Closing the Personnel Gap; Robin Hood and Sacred Cows

Editor’s note: This long read proposes a radical change to the current terms and conditions of service for all serving personnel; namely giving OR2s a 20% pay rise and scrapping the pension (and replacing with milestone payments).  To support this article, the author has created a spreadsheet of evidence that will be explained at the end of the article. However, the article stands as a long read without trawling through sheets of data. Agree with the author or not, it’s worth committing 30 minutes to read this article in full.

The Prime Minister is concerned about personnel levels in the Armed Forces. Such concerns are well founded. In April 2018, the Armed Forces had a personnel deficit of 8800, or 6% of requirement. As it stands today, 1 in 17 posts are unoccupied. On its current trend this deficit increases significantly over the next decade.  This deficit is acutely felt across the other ranks (below OR7). This should be a source of concern for the nation. The magnitude of this personnel gap places our national security at risk.

A bold proposal

This article makes two core arguments to remedy the personnel gap.  Firstly, that OR2s should be given a 20% pay rise. To pay for this, the Defence Minister should use Robin Hood as inspiration, don its tights and take from the rich, (defined as older, more senior personnel) to give to the poor (junior ranks). Secondly, the MOD should slaughter one of its sacred cows; the Armed Forces Pension scheme. For the modern workforce, the pension is simply not fit for purpose. Nor is it affordable for the nation in the log term. The proposals in this article can be achieved with no new money and are cost neutral.

This long read makes four key points; 

Firstly, I examine the background of the current pay model to show that the modern workforce has different expectations to those that the current pay and pension model is built upon.  It then looks at the wider Defence context and outlines why the current system will eventually lead to further personnel cuts.

Secondly, it looks at the current pay and conditions package. It argues that the current system unfairly advantages the older and more senior cohorts at the expense of junior ranks.  Non-cash allowances, such a service families accommodation, are highlighted as the reason behind this.

Thirdly, I lay out this proposal; to simultaneously raise the pay of OR2s 20% and to scrap the military pension. The pension would be replaced with a series of cash benefits paid at timed intervals. that are affordable in the long term and more suited to how “generation z” approach the world of work.

Fourthly, I show why the pension is un-affordable and is a strategic risk.

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Background: A Sense of Belonging?

When examining the modern workforce the consultancy McKinsey made two observations relevant to the personnel gap. The first is that ‘for people with satisfactory salaries, some non-financial motivators are more effective than extra cash’. Non-cash benefits are, therefore, effective retention tools for those that are satisfied with their pay. Yet, those in the lower pay scale value cash in hand.  This is important because the most recent Armed Forces Continuous Attitude Survey (AFCAS) said that only about a quarter of ORs felt their pay was sufficient. Therefore, a pay rise is likely to be an effective retention tool for ORs.

It is easy to see why juniors are dissatisfied when comparing other jobs. A newly qualified OR2 earns £18,489 (2017-18)[1] a year or about £1,270 less than an Amazon warehouse worker does. Yet, an Amazon worker lives in a town of their choice, works 40 hours a week and receives overtime pay. None of which can be said for service personnel.  Even with the x-factor, a bonus to compensate for the restrictions of service life, military personnel are paid less than civilian counter parts. The AFCAS conclusions show clearly that the current base pay package is not considered sufficient compensation for the impact of service life.

Public sector comparrison

A 20% increase would give a newly trained service person the same pay as another public sector worker; a newly qualified Nurse (2017-2018).¹ The Nurse enjoys the same advantages as the Amazon worker and their skills are much more portable than, say, an Infantry soldier. They do however need a degree which comes with it a significant financial outlay that ORs do not need.

The second point the report makes is that the modern work force look for ‘meaningful work, and a sense of purpose’. This point was recently driven home. In an open letter from a Millennial to the First Sea Lord the sailor who was ‘born in Carlisle, but made in the Royal Navy’ went on ‘to work sentry on the gate for…a year’. After the highs of passing out parades the routine nature of service life does not always translate into “meaningful” sense of purpose.   With neither the non-financial reward of a challenging purposeful career, nor the pay that their friends earn at home, a significant number of service personnel are choosing to leave.

