3.1 Introduction

3.1.1 This Chapter contains a brief overview of the financing and administrative arrangements applying to public service pension schemes. It gives some initial consideration to the question of the most appropriate mechanism for meeting public service pensions costs - pay-as-you-go, funding, or some alternative - and comments on the transparency of pension costs and liabilities within government accounting systems. It identifies also a number of other administrative and operational matters which the Commission intends to examine further in its final report.

3.2 Financing of Public Service Pensions

3.2.1 Traditionally, public service occupational pensions have been financed on a pay-as-you-go basis as part of the public service pay bill, with the costs met each year from current revenue and employee contributions. Thus the liabilities of the scheme are secured by the Government and by its ability to tax. In contrast, private sector companies and commercial state sponsored bodies operate a pre-funding system, setting aside funds and investing them to meet future liabilities as and when they arise. As part of its report, the Commission will consider whether the financing of public service pension schemes should move from pay-as-you-go to advance funding or to some alternative financing mechanism.

3.2.2 Arguments in favour of a pay-as-you-go system include the following:

* the primary objective of funding in the private sector - to provide a secure basis for the pensions of employees - is adequately met in the public service by the State's permanent and continuing commitment to discharge its obligations as they arise

* pay-as-you-go is easy to operate and the administrative costs are low

* it is in keeping with the Government's budgetary system generally

* pay-as-you-go facilitates transferability of service within the public service (in most cases, no transfer payments need be made when a public servant moves from one public service scheme to another).

3.2.3 Arguments made in favour of funding include:

* pay-as-you-go does not make advance provision for future liabilities

* there is a lack of transparency about the real costs of pensions under a pay-as-you-go system; thus, increases in the number of personnel covered and/or improvements in pension terms have only a minor impact on costs in the short term but could result in a disproportionate increase in medium- to long-term expenditure; this long-term effect is not immediately apparent to the parties concerned

* contribution rates for a pension fund would bring home to members of schemes the value of their pension entitlement and to employers the real cost of recruitment

* funding would give a more stable profile of costs over time compared with pay-as-you-go.

3.2.4 It is also argued that the accumulation of funds facilitates capital formation, which is necessary for the economic growth needed to meet future liabilities, although this point is subject to some dispute among economists.

3.2.5 The amount required to fund the cost of public service pensions would be very substantial. It has been estimated that a fund of the order of £15 billion would be needed to match public service pension liabilities accrued to date, with an annual contribution of around £700 million to pay for future service (a more complete picture of the accrued cost of public service pension schemes will be provided in the Commission's actuarial review - see section 4.3 below). In practice, the establishment of a fund would require "double" contributions from the Exchequer from the outset - for example, on a pay-as-you-go basis in relation to the current generation of pensioners and on a funded basis towards the cost of future pensioners. The additional resources which would be required to finance this would have to be raised through either additional taxation (which would have adverse competitiveness implications and would conflict with tax reduction priorities) or increased borrowings (a course of action possibly constrained by EMU considerations). A further issue arises as to whether it would be appropriate for the Government to raise revenues to provide for prospective liabilities rather than to meet its current needs.

3.2.6 Rather than establish a fund capable of meeting all past pension liabilities, an alternative would be a partial or reserve fund, to which, perhaps, pension contributions made by public servants could be lodged. It will be seen in Chapter 4 (paragraph 4.2.2) that annual contribution income from members of pension schemes is approximately £178 million, excluding notional contributions. In addition, main pension schemes which were previously non-contributory or had a low rate of contribution - primarily, schemes for the civil service, the Garda Síochána, and Army officers - are now contributory for new entrants (post-April 1995) at the standard 5% contribution rate, integrated as appropriate with State Social Insurance benefits. A fund established with member contributions could be used to supplement the pay-as-you-go system and maintain pensions expenditure at a reasonably stable level when the major increase in costs occurs in the first quarter of the next century. The Department of the Environment have referred to a possible limited funding option for the Local Government Superannuation Scheme. There may also be other possibilities to be examined, such as funding for certain aspects of a pension scheme, even if the main terms of the scheme are dealt with on a pay as you go basis.

3.2.7 Even a partial fund would impose significant "double" costs. Ultimately, as discussed at paragraph 3.2.5 above, the extra cost involved would have to be met from taxation or borrowing.

3.2.8 If a public service pensions fund (whether a full or partial fund) were to be established, questions would arise as to the management and control of the fund, and the assets it would hold. If the fund were managed in the same way as a fund in the private sector, its investment strategy would be to maximise returns and diversify the spread of risk to its assets. This would likely result in large investments being made abroad, which would raise public policy issues. On the other hand, if the Government was enabled to place specific requirements on the fund, for example, requiring investment to assist economic development, the financial returns to the fund would probably be lower than would otherwise be the case. Employees might also have concerns about the Government continuing its payments to the fund during periods of serious financial difficulties.

