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UK public sector pensions akin to 'unstable Ponzi' scheme

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UK - The existing approach to UK public sector pensions has been compared to an "unstable Ponzi scheme" in an independent report from the Public Sector Pensions Commission.

Findings from the commission - established last December by organisations including the Institute of Economic Affairs and the Institute of Directors - suggested the government had used artificially high discount rates to report unfunded liabilities and a different rate to calculate employer and employee contributions, which appeared to lower the cost of providing public sector pensions. (See earlier IPE article: UK roundup: ONS and Public Sector Pensions Commission)

The report said the government employed a discount rate based on AA-rated corporate bonds instead of index-linked gilts to calculate liabilities, while public sector employers and employees are "not charged the full current service costs of the liabilities the pension schemes are taking on each year".

It said a "completely different discount rate" chosen by the government had been used to compute these.

As a result, the commission argued that both employers and employees undervalue the scheme because although they are paying combined contributions of around 20% of salary, the true value based on index-linked gilts is closer to 40% of salary, or even 30% based on long-term gilt returns.

It estimated that, in 2010-11, using the government's methodology for calculating the annual service cost, these pensions would cost £18.5bn (€22.2bn), of which £4.5bn would come from the Treasury, or the taxpayer.

But the commission said this was an inaccurate measure of the cost, that the figure was closer to £35bn a year and that this is what employers and employees should be paying.

Peter Tompkins, fellow of the institute of actuaries and chairman of the commission, said: "It is a matter both of justice and good economics that public sector employees and employers should bear the full cost of their pension provision as it accrues.

"So long as those contributions are sufficient to pay the public sector pensions of today, the cash flows in and out steadily and in balance.

"Of late, however, the amount the Treasury has to pay to top pensions up has risen and will rise still further into the future.

"Like an unstable Ponzi scheme, it will only work if tomorrow's generations of new members and taxpayers are able to stomach a higher cost to pay tomorrow for the unfunded promises being made today."

Tompkins added: "No one change on its own will be enough to control costs if you want to bring costs down to the 20% level people have in mind, rather than a 40% we believe we have shown they are actually costing."

The commission outlined a number of potential reforms to try and improve transparency and reduce the cost of the public sector pensions to the taxpayer, such as:

A reformed defined benefit option to bring costs down to 20% of salary Reducing the accrual rate to 1/80th or switching to a career average scheme could save £10bn a year Increasing pension age to 65 for all members, which would save £5bn a year Reducing index-linking of pensions from Retail Price Inflation (RPI) to Consumer Price Inflation (CPI), which would save 10% of the costs Increasing employer contributions by 2 percentage points, raising £2bn a year

Other possibilities considered by the commission included moving to a defined contribution or a hybrid scheme, although the report noted each option for reform had its pros and cons.

Tompkins added: "As Greece has been experiencing, increases to retirement ages or cuts in benefits are not popular at the best of times, but implementing them as part of a package of crisis cuts is the least palatable option of all.

"It is essential reforms be conducted early in a measured way rather than waiting until we have a crisis."

Tompkins repeatedly said he believed existing benefits should be "sacrosanct".

Of all reform proposals, he said contribution increases were the easiest to put forward.

"It can be a little bit painful because employees are going to have to pay more, as are employers," he said, adding that this was the way the Irish government had successfully tackled the problem.

He was critical of the government's proposal to link public-sector pensions to CPI as of next year, saying: "If you've promised people an RPI-linked pension for the work they've done until now, you should be delivering that."

The commission calculated that the shift to CPI-linked pensions would gradually reduce the overall public-sector liability from £1.28trn to £1.1trn.

Other proposals put forward recently included an upper limit on public-sector pensions, setting a cap at £50,000 a year.

The chairman said these saved "next to nothing" and were merely "cosmetic".

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