“I’m afraid there is no money”

The problem with suggesting this significant pay increase revolves, of course, around money. In 2018, the Public Accounts Committee assess that the MOD faced an equipment funding gap at £7Bn. They also noted its potential to rise to £14.8Bn. Any money that the MOD finds, therefore, will almost certainly go towards filling this.

Personnel costs already consume 37% of the Defence budget.² It is clear, then, that no new money is forthcoming for a pay rise. The MOD must, therefore, look at redistributing its current resources if it wishes to pay personnel more.

Institutional bias against pay rises?

One of the issues with suggesting a pay rise is an embedded bias against it.  Civil servants are the decision makers when it comes to money but their perspectives are founded on their day-to-day interactions with service personnel. They mainly encounter senior Officers many of whom are living in subsidised housing and with children in boarding school.  They rarely encounter or understand the nature of the average OR2. These Civil Servants then compare the remuneration packages of others in the civil sector, which is nowhere near as generous as the Officers they are working alongside. They then draw their own conclusions forming a bias against a pay rise. Civil servants struggle to see why Armed Forces personnel need more money against this backdrop. They inwardly ask themselves ‘can’t they reallocate what they already have?’

The unseen link between pay increases, personnel numbers, and decreasing moral

The decoupling of the size of pay increases for the Forces and the size of the Defence budget has created a growing personnel problem. If pay increases are granted at a higher percentage than any increase to the Defence budget then personnel will consume an increasing portion of the budget. Because of this, and coupled with other budgetary pressures such as the NATO commitment to spend 20% on equipment, the MOD has been forced to cut numbers. However, the MOD rarely cuts commitments in line with cuts. This increases the pressure on the remaining service community. 

The Armed Forces Pay Review Body (AFPRB) uses the Consumer Price Inflation (CPI) as a factor when considering wage growth as it reflects changes in the real cost of living. In the 5 years prior to public sector wage austerity (2006-2011), when indexed, the AFPRB recommendations and CPI increased in lockstep. Pay rose with inflation. The average Armed Forces wage inflation since 2011, however, has been 1.4%. The 2018 pay recommendation of 2.9% was in line with the pre-austerity average of about 2.8%.

The impact of austerity

A 2018 cabinet briefing paper stated that ‘the UK achieved the NATO 2% [of GDP] target in each of the last 8 years’. Although not explicit, the implication is that 2% is the minimum the country can get away without losing face. Over 2016-2018 growth was significantly below 2.8%. If Defence spending follows its historical trend of being based broadly on GDP, and wage increases continue above GDP growth, then personnel will consume a bigger slice of spending. These increased personnel costs risk endangering Defence spending on other vital projects.

When the Defence budget looks as though it needs to grow above 2% efficiency savings will be sought. Historically, savings have been made by cutting equipment programmes, activity, or personnel numbers. In the current context, carrier strike and the nuclear deterrent are unlikely to go unfunded. Defence has been saving and ‘in 2017/18, the Army delivered £210 million of activity savings’.

On the record, these cuts have not effected effectiveness. Off the record, however, few agree. Many say cuts are now past the bone and into the marrow. Poorly funded training can seem to lack the purpose generation z desire. It is a significant factor in another problem: low morale.

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Problem: low morale

The Royal Marines complain that they don’t deploy enough. This is symptomatic of the younger generation looking up to Afghan and Iraq veterans and wanting their own meaningful purpose. They put themselves through months of arduous training on the Commando Course and feel that they’ve earned the right to a career where they get to take on bad guys. They want to do more than just complete another exercise on Dartmoor.

Paradoxically, morale is low due to over deployment in the Royal Navy. If the Millennial Sailor is to be believed, this may be symptomatic of poor manning practices leading to a manning death spiral. Under manning leads to increased deployments for those left leading to more personnel leaving. Another cut in numbers, without a matching or greater cut in commitment, will exacerbate this. Yet if the tone if the Defence Secretary’s February 2019 speech was anything to go by the ambition to deploy is increasing.

