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The Actuary The magazine of the Institute & Faculty of Actuaries

Career average pensions could benefit lower paid public sector workers

Calculations from the Actuarial Profession have shown that a career average pension could benefit lower paid public sector workers.

The figures have been announced to coincide with the publication of Lord Hutton’s Independent Public Sector Pensions Commission report, which recommends a move from final salary schemes to career average schemes for the public sector, and should provide some comfort to lower paid public sector workers.

Career Average Revalued Earnings (CARE) schemes give members pensions based on a percentage of their salary earned in each year of their working life. The pension is adjusted each year in order to maintain value. In the public sector, adjustments are generally in line with either a prices index or an earnings index.

Figures published today by the Profession demonstrate that using average earnings increases in pension adjustments will result in a more generous pension for public sector workers on lower wages than the current final salary pension design. The difference is illustrated by the following two examples of public sector workers starting a career aged 30 and finishing aged 68 and earning a pension each year at a rate of 1/60th of salary:

>> A lower paid worker, starting on a salary of £15,000 and with a future earnings growth of 1% above CPI each year would have a CARE pensions, adjusted with the national earnings average some 21% bigger than a final salary pension.

>> For a higher paid worker, starting on a salary of £30,000 and with a future earnings growth of 3% above CPI each year, a national average earnings adjusted CARE pension would be 17% smaller than a final salary pension.

President of the Institute and Faculty of Actuaries, Ronnie Bowie, said: "Lord Hutton’s recommendations provide a coherent framework for the future of public sector pensions. Within the schemes the move from final salary to CARE and his recommendation to revalue each year’s benefits in line with national earnings is likely to favour the lower paid over the higher paid. However there is much still to be decided; in particular the rate of accrual and the mechanism for keeping the cost to taxpayers within an agreed cost envelope.

"The key unknown factor which affects how much an individual will earn from a pension is the rate at which pensions build up. Our figures are based on the current typical build up rate of 1/60th of salary each year but Lord Hutton has left it to the Chancellor, through consultation, to determine what the level of build up should be. Nevertheless, our figures demonstrate the significant and positive effect a change to CARE pensions may bring to those whose pay rises more slowly than national average earnings.

"Lord Hutton has provided a coherent framework. The challenge is now for the Government to fill in the missing pieces. There remain significant design and implementation risks to be overcome before we can be confident that what is eventually put in place is similarly coherent and sustainable"

Indicative figures:

Lower earner (starting on £15,000 pa)
Final Salary pension - £13,879 pa
CARE using average earnings index - £16,860 pa (21% increase)

Higher earner (Starting on £30,000 pa)
Final Salary pension - £58,908 pa
CARE using average earnings index - £49,129 (17% reduction)