The private sector has effectively abandoned defined benefit (DB) pensions provision in the last 20 years. The public sector, however, at least in the UK and North America, still makes DB pension schemes available for employees. Is this disparity here to stay?
There is a long list of reasons why pension provision in the public and private sectors is managed differently. Friedman’s view on corporate purpose and the rise of shareholder primacy have, over the years, heavily influenced what the social responsibility of a business is deemed to be. Pension provision in the private sector has shifted to defined-contribution plans placing the investment risk of saving and investing for retirement on employees. And there appears to be a strengthening trend to opt out of pension arrangements by younger workers[1]. In the public sector the employment deal is different, with remuneration balanced more towards pension provision than pay. Increasingly, however, stretched government finances and economic uncertainty emphasize the importance of finding ways to make pension provision in the public sector affordable.
Traditionally, working for the public sector meant stable employment, work-life balance and generous, reliable retirement benefits. The public sector is competing for talent and the pension is an important part of their employee value proposition.
Public sector workers are much more likely to be enrolled in a workplace pension and more likely to be in a more generous, defined contribution scheme[2],[3]. There is also a higher degree of unionisation among public sector workers. Evidence suggests that union power can lead to increases in pension benefits, through centralised and coordinated action across the different bargaining levels and lobbying expertise[4],[5].
Some might argue that those who care for us and our loved ones, such as nurses and teachers, or those who face personal risk to keep us safe, such as firefighters and police, should be looked after by the public after they retire.
However, demographic changes and constant pressure from state budgets means public pension schemes must be kept affordable if they are to be sustainable in the long term. A few changes have already been implemented – from increasing member contribution rates[6] to changing the defined benefit schemes from final salary to career average earnings and linking pension age to State Pension age except for those in the ‘uniformed services’[7].
These steps were taken to address the legitimate concerns of taxpayers about the present and future cost of pension commitments in the public sector. The question now is, are these reforms enough or are they just a sign of things to come? Are these schemes able to deliver what they promise long into the future?
Factoring in the needs and preferences of the growing number of younger workers is also essential in making pensions and benefits packages as a whole attractive. The changes in the pension schemes that are implemented or being planned for the future affect these younger cohorts the most.
According to a national survey of workers in the US public sector conducted by The Pew Charitable Trusts, young people’s top priority is the ability to take savings with them when changing jobs and 60% of workers under 30 do not expect to work for their current (public sector) employer until retirement. The results suggest that younger workers choose government jobs more for the day-to-day advantages, such as stable employment and work-life balance, than for the retirement benefits[8].
The UK’s Institute for Fiscal Studies’ (IFS) report “Public spending, pay and pensions” highlights severe budgetary challenges for many areas of government and suggests there is a strong case for rebalancing public sector remuneration away from pensions and towards pay. This will “potentially improve the welfare of public sector workers, who might prefer higher pay today in return for a moderately less generous pension tomorrow, without increasing costs for public sector employers. It might also help prevent a fall in pension scheme membership.”[9]
For now, the public sector is continuing to provide defined benefit pensions to their employees, albeit that the terms and structure of them are under continuous scrutiny and review. The problems of DB pension provision can, simplistically, be attributed to decisions that were taken a long time ago that did not adequately appreciate the cost implications of those decisions.[10]
Macroeconomic uncertainty and a potential reduction in long-term growth would make it costlier to meet pension promises in the future[11]. With the Netherlands’ pension reform, now approved by the Dutch Senate, set to move both the public and private sectors away from DB to contribution-based hybrid-style pension provision, and several US states replacing traditional defined benefit plans with mandatory hybrid plans – is this the long-term future?
[1] Pensions Age “Research highlights prevalence of young people opting out of pension contributions”
[2] Institute of Fiscal Studies “Public spending, pay and pensions” 2022
[3] U.S. Bureau of Labour Statistics “Union workers more likely than nonunion workers to have retirement benefits in 2019”
[4] Ebbinghaus, Bernhard (2017) “The Role of Trade Unions in Pension Policymaking and Private Pension Governance in Europe”
[5] Centre for Retirement Research at Boston College, “Unions and public pension benefits”
[6] National Audit Office, HM Treasury “Public service pensions” 2021
[7] House of Commons, “Public Service Pensions – the 2015 reforms”
[8] Pew Charitable Trusts “Retirements needs and preferences of younger public workers” 2017
[9] Institute of Fiscal Studies “Public spending, pay and pensions” 2022
[10] National Bureau of Economic Research “Public sector retirement plans”
[11] IFS “A reduced discount rate for public sector pensions will add billions to employer costs” 2023