1) Public service pensions are the single largest liability on the government balance sheet – bigger than the national debt. (https://t.co/F8dsk2oIij)
2) The public sector employs more than 5 million people (most of whom have a pension).
It’s a big deal. pic.twitter.com/t0RLzseyOJ
— Ben Zaranko (@BenZaranko) April 6, 2023
We have got used to saying that if you are working in the private sector, you are unlikely to be accruing defined benefits. This should be modified to “you are unlikely to be accruing in your employer’s defined benefit scheme“. Most public service defined benefit schemes have sponsoring employers both from the public and private sectors. For instance, many teachers in private schools are in the public sector teacher’s scheme,
The anticipated cost of paying the pensions to members of these public sector schemes is determined by the Government and is huge.
The estimate of more that two trillion pounds of public sector pension liabilities is based on projections from the Office of Budget responsibility and the way of meeting those costs is decided by using a discount rate linked to likely Gross Domestic Product. This is known as the SCAPE rate ( Superannuation Contributions Adjusted for Past Experience).
The higher our likely GDP, the higher the discount rate , the lower the cost of servicing the liabilities and the lower the bills to employers.
Sadly, projections for GDP aren’t improving, they are worsening and this means that the cost to employers of participating in these public sector pension schemes is going up. But this cost will not be directly felt as the Government is promising to compensate public sector employers with a subsidy.
This subsidy will not extend to private sector schemes who are going to see pension costs increase (again). I last wrote about this in 2018 when the SCAPE rate fell to CPI +2.4%. This time it is falling to CPI+1.7%. This is just latest in a string of downgrades (from 3% in 2011, to 2.8% in 2016, to 2.4% in 2018, to 1.7% in the latest 2020 valuation) as the UK’s long-run growth prospects have become ever more dismal. But this downgrade is particularly large.
Public sector pensions are too big to be vulnerable to challenge by disgruntled employers, but private sector schemes who participate in public sector pensions have different dynamics. This blog looks at a potential way forward for these employers.
Impact on public sector services
Economists such as Ben Zaranko at the IFS expect the increased cost to employers of public sector pensions to eat into the supposed increases in budgets regularly announced in budgets. The Chancellor giveth in high level terms, but taketh back by demanding its money back to pay pensions (and from pensions paid).
So what seems like an increase in funding for public services can easily be wiped and even mean services have to be curtailed or closed. Despite this , it is unlikely that any Government is going to take on the public sector through further changes in pension promises at the moment.
Impact on private sector services.
As mentioned above, the impact of the lowering of the Scape discount rate, will be to increase pension costs to private sector schemes participating in public sector pensions. In the example of private schools , this means either putting up fees or cutting costs (for instance moving to a DC workplace pension).
Many will say that this no more than creating equality between private sector workers but that doesn’t count for much if your contract with your employer was partially based on you participating in a DB pension plan. Unsurprisingly, these fundamental changes in terms of employment do not go down well and can be more disruptive than directly passing on pension costs through the price of goods and services.
The case for a fundamentally different approach to either a guaranteed unfunded DB plan or a funded but limited DC plan is obvious.
Time for concerted action
There is here a clear need for a third way. This looks like an opportunity to establish a CDC scheme capable of providing an equivalent benefit to that given up when leaving a DB scheme – albeit without the guarantees.
CDC seeks to provide equivalent benefits to DB with a fixed cost to an employer and without guarantees to members.
It is not beyond the wit of the pensions industry to provide the infrastructure for such a scheme but it would be a huge risk to any private sector pension provider. Such a solution would need state aid, at the very least to meet the funding of the initial costs of authorization and establishment.
But since a very large part of the problem for the private sector is created by the TUPE transfer of staff out of public sector employment, it could be argued that these staff’s retirement welfare is still linked to work in the public sector (albeit for private contractors).
There is a prima facie case for Government, unions, advisers and employers to get round a big table and start talking about CDC.
The SCAPE rate can’t be a scapegoat for poor pensions – we need a third way.
The Government is currently considering broadening the capacity of CDC schemes to become “multi-employer” – effectively CDC master trusts.
There has not been much enthusiasm for the idea from employers with existing DC workplace pensions.
However, there may well be more enthusiasm from employers who have DB pensions – whose costs are about to sky-rocket.
Maybe the multi-employer CDC scheme has found its market.
The greatest weakness of collective schemes over the last 50 years has been the lack of meaningful communication with or responsibility accepted by the individual beneficiary.
It is people’s tendency to process information by looking for, or interpreting, information that is consistent with their existing beliefs.
That belief is that someone else is taking responsibility for the outcomes. In reality the consequences are found in the small pot results admit it the arithmetic has been there all the time.
Silence on the part of the knowledgeable minority at one end apathy at the other with a few uplifted 50ths for the parasites with the power to fix things but instead feathering their own nests
One thing LDI has underlined is that accountability is absent when you don’t identify an individual victim so 40% of a fund can evaporate and can be swept under the carpet. A worker in south wales can demonstrate, at a level anyone can understand, mobilised action, sympathy concern and some redress. That redress mainly from advisers who don’t know where Swansea is let alone not seeking to advise unsophisticated retail customers.
It is absurd to conclude that finally admitting that DB never worked, other than risk underwritten by the tax payer, the death of a thousand cuts of DB schemes should give life to another version of collectives CDC.
This is conformational bias and again fails to engage the ultimate beneficiary
What is required is education at the individual level that your pay packet today is to fund this week and 4 days of retirement.
