Are Public Sector Pensions Better?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

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.

Comments

[Anonymous]

Public sector pensions are dangerous because the employees usually have enough political power to buy (on the cheap) politicians who will vote to increase pensions. That feedback loop is one of the main reasons Calif is in such a fiscal bind.

I taught part time at a state university a few years back. I got a small contribution to a pension fund for state employees. To my astonishment, I get 15% guaranteed return every year compounded. I've just a little pension. But can you think of a single state government that has the ability to pay pensions indefinately, given a compounded 15% rate of return.

In other words, the politicians made a better deal than I originally thought. They got campaign contributions in return for a fake payment plan. It will eventually crash when someone else is in office and those later politicians will get blamed, not the perps.

[Anonymous]

We just had a similar analysis done in Canada and the DB pension of the average public sector employee was 5X the total value of a pension in the private sector.

$1,250,000 if you suckle .gov's teat and only
$250,000 if you don't.

But any lucid ZHer knows these future obligations are never going to get paid out.