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The slow death of the public-sector pension

6 January 2018

9:00 AM

6 January 2018

9:00 AM

Hedge funds have already spotted it: Jim Mellon’s latest book, Juvenescence, reviews the new science that will lengthen our lives by 20 years. Through regeneration (stem cell) and repair (DNA) technologies, we’ll soon be living healthily and happily to 110 or more. How soon? Who knows. But the repercussions will be enormous. Major insurance companies will go bust; speculators will make a fortune shorting them; 90-year-olds who bought annuities will become destitute when their annuity provider fails; there will have to be a total rethink of the nation’s state pension age.

The annuity recipients; those without savings; company pension funds (many of which are already in negative cash flow): all will be in trouble. But nowhere will the impact be so great as in our public-sector pension schemes.

Private-sector schemes are funded. Most public-sector ones are not — there are no underlying assets to meet the pension promises, which have to be financed on a pay-as-you-go (PAYG) basis, out of general taxation. Their unfunded net liabilities now total more than £1.3 trillion. Some 15 per cent of public-sector pensions are funded, but with assets of £266 billion compared with liabilities of £370 billion. Combined liability — £1,425 billion, 75 per cent of GDP — is up 26 per cent since 2010. That’s before adding in quasi-public schemes (such as the Universities Superannuation Scheme, the deficit of which near doubled last year to £17.5 billion).

Public-sector pension fund beneficiaries in their sixties are forecast to receive some 20 years of pension before they die. With luck, actuaries have overestimated current longevity by about three years, so before any longevity increase there may, on average, only be 17 years of future payments to make. But what happens if the longevity revolution adds a further 20 years of life? The pension liability actually almost doubles. Remember: almost all of the original obligation was already unfunded. None of this new obligation would be.


On top of that, we’re adding huge additional obligations all the time, as new young employees arrive into pension schemes. With the existing shortfall, growing obligations and the longevity revolution, if we want to start paying the amount we need for future pensions, we need to increase our payments, at a minimum, threefold. Immediately.

A typical unfunded scheme’s total current contribution rate is more than 30 per cent of salary. Take teachers, who pay in an average of 9 per cent of their salary, while their employer pays 16 per cent (so 25 per cent in total). A teacher earning £40,000 sees £10,000 paid annually. Probably she imagines it goes into a secure pension pot. Not so: that £10,000 gets spent by the government now (housing benefits, road-building etc). There’s no ‘pot’ put aside for teachers: further generations will have to cough up.

And 25 per cent isn’t even enough — the government says (optimistically) that 32.3 per cent is needed (so it’s £13,000, not £10,000 — but let future fools be saddled with that problem). If you add in beneficiaries living longer, then properly funded public-sector schemes require total contributions of almost 100 per cent of salary.

Contributions (£26.8 billion in 2016) are already way below what’s needed to pay for today’s pensions. Ten years ago the cashflow gap between annual contributions and unfunded pensions in payment was a bearable £200 million. Last year, the Treasury had to find an additional £15 billion to plug the gap, rising to £15.7 billion in 2021-22 (0.7 per cent of GDP), and growing. Overall, taxpayers will contribute roughly £33 billion to unfunded public-sector pensions, through employer contributions and the Treasury plug, shrouded within the obscure complexity of the national accounts. Employer contributions to funded schemes (notably the Local Government Pension Scheme) will take this to perhaps £42 billion, adding up to £1,550 per household. That’s before any deficit reduction, or 20-year longevity increase.

With PAYG, this has to be paid out of current budgets. These are contracting in real terms. Across the public sector, some 6 per cent is going to fund retirement and sickness benefits. Ever wondered why they keep cutting the number of coppers on the beat? Increased pensions and health-related costs. Closing down a fire station? Ditto. Why teachers, doctors, nurses all go out on to the streets demonstrating? It’s because of (very limited) efforts to cut their pensions back. Attempts to remove the slightest amounts are met with a furious reaction.

The Hutton Commission was meant to sort this out. Eighteen of Hutton’s 20 commissioners were members of public-sector pension schemes. The report concluded — surprise — that these defined benefit pensions were jolly good things and should be retained. A last-minute panic by the government led to a further watering-down of reforms. The Commission eventually recommended minimal reform — and Lord Hutton confessed, not long after, that his assumptions had been too optimistic; the sustainability of these pensions was in question.

When we decide we need three times as much money to pay for these pensions as we are putting in, the percentage of the UK’s budget increases from 6 per cent to almost 18 per cent of our entire government budget. Something will have to give. A hike in taxes? That usually doesn’t result in significantly increased tax revenues (think stamp duty or 50 per cent income tax rates). Reduce other public services? Good luck with selling that. Or: a renege on promised public-sector pension benefits. Three options that imply those currently living in expectation of receiving their public-sector pension — particularly ex-mandarins with very large pots — should take a very cautious view on whether they will continue to benefit, right up until death do them part from their pension.

One bright note. If a longevity revolution adds 20 years of life, then nearly everyone will be able to continue working until — let us say — 80 at least. And given the financial implications, they may need to. Otherwise, the government may have to make it necessary for each public servant to sign away their pension rights before they’re allowed to get their regeneration treatment.

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