Pay increases linked to GDP not CPI would rightly be seen as unfair to service personnel. This doesn’t change the fact that in these circumstances personnel costs will consume more of the defence budget. By virtue of them having higher starting salaries, Officers and SNCOs account for a greater share of increases. This has been magnified as there has been an increase in the proportion of establishment of those above OR-2. It is compounded because they use non-cash benefits more, which still have associated costs.

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Subsidised seniority & non-cash benefits

The older you are, and the longer you have served, the more likely you are to use non-cash subsidies such as service families accommodation (SFA).  Non-cash benefits still come at a cost and are integral to MOD workforce planning. To take two specific non-cash benefits in which juniors subsidise seniors:

Service Families Accommodation (SFA). Officers and NCOs predominately occupy Service Families Accommodation. This is reasonable given that as people get older they marry and have a family. In contrast, junior ranks predominately occupy Single Living Accommodation (SLA). If measured by square metre I believe (although I cannot categorically prove) that an OR2 pays more in rent than is charged for SFA. Thus in some way, juniors are subsidising those who are generally senior to them.

Continuity Education Allowance (CEA) is a payment to assist with school costs to provide stability for children and allow service families to move as their career demands.  60% of those claiming continuity education allowance (CEA) are Officers even though they only make up 18% of all service personnel. Officers are required to move more often than ORs so it is reasonable that they make greater use of it. However, some Officers use the 2-year posting cycle to remain mobile which allows them to fund the educational aspirations for their children. This aspiration is usually based on their personal history. Government figures show that 43% of those who entered the Royal Military Academy Sandhurst in training year 2016/17 attended a fee-paying school whereas the percentage of wider society is around 7%.

Loss aversion theory

Making changes to these subsidies is difficult for psychological, financial, and operational reasons. In his book Thinking Fast and Slow, the economist Daniel Kahneman explains loss aversion theory.  Kahneman argues that people feel losses about twice as much as they value gains. SFA and CEA have a value purely beyond a monetary subsidy, with ‘the patch’ providing a support network when personnel are deployed. Should SFA or CEA be withdrawn it is likely that  significant numbers of experienced, competent, and expensively trained Officers and Senior NCOs would leave the service. This is because they would not be able to stomach either the financial pain or the huge change in relationship between them and the Forces. These loses would in turn make day-to-day operations more risky with fewer properly qualified individuals able to carry out essential tasks.

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Rank inflation and its effects on pay and retention

There has also been significant growth in middle management across the Armed Forces. This is an important factor driving modern increases to personnel costs. If the rank structure was adjusted back to its 1975 proportions, then the annual wage bill would have been £225M less in 2017/18 alone. For comparison, this would equate to 90% of the cost of a Type 31e Frigate.

In 1975, for every three OF3s there were roughly two OF2. In contrast, in 2018 the number was not far off one to one. Similarly, 1.9% of OR establishment in 1975 was OR8. In 2018 this had increased to 3.4%. Conversely, the OR2 establishment reduced from 49% to 39%. Rank inflation might be justified as the Forces have moved from generalist to specialist roles. However, it has come at a significant cost and at  the expense of the quantity of junior ranks.

A recent study by the consultancy EY found that not being able to advance through an organisation is one of the key reasons for Millennials to move jobs. Rank inflation may have opened more opportunities to promote, initially at least, but it has led to the rank pyramid getting badly out of shape.

This causes the system to clog up at certain ranks, OF2 to OF4 for example. Open-ended Officer contracts mean that some stay for the non-financial benefits. In ‘keeping the knowledge workers’ Chris pointed out that this combination of unlimited chances at promotion and likelihood of promotion increasing with tenure is a dangerous mix. SFA and CEA combine with this causing, expensive, long in the tooth, service personnel to remain until they promote.

Assumptions

Before I outline my proposal, I will first set out the assumptions that I have made.  I have assumed that there is little will and no new money to increase spending on personnel. Any proposals must, therefore, be zero sum. Two potential options for funding I considered are: slow wage inflation for those above OR2 for 5 years or change the rank structure to something closer to historic levels with changes taking place over 5 years.  