3.2.9 If formal funding is not introduced, it is considered that there is need to put in place a system which can clearly and quickly identify existing pension liabilities and the impact on those liabilities of increases in numbers or improvements in terms. The need for regular actuarial reviews of public service pensions is discussed in Chapter 4. The usefulness of such reviews could be enhanced through the introduction of an accrual-based approach to pension costs within government financial management and accounting systems. Such an approach has been adopted on a pilot basis by the Department of Transport, Energy and Communications. A notional cost was included among staff costs in the Department's financial statements for 1995. This figure represented the additional annual contribution calculated as being required to fund the pension costs for the future service of serving staff. A note indicating the unfunded pension liability in relation to serving staff was appended to the financial statements. The idea of a notional fund in respect of public service pensions financed on a pay-as-you-go basis has been implemented in the UK. Whatever approach is considered, it is important to ensure that there are mechanisms in place to identify pension costs, both immediate and emerging.

3.2.10 As noted at paragraph 6.5.5 below, the Strategic Management Initiative has as one of its objectives the development of better financial systems and the adoption of a more developed approach to expenditure management generally. The Commission considers that ensuring greater transparency in pension liabilities would contribute towards meeting this objective.

3.2.11 The Commission will consider further in its final report the arguments for and against pension funding or alternative mechanisms for meeting public service pensions costs. While it is clear from the above that funding would raise significant practical and budgetary issues, the Commission considers it an important issue to be examined in more depth. The experience of other countries may be useful in this regard. Apart from the question of funding, the Commission will look into other methods that might be used to make public service pension costs and liabilities more transparent.

3.3 Policy and Operational Responsibility for Public Service Pensions

3.3.1 The Minister for Finance has statutory control, either personally, or in association with another Minister, of virtually all public service pension schemes.

3.3.2 Policy on public service pensions comes within the Department's overall policy on incomes development, and its contribution to competitiveness. At a general level, this involves advising on, negotiating (both centrally and at sectoral level) and overseeing the implementation of policies on the evolution of public service pay, pensions, and conditions of employment which balance the needs of the economy and the community, with particular reference to the employment/unemployment situation, the needs of the Exchequer, the interests of employing organisations and staff, and the need to raise levels of efficiency and effectiveness.

3.3.3 More specifically, the principal pensions policy objective is to advise on, negotiate and oversee the implementation of policies on pension matters across the public sector, so as to ensure that:

* insofar as the civil service is concerned, the pensions code addresses current and emerging pension requirements in a framework which balances the competing needs/requirements/interests set out above;

* the pensions arrangements in the public service are consistent, to the greatest extent possible, with the civil service model and that pensions developments in the wider public sector also accord with the relevant requirements as set out above.

3.3.4 Operational responsibility for the pension schemes of each of the major groups of public servants is set out in Table 3.1. Apart from the civil service, the pension schemes for all public servants are subject to the approval of the appropriate Minister, with the consent of the Minister for Finance.

Table 3.1 Operational Responsibility for Public Service Pension Schemes

3.3.5 Non-commercial state sponsored bodies and universities operate their own pension schemes. In most cases, the terms of these schemes are subject to the approval of the parent Minister, usually with the consent of the Minister for Finance.

3.4 Administrative and Operational Issues for further consideration

3.4.1 In addition to the mechanism for financing pensions and the question of transparency in pension scheme costs, the Commission has identified a number of issues for further consideration. These include:

* tracking of pensionable service for individual public servants who have worked in a number of different public sector employments. This appears to be an ongoing problem. Often, it would seem that details of total pensionable service become available only when the public servant retires.

* arrangements to improve the provision of general pension scheme information as well as the provision to individuals of information on their pension entitlements and any outstanding contribution liabilities.

* the continuing need to ensure that pension schemes are as simple and easy to understand as possible, and are fair and transparent in their operation.

* the most appropriate system for resolving difficulties concerning pension entitlements.

* the existence of separate pension schemes for each area of the public service and each public service body. Delays and administrative difficulties may arise in respect of changes made to the civil service pension scheme which are to be passed to other public service schemes. The existence of a single scheme for all, or certain blocks of, the public service might resolve these difficulties. It might also resolve the problem of tracking pensionable service for individual public servants.

* mechanisms for considering the implications for public service pension schemes of issues arising at national or EU level, such as legislation in the area of pensions and relevant court judgements.

* provision of centralised data on public service pension records and costs.