Allan Martin discusses changes to a little-known discount rate that could prove to be a ‘lifetime pensions lock’ for public sector pension schemes.
The ministerial statement made by chief secretary to the Treasury John Glen at the end of March confirmed the methodology and actuarial discount rate for costing the defined benefit (DB) pensions for five million UK public sector workers.
The methodology remains based on the assumed growth in the economy - the tax base from which benefits are paid in future, as measured by gross domestic product (GDP) - but the so-called SCAPE (Superannuation Contributions Adjusted for Past Experience) discount rate, which is used to calculate benefits and contributions and retirement ages, has been reduced from CPI plus 2.4% per annum to CPI plus 1.7% per annum.
This is the most unappreciated but important actuarial assumption in the country - and the change will have a significant impact.
The minister acknowledges that this reduction will lead to significant employer contribution increases in the delayed 2020 actuarial valuations.
In practice the biggest immediate financial impact will be on private sector employers participating in the public sector schemes, like independent schools. Equivalent increased employee contributions, a later retirement age or reduced benefits might not have been so easily explained!
These deferred pay promises are for over five million hugely deserving public sector employees, not just those finishing a night shift. The whole of government accounts for the year to 31 March 2020 put this accrued unfunded liability at £2,100bn.
The "fund" for this liability is the UK economy from which taxation will be levied in future. Just like funded private sector schemes, if the economy or fund doesn't grow as expected something has to give - higher contributions/taxes or lower benefits or later retirement. Squeezing individual government department budgets equates to longer NHS waiting lists, bigger school classes, fewer officers on the beat etc.
The public sector benefits were previously promised assuming real GDP growth of 3.5% to 2.4% per annum. GDP growth at such rates hasn't been achieved since the 2008-09 financial crisis and we have of course had Brexit, Covid 19 and the war in Ukraine affecting actual and prospective growth.
This suggests a consequential and massive intergenerational transfer of liability to future taxpayers - you, your children and grandchildren. And, unlike the currently temporary state pension triple lock these DB promises are a lifetime pensions lock.
Sadly, the June 2021 consultation on the on the discount rate methodology and the government response to the consulation in March this year failed to address any aspect of past service experience and, while the lower discount rate for future benefits is a step in the right direction, we still have a lifetime (not triple) pensions lock on £2.1trn of index-linked pension promises assuming GDP growth averaging CPI+3%.
If you total all of this up over 35 years on a 2020 liability of £2.1trn - using the assumed 3% per annum average real growth, minus the 1.7% per annum now expected - it suggests a DB deficit in the ballpark of £500bn, the biggest admitted deficit in history.
The long term GDP projection is taken from the Office for Budget Responsibility's (OBR's) Fiscal Risks and Sustainability report published in July 2022. A look at the OBR's more recent Economic and Fiscal Outlook report, published in March this year, provides will provide lots more areas of potential concern and material risk - such as levels of migration, impacts of climate change and sustainability. Whether you are a parent, grandparent or just a future tax payer, you are picking up this tab and underwriting the risks.
The difficult solution surely involves a necessary link of public sector deferred pay to achieved GDP growth. "Sharing and rewarding" are the politically attractive words that might be used, "affordability and sustainability", less so.
Allan Martin is a professional independent trustee and actuary