As a baseline to compare against, I (conservatively) assumed enduring wage inflation of 2% for all service personnel. 2% is the Bank of England’s inflation target, it is close to average annual GDP growth for the past five years. It sits broadly between the previously mentioned wage inflation figures of 1.4% and 2.8%. The 20% pay increase will be offered to OR2 who join after a defined date in the future. This would be accompanied by significant changes to their pension.

Neither option offered a cost neutral solution with the additional money needed ranging from about £150-£600 Million over 5 years. However, if a combination of the two methods was used (1998-2018 average rank structure) this would result in a modest saving (£49 Million). This achieves the aim of increasing new OR2 wages significantly whilst still allowing for small pay increases for the remainder of the Armed Forces, not to mention continued yearly increments.

Pensions; a excuse for poor pay…

When a member of the armed forces reaches their retirement age, they receive one of the most generous pensions schemes available in the UK. This fairly reflects the[ir] unique sacrifice.

UK Government

The Armed Forces Pension Scheme (AFPS) pension is used as an excuse to pay service personnel poorly. It relies on the promise of ‘jam tomorrow’ to compel long service. In turn, long service is often (wrongly) conflated with organisational loyalty. Those having served a full career (20 years plus) get a disproportionate amount of the benefit. Their sacrifice isn’t any more or less unique than someone who has served less time. If someone served for 20 years and left as an OR8 they would receive an £11,000 early departure payments and nothing in pension between leaving and 55. If they served for another 2 years they would receive around £185,000 in cash including a monthly pension starting from the day that they left. This is inherently unfair.

…and the need for reform

The pension began in an era when service might cause someone such physical damage that they would not being able to work again. In 1590, ‘the Chatham Chest was established to provide pensions to wounded seamen of the Royal Navy… pensions were payable on a fixed scale according to the degree of injury’. There have been three significant changes between now and then. Firstly, fewer people leave the service physically (ignoring the mental) unable to work again. Those that do receive a medical pension. Secondly, fewer jobs are labour intensive, meaning there are options post service that do not rely solely on physical well being. Thirdly, we have social security and the NHS that did not exist at the inception of a service pension.

I propose replacing pensions with redundancy style tax-free milestone payment for every full five year block of service completed. If an OR2 served for 5 years after their training, they would receive an additional £26,570. Broken down this would equate to just under £20,000 in additional wages (£4,000 per year) and a £6,600 tax-free milestone payment. These payments would be available for both OFs and ORs and based on their salary. Milestones would cost an additional £192 Million from years 6-10. Savings made in reductions to pay for those over OR2 would offset this making it broadly cost neutral (£13M saving).

Strategic risk: the pension sacred cow  

The Armed Forces non-contributory pension scheme is an unfunded liability. It is ‘paid out of current income’. If pension spending were added to the Defence budget (£1.5Bn), the budget would rise to £38.1Bn, or 2.05% of GDP. If this were spent on equipment instead of pensions, the funding gap would not exist. A recent report by McKinsey stated that Belgium spends a third of their Defence budget on military pensions. They count pensions towards their 2% commitment If a government hostile to Defence wanted to spend less, but maintain the 2%, it could include pensions in its budget. There is already precedent for such ‘creative accounting’. In 2015, war pensions were added to the defence budget at a cost of £800M. Such a move would see less money in the pot for further magnifying the existing problem.

General James Mattis, recently agreed that ‘the greatest threat to [US] national security is our own federal debt’. This is equally true for the UK. The Armed Forces are responsible for national security and this includes its contribution to economic security. The Harvard Business School Professor Cynthia Montgomery tells us that ‘strategy is about choice…both positive (“We do this”) and negative (“We don’t do something else”)’. If Britain does not want to become, ‘Belgium with Nukes’ then the MOD needs to make some difficult strategic choices around money.

