UK - Unfunded public sector pension liabilities have reached £1.1trn (€1.29trn), according to research by the Policy Exchange, leading to calls for the arrangements to be switched to a funded basis through the creation of a new public sector pension body.

The latest report on public sector pension costs - entitled The UK's Second National Debt - revealed estimates for the current cost of unfunded public sector pension schemes such as the NHS, teachers, civil service, armed forces and police, on a market rate basis rose from £931bn in 2006-07 to £1.104trn in 2007-08.

This compares to the government estimates, which the report claims are based on "artificial rates", which totalled £824bn in 2006-07 and a preliminary figure of £794bn for 2007-08.

In the report, written by Neil Record and James McKenzie Smith, figures suggested the £1.1trn cost is equivalent to 78% of GDP, much higher than the official national debt of £750bn, or 52% of GDP, and it warned the annual debt servicing cost to the pension liabilities equates to £45.2bn, or 105% of the national defence budget.

The research argued the government's method of calculating liabilities and the contributions required from members and employers is "not financially defensible" as it uses an AA corporate bond rate, in line with private sector accounting rules, rather than the current market rate with the effect of making liabilities seem smaller.

It pointed out that the average contribution to these schemes is currently 6% from the employee and 14% from the employer, totalling 20% of pay, however the think-tank warned over 40 years a public sector worker needs 48% of salary paid into the scheme every year to pay for the final benefits, which leaves a 28% shortfall to be picked up by the government.

The report also argued that wage increases for public sector workers mean the government is struggling to achieve an investment return to exceed the average real rate increase of 3.7% for men - after inflation - so public sector workers are effectively receiving a subsidy to their scheme of £28.3bn, or £5,700 each.

As a result of the high costs, the Policy Exchange has recommended the government become more transparent about the pension costs so an "informed and sensible debate about the future of public sector pensions can be conducted".
 
Among the recommendations put forward is the establishment of a new body, to be called the Public Sector Pension Fund or something similar, which will receive pension contributions, buy index-linked gilts to help secure benefits and pay out the benefits.

The new independent body would be expected to break-even and would assess longevity and other external factors when setting and adjusting pension contributions, while its own administrative costs would be paid for through employer and employee contributions, claimed the Policy Exchange.

In this instance, the existing liabilities of £1.1trn would be ring-fenced and allowed to run off over their remaining life, although all obligations would be met in full, even if the transparency means an additional £34.1bn of public spending would be visible on the government balance sheet.

It added that by moving to a funded system, future pensions are likely to need to be lower cost, which could be achieved through higher retirement ages, imposing a cap on pensionable salary, and/or moving to a career average salary scheme.

Record said: "The government has allowed public sector pension liabilities to run out of control, with the Treasury spending contributions received for the next generation's pensions to pay the current generation of pensioners.  The government's accounting for these pensions has been arbitrary and opaque, making it all but impossible to understand."

He said while public sector workers deserve security in retirement, the concern is the government "is creating an apartheid, when compared to those of the private sector", which could lead to high quality public pensions being completely abandoned.

"The Bank of England has already moved to make its schemes 100%-funded. If the government were to do the same, the changes would be costly - but the reality is this isn't money that would otherwise have been saved, and we urgently need to bring transparency to the cost of these schemes," added Record.

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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