Income deferment then needs a vehicle to secure the buying power of todays money and to avoid the ravages of repression currently being exercised with the fake news about inflation and the deliberate loss of buying power of buying government debt.
Unless there is realistic policy put in place over the long term living standards in the U.K. will continue decline, the top 1%, on who we depend on for 30-33% of income tax, will relocate.
I know that (young) Ben is the economist the Institute of Fiscal Studies, but I’m not sure he understands private sector DB:
…. a very large part of the problem for the private sector is created by the TUPE transfer of staff out of public sector employment really? Private sector schemes (I think he means employers() participating in public sector schemes can’t be that significant these days, even among the funded LGPS.
…. employers who have DB pensions – whose costs are about to sky-rocket. I think the rockets started being let off in 2004, Ben, when SCAPE was a discount rate of 3.5% real or the social rate of time preference.
I look forward to hearing from Scottish actuary, Allan Martin, on here. He’s been railing against unsustainable SCAPE rates for years, well before John Ralfe took to commenting about SCAPE for the first time last year.
As for John Mather’s on the money comments, I think the (re-)education needs to begin at the level of LDI consultants and DB trustees in thrall to LDI consultants.
Here’s what may prove to be an unpopular or controversial opinion…
LDI was a perfectly rational way to control the risk of scheme funding harming the sponsor and therefore the scheme.
The fundamental problem is that basing valuation on a volatile and short term (as in it’ll be a different value 5 minutes later) is completely irrational but almost universal.
I’m grateful to Byron for the prompt and apologies for the delay, a long weekend with only a phone screen!
On 14th March I blogged-
H M Treasury Ponzi scheme?
I write and extend this piece, and the above arithmetic challenging title in particular, in the hope of raising awareness of the UK’s index linked unfunded defined benefit (DB) pension promises. These deferred pay promises are for over 5m hugely deserving public sector employees. Our Whole of Government Accounts (2020) put this accrued unfunded liability at £2,100 bn. The “fund” is however the UK economy from which taxation will be levied in future.
The actuarial assumption underlying the schemes (NHS, Teachers etc) contributions, benefits and retirement age calculation is the SCAPE discount rate. I suggest it is the most unappreciated but important actuarial assumption in the country. SCAPE is currently set by reference to long term GDP growth of CPI+2.4%pa. Previous benefits were promised assuming real GDP growth of 3.5 – 2.8% pa. Is this reasonable and sustainable?
GDP growth at such rates hasn’t been achieved since the 2008-09 financial crisis and we have of course had Brexit, C19 and the war in Ukraine affecting actual and prospective growth. I suggest a consequential and massive intergenerational transfer of liability to future taxpayers – you, your children and grandchildren (if they don’t emigrate).
Rather than look at the State Pension “triple lock”, I suggest taxpayers, politicians and the media should consider this “lifetime pensions lock”. Hopefully the Chancellor will announce some action in the long awaited H M Treasury consideration of SCAPE Methodology. I suggest that these pension debts are unsustainable.
If attention catching headlines were required, I could also volunteer –
11.5% public sector pay rise. (Pensions are deferred pay, with CPI+ increases)
The irresponsible OBR? (OBR Fiscal Risks don’t include this GDP shortfall.)
Liz Truss’s brave attempt to avoid long term financial ruin. (GDP of 2.5% pa sought)
Pension recession cost – only 5p on the basic rate of income tax. (= 2.5% x £2.1tn)
The partial Pension Regulator (TPR doesn’t regulate its own staff pensions funding)
On 5th April I then blogged –
H M Treasury Ponzi scheme confirmed?
I write again following a Ministerial Statement last week confirming the methodology and actuarial discount rate for costing the defined benefit (DB) pensions for UK public sector workers. The methodology remains based on the assumed growth in the economy – the tax base from which benefits are paid, as measured by gross domestic product (GDP). The SCAPE (Superannuation Contributions Adjusted for Past Experience↑) discount rate has however been reduced from CPI+2.4% to CPI+1.7% pa. The minister acknowledges that this will lead to significant employer contribution increases in the delayed 2020 actuarial valuations* but these will be cost neutral in department budgets, i.e. fudged? Equivalent increased employee contributions, a later retirement age or reduced benefits might not be so easily explained! It is only a ~£8bn pa deferred pay cost increase or recognition! I’m sure any actual, potential or perceived conflicts of interest were appropriately addressed.
Sadly the initiating June 2021 Consultation and Response failed to address any aspect of past service experience↑ and whilst the lower discount rate for future benefits is a step in the right direction, we still have a “lifetime (not triple) pensions lock” on £2.1tn of index linked pension promises assuming GDP growth averaging CPI+3% – a huge intergenerational transfer of liability to future tax payers. Average real growth assumed >3%, minus 1.7% now expected, every year over say 35 years on a (2020) liability of £2.1tn implies the biggest DB deficit admission in UK pensions history; ~£500bn?
The long term GDP projection is taken from an Office for Budget Responsibility (OBR) July 2022 Fiscal Risks and Sustainability Report. Not much has happen since then! The “long term” view was crucial with the 2018 SCAPE change (the OBR projection for 2018-28 was ignored). A look at the more recent OBR Economic and Fiscal Outlook will provide lots more areas of potential concern and material risk, e.g. levels of migration, impacts of climate change and sustainability.
*These future actuarial reports, necessarily covering risk, materiality and “reasonable” third party assumptions might be considered professionally challenging.
Your DB pensions practitioner, voter and tax payer views would however be greatly appreciated.