The most recent unfunded future pension liability is £196 Billion. This has increased by nearly 95% since 2011 against a backdrop of unpopular reforms designed to make the scheme more affordable. The unfortunate truth, that is few dare to acknowledge, is that pensions are un-affordable. The continuing growth of the pensions black hole is reducing economic security. Now is the right time to acknowledge this and slaughter the pension sacred cow humanely for all new joiners.

Blue Murder and Millennials

Many will scream blue murder at the suggestion of losing the pension. They will say it will affect recruitment, retention and morale. Yet, the available evidence simply doesn’t support this argument. The military pension is not a significant factor for generation z. I didn’t see any ‘Join the Forces, get a pension in two decades’ tag lines in the latest recruiting ads. A 150 page report by Gallup entitled ‘How Millennials want to work and live’ didn’t use the word pension once. The current generation are more likely to switch jobs than generations before them. The MOD must work harder to retain personnel for long periods.

It stands to reason that generation z would rather have ‘jam today’. ‘Jam tomorrow’ is causing some to leave early as a pension is so far away as to be intangible. Moreover, the longer one serves the greater the risk of becoming a pension prisoner. Milestone payments offer a significant improvement on all the themes.

In order to make a career in the Armed Forces attractive to new entrants the MOD must improve the pay of its junior ranks. A 20% increase will give OR2s significantly more cash in their pocket and make a military career more attractive. Reducing the size and speed of the gains those above them in the hierarchy get would be a strategic decision.  It would provide a cost neutral way off funding the proposed pay increase. Although people feel losses more than gains, someone cannot feel a loss of something they never had. Because of the yearly increment system, most will still receive a meaningful pay increase every year even with these changes.  This must be done in conjunction with changes to the rank structure. It would begin to look more like a hierarchical pyramid again.

More flexible and cheaper

With an unfunded pension liability at over five times the Defence Budget, and growing at a rapid pace, it is clear that the military pension is un-affordable within current resources. It is disproportionately generous to full career service personnel and will be less of a draw to generation z. A generation which changes careers more frequently than previous generations.  Whilst new joiners will get a significant pay increase, they will no longer get a pension after 20 years’ service. Instead, milestone payments will give them a decent sum with which to retrain when they leave the Forces. This gives individuals more flexibility and is cheaper for the nation.

The MOD needs to be realistic about spending, in the context of persistent slow growth, emerging threats and demographic changes. Paying new recruits more upfront and giving them a decent sum for retraining, instead of a small pension decades later, will be more attractive to the current work force. Even if  this would represent a seismic change to the current terms and conditions of service. This approach would be a genuine strategic choice to support the new workforce in-line with modern trends. It would choose what the nation can and importantly cannot afford to do. 

Authors explanatory notes; the spreadsheets

I began writing this article in autumn of 2018. All the figures that it is based on were gather from open sources between September 2018 and January 2019. All figures are based on establishment and not on personnel numbers.

I chose to use pay and not capitation rates for two reasons. Firstly, because capitation means nothing to a newly trained 18 year old. They care about the amount of money in their pocket, not what someone far away in a building in Whitehall calculated that they cost to the taxpayer overall. Secondly, there is no consistent, historical data across time on capitation rates. There there is consistent data for rates of pay. 

This article is accompanied by two excel files. One is locked. The user will be able to adjust cells in blue and input their own assumptions around wage inflation, milestone payments, etc. The unlocked version allows those that want to see and critique the logic of my calculations the opportunity to do so. Users can adjust my assumptions and make their own changes if they see fit to do so. I accept that there may well be some errors within the Excel sheets. It is almost 1 megabyte and I made it alone. It may well be that I missed something although hopefully nothing too significant as to drastically affect headline numbers. Please let me know if there are and I will gladly accept recommendations.

LOCKED Spreadsheet.

UNLOCKED Spreadsheet.

The cover photo is the Gladstone Budget box. Used under licence from HM Treasury.

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1. All figures in this article relate to establishment, not strength, MSI or where stated different pay grades. Figures and calculations are based on Year 2017/18 data as this was the data that was available at the time of writing for both service personnel and nurses
2. UK Defence Expenditure Briefing Paper Number CBP 8175 8 November 2018