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Public sector pension costs are not soaring!

Public sector pension costs are not soaring!

There has been further recent press coverage (in the Sunday Times (£) and the Daily Mail) about the cost of public sector pension schemes.

The reports suggest that the cost of these schemes is soaring and even that we are passing the burden of dealing with these costs to our children and grandchildren.

Both articles quote John Ralfe, a pension consultant who has a significant interest in public sector pension schemes (as shown by the list of related press articles on his website).

But are the costs soaring?

The reports seek to imply this by quoting huge numbers (£1.8 trillion) as the public sector pension bill. But this is just an estimate of what all public sector pensions that have already been built up will cost once they are all paid out over many decades in the future. It does not represent a bill we have to pay now. The estimate is hugely dependent on assumptions used to convert future pension payments into a present value today. Small changes in the assumptions used can lead to huge changes in this estimate. If the assumptions changed in the other direction there would be similarly huge reductions in this figure (but probably very few press reports claiming that costs are plummeting).

But the real cost of these schemes is not the estimated overall liability expressed in a present value today but the actual payments made each year in the future.

If we look at independent forecasts of what these schemes will cost in the future (in terms of percentage of GDP) they tell a very different story.

The Office for Budget Responsibility’s long-term fiscal projections are the definitive forecasts of these costs. The latest report was published in January 2017. This showed the following projected costs for the main public sector pension schemes:

2016/17 – 2%

2026/27 – 2%

2036/37 – 1.7%

2046/47 – 1.5%

2056/57 – 1.4%

2066/67 – 1.3%

Clearly these costs are not soaring.

Far from passing on a higher burden to our children and grandchildren we are actually leaving them more affordable costs than we have to meet today.

The reason the costs are falling is mainly due to a series of reforms implemented between 2010 and 2015:

  • In 2010 the index used to increase these pensions in payment was switched from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI). CPI is generally lower and this switch is estimated to have reduced the cost of these schemes by about 15%.
  • Between April 2012 and April 2014 member contribution rates were increased by an average of 3.2% of pay.
  • From April 2015 future pensions are generally being built up in career average rather than final salary schemes and pension age has increased by up to 8 years (generally from 60 to 65, 66, 67 or 68).

When I challenged John Ralfe about these figures and his analysis on twitter he said:

“Current generation not paying full cost of pension promises being made.”

And:

“each generation should be paying for goods and services it consumes”.

This appears to be an argument for pre-funding these pension schemes, ie setting money aside today to meet the pensions being built up today when they fall due in the future.

But that ignores the reality that these schemes have been unfunded (ie the pensions are paid as they fall due) for generations. This means the current generation is paying for the pensions built up in the past. To move to a funded basis would require this generation to pay twice, to continue to pay for the past generations but also to fund today’s pension promises too.

This would place a disproportionate and unfair burden on the current generation.

The approach that was actually taken, of implementing reforms within the same overall unfunded approach, has made sure that this generation does not have to pay twice while also passing on lower costs to future generations.

The costs of these schemes are not soaring but falling – public sector pensions are sustainable.

Neil Walsh

Neil Walsh


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