A by-product of the current dispute over who should fund public sector pensions has been to shine a spotlight on the comparative inadequacy of private sector pensions.
The level of pension in the public sector is totally out of reach for those on an equivalent salary in the private sector, with a few exceptions among the ever dwindling number of private sector defined benefit schemes. Lord Hutton, who led the commission that came up with the proposed changes to public sector pensions, has said: "pension reform must not simply become a race to the bottom".
So what can the Government do to raise the level of private sector pensions?
The Workplace Retirement Income Commission has completed its independent review of retirement saving, which aims to answer this question. Chaired by Lord McFall, a former chairman of the Treasury Select Committee, the main recommendations focus on improvements to the current system; increasing participation and contribution levels; offering more consumer choice; better financial education; reducing charges; and improving communication by pension providers. All aim to tune up the current pensions system to deliver a good value for money for savers.
Sharing the investment risk
But the most important point raised was risk management; the report recognised the vulnerability of private savers to the volatility of the stock market and the impact of the economic cycle. To quote the report: "People in DC [defined contribution] pensions are being left to carry all the risk of funding their retirement. They are often confused by investment choices, and are at the mercy of stock markets. The Government must work with the industry to develop new products that help mitigate risk, and employers must be incentivised to take on a share of pension risk." If acted upon, this would be a very positive move. Public sector pension schemes guarantee a return for their members. Risk sharing has the potential to introduce a level of security so that, when boom turns to bust, savers will not find that all their pension saving had been in vain.
Sharing the risk at the investment level, however, can only go so far. If the returns on the pension scheme's investments are low then the returns available on annuities and hence the ultimate pension is also likely to be low.
Index linked pensions for the private sector
This also highlights another fundamental difference between public sector and private sector pensions, index linking. Inflation-proof pensions are standard in the public sector but far outside the reach of the vast majority of savers. Part of the solution to the pensions issue is for the Government to provide affordable index-linked gilts specifically for the provision of private pensions. This would of course have a cost, part of which would be offset since the Government would have had to borrow the money anyway. But by setting the price so that, in times of economic boom, they are less attractive than gilts on the open market we would be taking advantage of the Government's ability to stretch its borrowing across several economic cycles and ride out waves of inflation.
This would not only provide a lifeline to pension savers in times of economic extremis - such as now - but the prospect of a good return, whatever the economic situation in the future, will be an excellent incentive to save.
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