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Government should focus on current pension costs, says Towers Watson

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UK - The government should be focusing on how much pension promises being made today are worth rather than the increasing cost of past pension promises, Towers Watson has warned.

In the Office for Budget Responsibility’s (OBR) initial report, the figures showed the net service cost of public service pensions is estimated to more than double from a forecast £4bn in 2010-11 to £9.4bn (€11.3bn) by 2014-15.

The report noted that while receipts to pay-as-you-go (PAYG) schemes rise slightly across the forecast period of 2009-15, this is “more than offset” by the changes in demographics, which caused net public service pensions expenditure to increase year-on-year, by an average of 20% in real terms from 2009-10 to 2014-15.

In a speech yesterday, Nick Clegg, the deputy prime minister, argued that although public-sector workers deserve a decent retirement income, private-sector workers have seen final-salary schemes close and returns from defined contribution (DC) schemes fall, while taxes go toward “unreformed, gold-plated, public-sector pension pots”.

Clegg said the situation was unaffordable and warned the government “cannot ignore a spending area which will more than double within five years”.

However, Towers Watson claimed the government was “focused on the wrong figure” and suggested the OBR calculations were an “odd way” to measure the cost of public-sector pensions.

The company said the government ignored certain issues such as whether the cost of new pension promises could exceed contributions, and it showed savings from some public-sector reforms, but not others.

John Ball, head of DB pension consulting at Towers Watson, said the £9.4bn figure “just shows how the cost of pension promises in the past are catching up with us as more people retire”.

He added: “The government has said it will not renege on pension promises already made, so it should forget about water under the bridge and focus on how much future taxpayers will have to pay for pensions being promised now.”

Towers Watson suggested the most important part of the OBR report was the calculation of the current service cost for all PAYG public pension schemes as £26bn for the year ending 31 March 2008.

It claimed the OBR’s position is that employer contributions to PAYG schemes do not reflect the true value of the benefits to employees or their true cost to taxpayers.

Instead, the report states: “In terms of the annual accruing ability in these schemes, the most appropriate measure is probably the current service cost.” 

Towers Watson said the calculation of service cost depended on the interest rate used to discount pensions and that the £26bn figure suggested the OBR believed future pension payments should be discounted in-line with the yield on high-quality corporate bonds.

But because these yields are volatile, the cost to employers could vary significantly from year to year.

For example, in the NHS pension scheme, using this discount rate would place the cost at 19.8% of pensionable pay for 2008-09 - excluding employee contributions - against the headline 14% contribution rate paid by NHS employers.

But because of volatility, the cost would have been 25.8% in 2007-08.

Ball warned: “The way it [OBR] wants pension costs to be estimated still ignores the value of having the taxpayer standing behind the benefits.

“On that basis, many pubic-sector pensions would cost more than 30% of pay.”

The OBR concluded in the report: “We will continue to assess public service pensions, drawing on the work of GAD and the ONS, and we expect the publication of the Whole of Government Accounts (WGA) to establish a figure for the total public-sector liability, covering both unfunded and funded schemes.”

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