John Lewis is ending its final salary scheme - the public sector should follow suit

John Lewis is a retail success story. While results have lately have been somewhat shaky (though still far from a Debenhams-esque situation), this is a company known for quality of product and service, and a concomitant brand loyalty.

But they’ve also acknowledged the need to change their offering to employees. Their pension liabilities are now almost £4.9 billion. Last week, they announced the end of the link to final salary with their staff pension scheme. All workers from next April will have access to a defined contribution scheme, with retirement income generated from returns on assets, rather than a fixed sum paid out (as a defined benefit scheme offers).

This transformation has been happening in the private sector for some time. A quarter of FTSE 100 companies only offer defined contribution schemes now, with many defined benefit schemes closed to new employees over the last 20 years.

Those who are retired, or will soon finish working, have also adapted to this. Pensioners now receive 67 per cent of their income from personal pensions. 25 years ago, it was 62 per cent. Similarly, the popularity of self-invested pension plans shows a growing awareness of the need to plan for a future after employment and without as much recourse to the state. Auto-enrolment has also precipitated a change in mindset.

But for those at the top of the public sector, such planning and restraint has not been witnessed. Earlier this year, the TaxPayers’ Alliance showed that the 22 individuals who run UK government departments have an average pension pot of over £900,000. On retirement, they can look forward to an annual income of £51,000. Sir Simon McDonald, the head of the Foreign Office is sitting on a pension pot of £1.9 million. Add this to fantastic job security and a clear promotion path, and the mandarins are sitting pretty.

Let us be honest: the senior civil servants in Whitehall have not covered themselves in glory in recent years. From the continual re-assessment of the final cost of HS2, to the MOD civil servants who shaft the taxpayer with wildly expensive kit, the failures of this supposedly ‘Rolls-Royce’ institution have been racking up for years. Such a title has now been shown as the conceit that it always was.

The 84 per cent us who aren’t employees of the state generally have funded pensions (a fund manager invests in equities, bonds and other assets), with public sector schemes invariably paid for from general taxation (unfunded schemes). The public sector pensions landscape today has some truly eye-watering figures. The ONS most recently estimated employees’ pension liabilities to be £917 billion (in 2015). In spite of the gradual raising of the state pension age in recent years, liabilities are now over £4 trillion. That’s twice the size of the UK economy.

Life expectancy is beginning to atrophy and mortality rates are increasing. But the government does, at last, seem to be acknowledging the wider problem at hand. Although almost all of the public sector is in an unfunded scheme, one notable exception is the local government pension scheme. Annual returns on assets have averaged 10.7 per cent over the last 5 years (though it remains in deficit).

For those schemes that are not funded, the level of contributions will be increasing. This was in part because of a more realistic assessment of the future payments that the government will need to make. The discount rate (which puts a number on today’s value of pension payments in the years ahead) has been gradually reduced in recent years for the main public sector pension schemes. Extra money for such schemes will need to be laid out in budgets set in the comprehensive spending review.

The government should go further, and several proposals could be readily implemented. First, all new public sector employees should join on the basis of a defined contribution scheme. This is a perfectly reasonable step, since defined benefit schemes are effectively unavailable in the private sector for new starters. These new defined contribution schemes should also be fully funded, thus reducing the burden on current and future taxpayers. Such a transition took place at Royal Mail after privatisation, for instance. Its schemes are currently in surplus.

Pensions should also be a more central feature in public sector pay negotiations, with the remit of pay review bodies changed to reflect that. This follows the recommendation of the Hutton Report in 2011.

The experience of John Lewis shows that the private sector is adapting to changing demographics. It’s time we saw such transformation in the state.