Public service pensions – government is hiding the true cost
30 January 2008
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Liabilities estimated at £1,071 billion
In a new report for the Institute of Economic Affairs, economist Neil Record shows how the government is using an artificial interest rate to depress the apparent annual cost of public sector pensions, and also failing to report fairly and on time its outstanding liabilities to its pensioners.
Government Treatment of Public Sector Pension Liabilities
No figures have been published on total occupational pension liabilities for two years running – breaking a well-established convention. The government has finally used a more realistic discount rate to value the liabilities of individual schemes, although it still does not apply the international standard for government accounts (IPSAS 25: employee benefits). As far as can be seen from published figures, the government estimate of total public sector pension liabilities are now £835bn. Record produces a more realistic estimate of £1,071bn. The growth of the liabilities of some schemes has been dramatic. The liabilities of the NHS scheme have risen at 20.2% compound per annum for the last five years as recent salary increases have taken effect. This is a very real call on future taxpayers that is not properly revealed to or understood by taxpayers.
The government has refused to implement the international accounting standard for government accounts which would require it to use a risk-free rate to discount pensions promised by the government. Record has found evidence from Treasury minutes that explicitly states that the government does not wish to be “set apart from other [private sector] entities.” This can only mean, as is stated in the private sector accounting standards, that the government believes that, as in the private sector, there should be an allowance for ‘risk’ in the interest rate to “reflect the options the employer has to reduce the assumed scheme liabilities” (i.e. not pay pensions that have been promised). It should also be noted that the relevant private sector accounting standard (FRS 17) requires that pensions be funded and that the cost of pension accrual be properly recognised. The government has not applied this aspect of the standard to public sector pensions as explained below.
Pension Contributions by Employers and Employees
However, Neil Record argues that the biggest problem is with regard to the way in which contribution rates are calculated for today’s public sector workers. Perversely, the government is still using a discount rate of 3.5% to calculate contributions for public sector employers and employees whilst using 1.8% to value existing liabilities. This has the effect of reducing the contributions charged to public sector employers and employees by £10bn. If international accounting standards were applied the contribution rate for a typical public sector scheme would be over 35% of salary compared with the 18.6% of salary that is actually charged. Furthermore, the government does not reveal any cost for pension accrual in its annual public spending figures. If public sector pension costs were properly accounted for, the government deficit would swell by £40bn – more than doubling the reported government deficit to 5.4% of GDP, at a conservative estimate. Neil Record commented: “The Bank of England – a public sector employer with a funded pension scheme (and so outside the scope of this report) – is costing all its pension provision at a risk free rate of interest and has found that its required contribution rate is over 40% of salary. Exactly the same principles should be applied to all public sector employers so the cost of providing pensions is fully understood.”
Commenting on the report, IEA Editorial and Programme Director, Professor Philip Booth said, “We have known for some time that public sector pensions are not properly accounted for, yet promises made so far have a value of nearly 80% of GDP. Whilst the press has focused on that issue, here Neil Record has revealed a more important issue. The government is hiding the true cost of granting new pension rights to public sector workers to an enormous extent. Only when these costs are revealed will we have a sensible debate about pension reform.”
Read the full report here.
Government Treatment of Public Sector Pension Liabilities
No figures have been published on total occupational pension liabilities for two years running – breaking a well-established convention. The government has finally used a more realistic discount rate to value the liabilities of individual schemes, although it still does not apply the international standard for government accounts (IPSAS 25: employee benefits). As far as can be seen from published figures, the government estimate of total public sector pension liabilities are now £835bn. Record produces a more realistic estimate of £1,071bn. The growth of the liabilities of some schemes has been dramatic. The liabilities of the NHS scheme have risen at 20.2% compound per annum for the last five years as recent salary increases have taken effect. This is a very real call on future taxpayers that is not properly revealed to or understood by taxpayers.
The government has refused to implement the international accounting standard for government accounts which would require it to use a risk-free rate to discount pensions promised by the government. Record has found evidence from Treasury minutes that explicitly states that the government does not wish to be “set apart from other [private sector] entities.” This can only mean, as is stated in the private sector accounting standards, that the government believes that, as in the private sector, there should be an allowance for ‘risk’ in the interest rate to “reflect the options the employer has to reduce the assumed scheme liabilities” (i.e. not pay pensions that have been promised). It should also be noted that the relevant private sector accounting standard (FRS 17) requires that pensions be funded and that the cost of pension accrual be properly recognised. The government has not applied this aspect of the standard to public sector pensions as explained below.
Pension Contributions by Employers and Employees
However, Neil Record argues that the biggest problem is with regard to the way in which contribution rates are calculated for today’s public sector workers. Perversely, the government is still using a discount rate of 3.5% to calculate contributions for public sector employers and employees whilst using 1.8% to value existing liabilities. This has the effect of reducing the contributions charged to public sector employers and employees by £10bn. If international accounting standards were applied the contribution rate for a typical public sector scheme would be over 35% of salary compared with the 18.6% of salary that is actually charged. Furthermore, the government does not reveal any cost for pension accrual in its annual public spending figures. If public sector pension costs were properly accounted for, the government deficit would swell by £40bn – more than doubling the reported government deficit to 5.4% of GDP, at a conservative estimate. Neil Record commented: “The Bank of England – a public sector employer with a funded pension scheme (and so outside the scope of this report) – is costing all its pension provision at a risk free rate of interest and has found that its required contribution rate is over 40% of salary. Exactly the same principles should be applied to all public sector employers so the cost of providing pensions is fully understood.”
Commenting on the report, IEA Editorial and Programme Director, Professor Philip Booth said, “We have known for some time that public sector pensions are not properly accounted for, yet promises made so far have a value of nearly 80% of GDP. Whilst the press has focused on that issue, here Neil Record has revealed a more important issue. The government is hiding the true cost of granting new pension rights to public sector workers to an enormous extent. Only when these costs are revealed will we have a sensible debate about pension reform.”
Read the full report here.
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