Public sector schemes facing £102bn gap in next 10 years

Despite the government announcing last year that it would be reducing the Superannuation Contributions Adjusted for Past Experience discount rate – used to convert a future stream of pension benefits into a single figure, in today’s terms – by 0.4 percentage points, this is not enough, several specialists have told Pensions Expert.

That looks politically impossible because it would trigger a huge increase in contributions required

Ian Neale, Aries Insight

They argue that future taxpayers will be called in to plug the gap to pay current pension promises, as the calculations used by the government for these pension schemes are more optimistic than the current short-term gross domestic product estimates for the UK.

Allan Martin, a director at trusteeship and advisory consultancy ACMCA, explains that this rate “affects contributions, benefits, retirement age, commutation terms and divorce shares for over 5m voters”.

GDP growth is used to represent a fair assessment of the government’s income. The Scape discount rate currently sits at 2.4 per cent above the consumer price index.

It is based on the Office for Budget Responsibility’s assumption of real GDP growth for the period 2016-2050 of 2.2 per cent. This figure is adjusted to 2.4 per cent via the GDP deflator (+2.2 per cent) and CPI estimate (-2.0 per cent).

However, the short-term GDP growth estimate for the next 10 years from the OBR sits at 1.6 per cent.

By multiplying the difference between the two rates with the current unfunded public sector pension liability, which now totals around £1.74tn, Mr Martin found a shortfall of £102bn in these schemes.

He says: “Unless GDP expectations are achieved, not reducing benefits or increasing contributions will guarantee pressure on government budgets which will in turn require higher taxation or reduced services.”

A HM Treasury spokesperson says: “Benefits earned today will be paid out over many decades. That is why it is appropriate for the discount rate, which is known as Scape, to be set in line with the long-term OBR growth forecast.

“Adjustments stop shortfalls building up as employers pay out benefits to today’s beneficiaries.”

‘A game of pass the parcel’

Richard Warden, actuary and partner at consultancy Hymans Robertson, explains that the Scape rate is used to calculate the amount of contributions that need to be paid in theory to cover the cost of the pension schemes.

He says: “Crucially, because these are unfunded schemes, there is no investment income here, so they are entirely reliant on future taxpayers paying ultimately for it [and] employers and employees paying towards it.”

David Robbins, senior consultant at Willis Towers Watson, notes that in a Pay As You Earn system, employer contributions are “just a game of pass the parcel with taxpayers’ money”.

He says that “they involve Treasury giving a department a budget and then taking some of it back again”.

Mr Robbins adds: “Under a sensible spending review negotiation, the budget awarded ought to allow for what will be coming back, given that they want enough to be left over to deliver the targeted amount of services.”

Bringing down the discount rate further would mean that public sector employers would have to raise their pension contributions to make up the difference.

Ian Neale, director at pensions specialist Aries Insight, who has analysed Mr Martin’s figures, says that the numbers suggest the Scape rate should be further reduced.

“But that looks politically impossible because it would trigger a huge increase in contributions required,” he notes.

The last change to the calculation, announced by the Treasury in September 2018 – from 2.8 to 2.4 per cent to take into account OBR’s lower long-term growth forecasts – is already taking its toll.

For example, Pensions Expert reported in January that the survival of some state schools, colleges, universities and independent schools is threatened by the £1.1bn rise in the employers’ contribution to the Teachers’ Pension Scheme from September 1 2019.

Benefit structure changes?

Mr Warden notes that if the GDP growth does not happen in the later years, “someone will have to pay, which ultimately will be the taxpayers, because there aren’t any assets in these pension schemes”.

He adds that it is difficult to imagine the Scape rate rising anytime soon. “You might expect some further reductions if you believe in OBR forecast, which puts more pressure on the schemes,” Mr Warden says.

He adds: “You would think that there is some kind of breaking point; is it sustainable? Can we keep putting pressure on employer costs?

“The most sensible thing would be to have another look at the benefit structure, which would open a can of worms, but maybe this is a can of worms that needs to be dealt with at some point.”

Despite having an impact on employer contributions, the Scape rate does not affect scheme members’ payments, according to Neil Walsh, pensions officer at union Prospect.

Changes in this calculation are “specifically excluded from the cost cap mechanism that is designed to maintain the costs of the benefits being accrued at an agreed level over time”, he explains.

Mr Walsh argues that the employer contributions are an “accounting mechanism designed to impose a discipline of recognising the cost of accruing pension on employers and do not actually affect net payments into or out of the schemes”.

Increasingly affordable

He stresses that there is a relationship between affordability and the Scape discount rate and hence estimated liabilities, but it is not directly causal.

“If projected real economic growth falls, then a given level of future pension payments will be relatively less affordable and the Scape discount rate will also be lower, and hence estimated liabilities will be higher,” Mr Walsh notes.

He adds that affordability and the estimated liabilities will both have been impacted by the changes to projected economic growth and not each other.

Mr Walsh argues that the future affordability of the schemes depends on two main factors: the amount of pension benefits paid out each year (net of the contributions from members) and the ability of the economy at the time to bear the amount being paid out (ie the relative size of the economy).

The OBR’s latest report, published in July 2018, projects the net cost of these schemes to fall from 1.7 per cent of GDP in 2022-23 to 1.0 per cent in 2067-68.

“Payments from these schemes are projected to comprise a smaller proportion of the size of the economy over time and hence become increasingly affordable,” he concludes.