Wednesday, March 29, 2006

Public Pensions: Show Me The Money!


Following yesterday's local authority pensions strike, there's been more discussion of what all these public sector pensions are actually costing us. Remembering of course that the bulk of them are unfunded (ie there's absolutely no money set aside to pay for them- remember that).

For all the obvious reasons, the government specifically excluded this particular ticking package from the remit of the Turner Commission- most unhelpful. Still, the Commission's Report did slip in the official cost projection, which goes from 1.5% of GDP in 2003/04, up to 2.3% in 2033/34 (Figure 1.20). That's getting on for £30bn pa in currrent prices, which is what we taxpayers will be paying those public pensioners year to year. About 8p extra on the standard rate of income tax.

That's bad enough, but clearly we also need to know the capital value of our liability, when we compound all those future cash payments together. On that, the government recently estimated the present value of the unfunded liability at £530bn, substantially higher than our official National Debt. But leading consulting actuaries Watson Wyatt point out even that's a huge understatement.

Watsons reckon the real total is £960bn, getting on for twice as big, and a cool £40 grand per British household. They say:

"The official estimate...of £530 billion ...is a significant underestimate because it doesn’t take account of falls in long-term interest rates that have pushed up the cost of pensions. Once account is taken of current interest rates, a year’s extra pension and improving longevity, this figure increases by over 80 per cent to £960 billion. The Government is taking a rosy view of the cost of public sector pensions. If the private sector were allowed to use public sector methods to value their own pension liabilities, the £78 billion deficit for the companies in the FTSE 350 index would be completely wiped out."

Once again, the government is using accounting methods that would be totally unacceptable in the post-Enron private sector.

Now if you happen to be one of those prospective public pensioners, you might well be looking at this a little differently. You might be saying, hang on a minute...I'm contributing to my pension, so why the bleepin' bleep shouldn't I get it? And indeed you are contributing. Here are some of the current employee contribution rates:
  • Civil servants: 1.5-3% of salary
  • NHS staff: 6%
  • Local authority staff: 6%
  • Teachers: 6%
  • Firefighters and police: 11%

The problem is, these contribution rates are not enough to buy the kind of benefits your schemes offer (note that while firefighters and police contribute more, they can generally retire at 50 on up to two-thirds salary). As private sector companies have discovered the hard way, the true cost of providing final salary pensions with retirement at 65 (let alone 60) is at least 25% of payroll (see Turner Report).

Which of course is why your employers (ie we taxpayers) are having to stump up some extraordinarily hefty contributions of their own:

  • Civil Service: 12-20%
  • NHS: 14%
  • Local government: 20%
  • Education authorities: 13.5%
  • Police/Fire employers: 26%

OK you say, sorry about the cost and everything, but at least the money has gone in to pay for the pensions. So everything should be fine.

You'd think so wouldn't you.

Ah, well, unfortunately it isn't quite like that. Because with the single exception of the funded Local Government scheme, all our contributions- yours and ours- exist solely in the realm of funny money: money that has been sucked out of our wallets simply to disappear in the great maw of government finance. The sad twisted bitter truth is that these contributions are no more than a few extra strokes of the government's Enron pen.

What's that you say?

I'm sorry...there's just no point standing there screaming "Show me the money!"

As I'm trying to tell you: there is no money.

PS For a good illustration of the BBC's cluelessness with money matters see their coverage of the Watson Wyatt analysis here: "The Watson Wyatt analysis is really a comparison of apples with pears. The first point is that the government has absolutely no plans to create a national pension fund to pay for the retirement income of civil servants, nurses, teachers etc. And even if it did, there wouldn't be nearly enough inflation-proofed bonds in circulation left to buy up. Any such fund would be forced to put much of its money in a much wider spread of investments such as shares, bonds issued by companies and foreign governments, and property. In other words, it would have to act rather like a real investment fund, such as the ones that underlie most private sector pension schemes. Almost by default then, it would probably earn a higher real rate of return...You won't have reach for your cheque book and write out a cheque for £40,000." So that's OK then. Obviously those ill-informed Fellows of the Institute of Actuaries have got themselves into a lather over nothing.

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