Public service pension costs – separating fact from fiction

Reform recently became the latest opposition political party to propose closing the main unfunded public service pension schemes to new entrants on the grounds that they were unsustainable.

Deputy Leader, Richard Tice, announced the policy in a speech to Bloomberg on 5 November, but it had been heavily trailed in the Daily Telegraph (£) and the Daily Mail (which both have a long record of publishing hostile articles about these schemes).

This is potentially a very serious development for public sector workers. The last opposition politician to announce something similar was David Cameron in 2008 (£). He subsequently found the policy was unworkable after he entered government, but we’re still trying to resolve the issues arising from the scheme reforms that his government ultimately delivered in 2015 instead.

Prospect was quick to respond to this threat. We produced analysis, that was published in both the Guardian and Civil Service World, which disproved Reform’s claims and even showed that closing these schemes to new entrants would actually increase costs by many billions of pounds over the fiscal forecast period.

What Richard Tice said

The Daily Telegraph reported that:

“Mr Tice will question why “there has been almost no discussion” within the political class about reining in the cost of generous retirement plans.”

This was hugely revealing, as it suggests that he was unaware that the Coalition Government set up an independent commission to review these schemes.

That commission published an interim report and a final report that, between them, considered every potential reform.

The interim report ruled out introducing defined contribution schemes because:

“Prospect be dealt with appropriately through a funded, individual account, defined contribution model for all employees, which would place a major financing burden on taxpayers, ignore the ability of Government as a large employer to manage certain types of risk and increase uncertainty of post-retirement income for scheme members, which is difficult in particular for the low paid to manage”.

So not only has this issue been the subject of a thorough review and widespread political debate, but the outcome was to reject the proposals that Mr Tice thinks have not even been considered before now.

The reforms that were ultimately implemented involved benefits being calculated on the bases of career average salaries rather than final salaries, and pension age increasing from 60 to 68.

Did that not work? Why does Richard Tice think more needs to be done?

According to Civil Service World:

“In his speech, Tice said the “liability for the unfunded pensions schemes in public sector in the UK has grown in the last from about £750bn to somewhere between £1.5trn…”.

On the face of it, this increase in liabilities does seem to have serious implications for public finances, but things are not that straightforward.

Why Richard Tice is wrong

Richard Tice has drawn the wrong conclusions about the sustainability of these schemes because he has misinterpreted data that are a poor measure of sustainability and ignored data that are the best measure of sustainability.

He tries to draw conclusions about the sustainability of these schemes from their total estimated liabilities.

These have increased significantly. (From para 1.150 of the 2023-23 Whole of Government Accounts: “In the last 15 years, as shown in the chart above, the pension liability has steadily increased from £1,132.3 billion as at 31 March 2010 until it peaked in 2021-22 to £2,639.1 billion.”)

But more recently they have fallen a lot (ie halved since 2021-22 according to the same source: “It has since decreased to £1,311.9 billion as at March 2024”.

The most important part of the above paragraph is the last part: the reported increases and decreases are “largely due to changes in the discount rate”.

What does this mean?

Estimated liabilities are the future pension payments that scheme members are projected to receive that have been discounted into a total figure in today’s prices terms.

The rate at which future pension payments are discounted has a significant impact on the estimated liabilities.

If you owe someone £100 in 20 years’ time and discount it at a rate of 4%, then that debt is worth about £46 today. If it is discounted by 1% it is worth about £82 today.

In a similar way, the increase in estimated liabilities in the Whole of Government Accounts between 31 March 2010 and 31 March 2022 was mostly driven by a reduction in the discount rate used, from about 4% to about 1%.

Similarly, the fall in estimated liabilities from the peak as at 31 March 2022 to 31 March 2024 was largely driven by a large increase in the discount rate, rather than a significant change in the underlying liabilities.

Or, to put it another way (the way the NAO puts it in the 2023-24 Whole of Government Accounts:

“While the estimate of pension liabilities and accompanying information published in the WGA is helpful, it can be volatile, with significant changes often driven by changes in interest rates. Over the most recent publications, the WGA figure for public sector pension liability has been £2.3tn, £2.6tn and £1.4tn respectively. While this is appropriate from an accountancy perspective, the unfunded nature of the main public service schemes means that changes in the interest rate do not directly impact their affordability for future taxpayers.”

Richard Tice interpreted significant increases in the size of these schemes’ estimated liabilities as a sign that they were unsustainable because this suited his pre-existing agenda.

He did not ask whether this was an appropriate way to measure sustainability. He ignored the more recent significant reductions in the estimates because they were not convenient for him.

Much more importantly, he ignored the best measure of the affordability of these schemes.

Proof that these schemes are sustainable

It is not Prospect that says that Richard Tice failed to take into account the most appropriate measure of the affordability of these schemes.

From the NAO, in its 2023-24 Whole of Government Accounts again:

“The Government’s preferred measure for the affordability of Public Service Pension Schemes is the OBR’s projected cost of public service pensions as a share of GDP over the long term, as set out in the NAO’s 2021 report on Public Service Pensions. In its latest publication of September 2024, the OBR estimates that this will fall from 1.9% in 2023-24 to 1.4% in 2073-74. HMT considers this measure to provide the most helpful assessment of the affordability of public service pensions.”

So, the most appropriate measure of the affordability of these schemes shows that the cost to taxpayers is projected to fall significantly (by more than a quarter).

Awkwardly, Richard Tice’s proposals would cost significant amounts

It might seem obvious that paying a lower contribution into a new defined contribution scheme than public sector employers pay into current defined benefit schemes should save money.

But that’s not actually the case.

Stopping workers from building up defined benefit promises will eventually reduce payments in the future, but for the short and medium term the impact on benefits is negligible.

On the other hand, Treasury would immediately lose the member and employer contributions that it would otherwise have received (and used to pay current pensions).

So, over the fiscal forecast period, closing these schemes would require significant tax rises or spending cuts to meet the government’s fiscal targets. This is not something that Richard Tice has engaged with in his public comments so far.

Current workers would be affected

In an attempt to make his proposals less unpalatable to current workers, Richard Tice clarified that he was restricting them to future starters.

But that does not change the fact that he is trying to solve a problem that does not even exist.

It does not change the fact that losing the member and employer contributions in respect of even just new starters would cost billions and impact budgets and ultimately the pay of current workers.

And it opens the risk that when Richard Tice, or his successors, come back to attack the pensions of the remaining members of the schemes, that we will not have a united workforce we need to fight them off.