As inflammatory headlines goes, this takes some beating.
If the UK pensions minister has lost confidence in the sustainability of providing pensions to 6.6m public sector employees (including himself) then we may have more change on the horizon than ever we thought.
Let’s be clear about what Imogen Tew of the Sunday Times , reported.
And then there is the gnarly issue of public sector pensions. There are 6.6 million public sector workers (including MPs) who have defined benefit pensions that pay a guaranteed income for life. The taxpayer liability for these schemes is about £2.4 trillion.
Only 900,000 private sector workers have the same type of pension and only 600,000 are in schemes open to new members. They have been largely killed off because the guarantees proved too expensive for businesses and so workers were moved in to less generous defined contribution schemes, where returns and pension income is not guaranteed.
Opperman said that public sector pensions “should be reformed, and a government in the future has to address that. It is not sustainable for this state, or any state, on a long-term basis. It’s a practical reality. I don’t believe it is the case that in 10 to 20 years’ time we’re all going to be in defined benefit schemes.
“It applies as much to the civil service and to members of parliament or anybody. We are going to move to a different type of pension scheme, and the public sector is the last bit.” (my bold)
So what does the Minister have in mind as a “different type of pension”. I have sat in a room with him and hear him use that very phrase of “CDC”, is that too speculative?
There are swathes of the Canadian state pension system that has moved from defined benefit to the less certain but much more affordable benefit of CDC. If there is any sense to the vase weight of legislation that has been thrown behind the Royal Mail’s CDC project, it is that scheme based CDC is repeatable.
But moving a funded pension like LGPS or the MP’s scheme to CDC is one thing, moving unfunded pension schemes onto a DC and conditional pay-out basis is quite another. There is no way that UK plc is going to find a fund for the bulk of that £6.6 trillion of liabilities and it takes a stretch to imagine how linking pensions to some measure of economic performance could work.
In the less ambitious approach where a CDC fund was established for future accrual (with the remainder of the liabilities guaranteed by the tax-payer), there is still an enormous strain on the exchequer and an issue of capacity. The largest pension scheme in the world (Calpers) still only caters for public servants in one US state. Calpersers serves 2m members, moving UK’s public sector to any alternative to an unfunded basis would triple that number.
But to say this to the Sunday Times – albeit with timeframes that exceed any hope of his ministerial tenure (not on Guy’s watch), suggests that somewhere in Government there is some thinking on this. Is that unthinkable?
Can we have some evidence in support of this claim?
There is no reason to do this calculation. What does it tell us? It certainly does not represent any actual payment that has to be made in the real world. It is nothing more than a thought experiment: it collapses all pensions to be paid in the future into a single sum – a discounted present value as of today (making what assumptions about discount rates etc and with an implicit notion that it has to be paid NOW.) That is a stupid idea. What about the rest of time? Where did that go? What happens in the future? What happened to the future?
This kind of reasoning is dangerous because it is pseudo scientific, seductive and persuades people to do bad things. It is a major problem with neoclassical economics which treats time this way.
DB pensions have become a pariah because “business UK” is ONLY interested in shareholder and executive renumeration. Caring about the workforces that actually creates the wealth for the shareholders and senior executives has sadly long since been abandoned. But what has this to do with government schemes? In the end this schemes are “funded” by the rich, and others, through taxation and the last thing executives and shareholders want is to see their income eroded by the taxation needed to pay for the pensions of mere workers. I’m sure the Pensions Minister has been listening to these rich people. I’m equally sure he has never even thought of talking to those who will be affected by any of the (misguided) changes the government are minded to introduce! If Pensions Ministers did actually talk to the people worse affected by pensions changes, neither DC nor “Pensions Freedoms” would ever have seen the light of day!
Unfunded public sector pensions for millions of deserving NHS staff, teachers, police officers, firefighters, civil servants and the armed forces are calculated by assuming our economy grows at CPI+3.5%-2.4% per annum. We haven’t achieved that growth in the last decade and the next decade looks even more challenging. A 1% shortfall in GDP is equivalent to a private sector deficit recovery contribution of 2p on income tax. These promises are simply unsustainable – guaranteed future austerity.
Surely DB pensions are defined with respect to actual salaries?
I think Alan is referring to how funding cost estimates are made. However, the actual benefits depend upon pay levels, not upon assumptions. To stret ch Dennis’s point further, the discount rate was created as the inverse of the investment return; they form a pair. Jut using an artificially built discount rate on its own tells us less than nothing; its value is negative.
Funding assumptions are necessary for inter-generational fairness and the assumed GDP growth in the discount rate is no different to an assumed life expectancy. Ignore either at your peril.
Only looking at cash flow, whether salary or CPI linked, risks a comparison with short term assessments of pyramid selling and ponzi schemes. Unattained assumptions simply transfer liabilities to future generations of tax payers. Accrued liabilities of £2tn+ won’t disappear with cessation of, or changes to, accrual.
Saying there are accrued liabilities of £2tn+ serves no practical purpose. You are quoting it (a) to demonstrate how clever you are in knowing the mathematical formula for discounting which (theoretically) collapses an infinity of future payments into a single number, and (b) to grab a sensational headline. The £2tn+ will never need to be paid.
This kind of calculation is just a thought exercise using clever clever mathematics. But context is all. By ignoring the whole of future life except for the pension payments you are making the analysis irrelevant. It says in effect that this is what will be needed to pay the public sector pensions if the government suddenly stops functioning (or something like it). Why would you do that?
If you must do the calculation it is necessary to put it in context and provide the comparable discounted present value for government revenue and GDP.
What has ponzi got to do with this?
You seem to be thinking there are more assumptions here than there are. There is no assumption that Government will cease to exist, nor is there ignoring future life. It’s just a check on what funds are available to pay pensions that have already been “earned”.
And that check shows a balance sheet with an asset of £0 and a liability of £2.4 trillion.
The cash flow may be positive (contributions charged to employers and members may exceed pensions paid out). But as liabilities continue to grow that can only continue by increasing contributions, which means increasing our population or increasing tax rates or both. Hence the Ponzi scheme analogy , it only works if the membership of the scheme (ie the numbers of taxpayers) continues to grow.
Assets £0? That makes no sense.
You need to use the same method as you did to get the liabilities. DCF. But you know that.
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