'Career Average' to Replace Final Salary?

The BBC reports, Public pension schemes 'should be career average':

Lord Hutton's review of public sector pension schemes has been urged to recommend they be changed to career average schemes.

The National Association of Pension Funds (NAPF) says such a switch would be the best way to keep the schemes going in the face of rising costs.

It would also protect the interests of lower-paid workers, the NAPF said.

Most public servants are in better final-salary schemes, whose costs are rising due to increasing longevity.

Review

Lord Hutton indicated he would recommend this policy when, in October, he published his initial findings on the future of the pension schemes.

His independent commission, set up by the coalition government, covers staff in the civil service, NHS, local government, education, police, armed forces and fire service.

Lord Hutton's first recommendation was that members of most of these schemes should pay higher contributions.

The government has said it will adopt this policy, with contribution rates likely to go up by an average of 3% of salary.

"Career average pensions are the most promising option for providing a sustainable, affordable and fairer public sector pensions system," said Joanne Segars, chief executive of the NAPF.

"While it will reduce the costs of public sector pensions, it will also protect lower-paid workers who don't usually have significant salary spikes late in their careers," she added.

The idea was supported by the London Pension Funds Authority (LPFA), which runs the local government pension scheme for councils in London.

"The conclusion we have drawn is that there is a need to share risk more effectively between members and employers," said the association's chief executive Mike Taylor.

"We believe the CARE [career average] system is the most appropriate solution to achieve this."

Cheaper

A final-salary scheme pays a pension based on both the number of years for which a worker makes contributions, and their final salary at retirement.

A career average scheme is fundamentally different.

A worker's pension builds up as a proportion of each year's salary during their employment.

In most cases, this means the pension paid out will be significantly lower than in a final-salary scheme.

As such, career average schemes are much cheaper for employers to finance, which is why Lord Hutton, and now the NAPF, have come out in favour of them.

At the moment, the only significant career average scheme in the public sector is the one that has been open since 2007 for new recruits in the civil service.

The universities' scheme - not part of the Hutton review - is currently considering making a similar change for new staff.

Lord Hutton will publish his final report in time for the 2011 Budget and has received 137 submissions.

In October, he acknowledged that the future cost of paying for the public sector schemes - all of which are paid out of taxation, apart from the local government scheme - had already been cut by as much as 25%.

Among the typical changes already in place have been the introduction of a higher pension ages for new recruits.

The government is also about to enforce a lower level of inflation-proofing for all public schemes by moving from the use of the retail prices index (RPI) to the slower rising consumer prices index (CPI).

I'm not going to debate the pros & cons of final salary versus career average pension schemes, but it's obvious that policymakers in Britain are looking to make cuts to pensions and this, along with the switch to CPI, are all part of the measures they're introducing now.

The US is also taking note as many states are struggling to cope with their own ballooning pension costs. CBS's 60 Minutes had a segment on the municipal bond market this past Sunday which took a close look at the financial mess plaguing many states (see videos below or click here).

Will a collapse in the municipal bond market be the next major hurdle? Who knows? But I can guarantee you the Fed and the US government will do whatever it takes to avoid any collapse of the municipal bond market. In the meantime, pension reforms will continue around the world, and many policymakers will be looking at Britain to see how their reforms are working out and whether they can bolster their pension system now that the day of reckoning has arrived.

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