Are Public Sector Pensions Better?

The UK Press Association reports that public sector pensions are better:

Public sector workers have more generous pensions than those working in the private sector who belong to similar schemes, research has claimed.

The Institute for Fiscal Studies said not only did public sector workers have greater access to so-called gold-plated defined benefit schemes than those who worked for private companies, but the schemes themselves were typically more generous.

It said a combination of being able to claim their pension earlier, having longer job tenures and having their earnings peak at a lower age, meant the schemes were worth more as a percentage of public sector workers' salaries than they were for private sector workers.

The research calculated that on average one-year's worth of accruals in a defined benefit pension was worth the equivalent of 25.5% of earnings for someone in the public sector, compared with just 18.9% for some in the private sector.

The difference was even greater for women, with annual pension accruals worth around 26% of a female public sector worker's salary, compared with just 17.6% for a private sector counterpart.

The report said: "It is not just true that defined benefit pension coverage is higher in the public sector than the private sector, but those pensions are also worth more as a share of the total remuneration package."

Under defined benefit pensions, including final salary schemes, pensions are based on the number of years someone has belonged to a scheme and their pay.

But the majority of the schemes have now been closed to new entrants in the private sector, with companies instead offering less generous defined contribution schemes, under which the individual bears all the risk of investment volatility and increased life expectancy.

There is also a growing trend among firms to close their defined benefit schemes to existing members as well, as they have become increasingly expensive to offer in recent years.

Increasingly expensive is an understatement. Kathy Sandler of the WSJ reports that Ofcom to Look at BT's Pension Deficit, Charges:

The U.K.'s telecommunications regulator said Tuesday it will consult on whether BT Group PLC's substantial pension deficit, and the contributions it is making to it, should be taken into account when setting the amount the company can charge for wholesale services such as broadband and telephone lines.

Depending on the outcome of the consultation, BT could be allowed to charge up to 4% more to its Openreach customers -- including Carphone Warehouse Group PLC, British Sky Broadcasting Group PLC and even BT's own retail department -- which could then choose to pass on any increase to consumers.

BT's rivals lease its copper lines and offer their own competitive telephone and broadband services to U.K. households, and the price BT can charge them for using its telephone lines is set by Ofcom.

Currently, Ofcom takes into account the costs BT incurs from its continuing pension payments, but not from any of the top-ups it is required to make to plug any pension deficit gaps. BT agreed earlier this year to make top-up payments of £525 million ($863.7 million) a year to plug an as-yet unquantified deficit in its £40 billion pension scheme.

The U.K. telecommunications company is expected to conclude discussions with the pensions regulator and confirm the size of its pension deficit in the first half of 2010.

Amid market worries about the cost to BT of plugging a substantial hole in its pension fund, the company in May took the unusual step of announcing the £525 million top-up payments, which are set for the next three years, before it confirmed the actual size of its deficit.

Ofcom's consultation will look at whether deficit payments should also be included in Ofcom's calculations on how much BT's wholesale Openreach division can charge for its services. If Ofcom decides to include the payments, BT's charges could rise by up to 4%. But if the regulator decides not to include the payments and changes the way it estimates continuing pension costs, BT charges could fall by a small amount, Ofcom said.

BT welcomed Ofcom's consideration of the issue, and said it "considers it entirely reasonable that we should be able to recover an appropriate share of our pension deficit costs through regulated charges.

"There is good regulatory precedent for pension deficit costs to be recovered in this way in other regulated industries," BT added, although it cautioned that it is too early to come to any conclusions as to the outcome.

Collins Stewart analyst Morten Singleton said in a note to clients that although there are no current conclusions drawn, "we suspect the likely outcome will be a net minor positive for BT. We believe some of the pension deficit costs will be rechargeable in regulated charges ... however, we suspect that this will be partially countered by a minor change to the cost of capital."

The company inherited its pension liabilities, which are now around four times the company's market capitalization, from the generous final salary pension scheme provided before 1984 while it was under government control, and which the company continued to offer until BT closed the scheme in 2001.

Until last year, BT had been topping up its pension fund with £280 million a year, on a 10-year payment scheme, based on the deficit at its last actuarial pension review in 2006 of £3.4 billion. Analysts have estimated the deficit could have ballooned to as much as £6 billion to £8 billion based on the value of equities and bonds at the end of 2008, when its latest actuarial valuation started.

Ofcom will publish a further consultation on BT's pension costs in spring 2010, with a statement to follow later in that year.

Shares of BT rose 1.4% to 142 pence in a broadly higher London market. The stock has risen almost 5% in the year to date.

BT is not the only company topping up its pension plan. Here in Canada, CP Rail announced it will voluntarily prepay C$500 mln into its pension plan:

Canadian Pacific Railway Ltd said on Tuesday it plans to accelerate funding of future pension obligations through a voluntary prepayment in December of about C$500 million ($476 million), a move an analyst said was disappointing although not unexpected.

The prepayment into its Canadian defined benefit pension plan will be made using cash on hand and help to reduce volatility in future pension funding requirements and make cash flows more predictable, the railroad company said in a statement.

The contribution is "certainly not a positive development as we believe it would have been more constructive to see that cash put to better use in the business," RBC Capital Markets analyst Walter Spracklin said in a research note to clients.

He added, however, that the payment was expected after CP raised the C$500 million in an equity issue earlier this year.

It will have a minimal impact on earnings, Spracklin said.

Calgary-based CP, Canada's No. 2 railway, now estimates its 2010 pension contributions to be between C$150 million and C$200 million after application of a portion of the prepayment. It had previously forecast that pension contributions would range between C$250 million and C$300 million.

CP's shares ended up 93 Canadian cents, or 1.8 percent, at C$51.90 on the Toronto Stock Exchange on Tuesday.

I like the analyst who was quoted as saying that this was not a positive development since that cash could be "put to better use in the business." I guess solidifying the pension plan is not considered good use of a company's capital among financial analysts.

Of course, unlike public sector pensions that are fully backstopped by the government, private sector pensions can easily experience severe deficits that if left unchecked, will jeopardize the pensions of workers.

So are public sector pensions better? You bet they are but their day of reckoning will also come and when it does, public and private sector workers will all be in the same sinking ship.