely to be reliant on the benefits system.

Recommendation: HM Treasury should lead from the centre, and seek to understand members’ views regarding their pensions, including the reasons why people may opt out of a scheme and whether this has a long-term impact on other parts of public services and expenditure. It should undertake a review into the take-up and retention of public pensions, particularly amongst young professionals, to help understand the issues employers face when trying to demonstrate the value of pensions. Such a review should identify areas where communication is working well and recommend best practice for employers.

8. HM Treasury has done little to identify and manage the stark differences in average pensions between genders and other groups. HM Treasury does not collect and analyse data on how pension outcomes differ across groups of scheme members or across generations. The NAO report identified a 45% gap in the average pension being paid to male and female pensioners. Similar gaps most likely exist in other groups, such as black and minority ethnic scheme members, but the Government Actuary’s Department tells us that there is insufficient data which means it is unable to look at this. The different pensions outcomes between male and female pensioners exist because of past differences in pay, and HM Treasury seemed resigned to the pension gap enduring for many decades after the pay gap is closed. However, we are concerned that this will lead to inequalities persisting and could lead to legal challenges in the future. We are also concerned that HM Treasury does not specifically consider whether armed forces pension scheme arrangements are sufficient to support personnel when it becomes time for them to move into civilian life.

Recommendation: HM Treasury should be proactive in collecting and analysing data to identify where significant gaps in average pensions exist between different groups. This analysis should inform a wider study on the adequacy of public service pensions, and to understand the impact of differences in pay and working patterns.

9. HM Treasury has had to revisit key elements of the reforms, and these issues may take decades to resolve fully. HM Treasury should have foreseen the age discrimination issue that gave rise to the 2018 McCloud judgment, and putting things right will take many decades to resolve. HM Treasury wants members to pay to put this right – at an estimated cost of £17 billion – despite this being its own mistake. Separately, HM Treasury is concerned that the cost control mechanism – designed to share costs of pensions fairly between employees and employers – is not sufficiently protecting the taxpayer and members. The Government Actuary’s Department says that the cost control mechanism is likely to be triggered every four years, rather than only as a result of ‘extraordinary, unpredictable events’ as HM Treasury intended. This undermines the usefulness and stability of the mechanism and will impact employees and employers alike. HM Treasury was advised at the time of the reforms of both the age discrimination problem and that the cost control mechanism could easily be triggered.

Recommendation: HM Treasury must prioritise work to quickly resolve the challenges presented by the McCloud judgment and cost control mechanism, in order to give certainty to scheme members and employers, and rebuild the trust lost through these issues. The Department should write to us with an update in six months’ time.

10. HM Treasury has not yet performed an evaluation of its reforms and we are not convinced it is on track to meet its objectives. As a part of its 2011–2015 reforms, HM Treasury made a commitment that there would be no more reforms for 25 years. We are just six years into that period and already there are substantial issues that need to be resolved. Both the McCloud judgment and HM Treasury’s concerns around the cost control mechanism have highlighted weaknesses in the reforms. COVID-19 and Brexit are likely to impact GDP in the short term, and it is too soon to tell if these events will have a long-term impact on public service pension affordability. HM Treasury has not yet performed an evaluation of its reforms as it is still in the process of implementing them. We are concerned that HM Treasury has still not prioritised an evaluation of its reforms, particularly given the importance of pensions to individual scheme members, their impact on frontline services, and their significant cost to the taxpayer.

Recommendation: HM Treasury should perform an interim evaluation of its 2011–2015 reforms to ensure it is on track to meet each of its objectives, taking account of whether pensions are working for employers, employees and other taxpayers. It should write to the Committee with an update of this evaluation by the end of the year.