Public sector pension reforms

Neil Record is the author of "Sir Humphrey’s Legacy", IEA, 2006.

On 20th June 2010, the Chancellor announced the formation of an Independent Public Service Pensions Commission chaired by Lord Hutton – former Labour Government Work and Pensions Secretary.  In the Commission’s Terms of Reference, the Chancellor asked for “recommendations … on pension arrangements that are sustainable and affordable in the long term, fair to both the public service workforce and the taxpayer … while protecting accrued rights”.

Lord Hutton’s report made two major recommendations for reform, both of which the Government accepted.  One was to raise the pension age in public sector pensions from generally 60 (occasionally 65) to the new State Pension Age (equating men and women at 65 – then rising to 68 by 2046).  The other was to change the basis of calculation of the pension from "Final Salary" to "Career Average Revalued Earnings" (CARE).  The imposition of the raised pension age has reduced the value of public sector pensions; the change to CARE has broadly not (although was portrayed in the press and by the unions as doing so).  Other provisions included a government "cost cap".

But one glaring third reform was needed to eliminate a hidden subsidy in public sector pensions, and that was the removal of the artificial discount rate used to calculate the cost of pension provision – and its replacement with a market discount rate.  This may sound esoteric, but the distortions introduced by an artificial discount rate are huge.  Why?  Because the cost of an unfunded public pension is best described as follows:

“The cost of a public sector pension is how much of a salary increase the government would have to give its workers in exchange for cancelling their future pension rights while leaving them in a position to buy exactly the same pension in the market using the additional salary.  Government would have to borrow the money to fund the salary increase in such a way that its future cash flows would be identical to the cancelled pension promises.  Such a calculation is determined by the yield on UK Government index-linked (IL) gilts, which are also the securities that the pensioners would buy.”

The coalition government inherited an artificial public sector pension discount rate of 3.5% p.a. above the Retail Price Index.  Using this discount rate, it appeared that a pre-reform NHS pension (Final Salary; 1/80th accrual; lump sum 3x pension; retirement at 60) cost 22% of pay, of which the employees paid 6%, so the net benefit appeared to be about 16%. But this is a grossly inaccurate calculation.  Today, the market rate for 20-year IL Gilts, and the Government’s own borrowing rate, is almost exactly 0% p.a. over RPI.  Using this rate, and leaving RPI as the index, the NHS pension above costs 61% of pay, not 22%.

After a public consultation, in March 2011 the Government announced a new public sector pension discount rate – in theory the growth rate of GDP – but interpreted as 3% p.a. over the Consumer Price Index. This is not a rate at which Government is borrowing or lending, nor at which private sector pensioners can invest their pensions contributions.  But this discount rate has been deemed to be the basis for all public sector pension "costs" on the grounds that since public sector pensions are paid out of future taxes, then the discount rate should be the prospective nominal rise in the tax take.  This argument is wrong in every respect – public sector pensions are not a public good – they are a private reward for employment.  The calculation of their cost should be with reference to the cost to any (not specially privileged or subsidised) member of the public. 

So in summary, this Government has explicitly chosen to adopt an artificial discount rate which massively understates the true cost of public sector pensions, and as a result all parties (politicians; taxpayers; unions) are ignorant of the real effect of the reforms, and public sector workers will continue to receive very generous pensions, to be paid for by future generations of taxpayers who are prevented from discovering the extent of the promises made on their behalf. 

Comments

[Framer]

Is that why the BBC Trust diverted £1 billion of licence fee payments into the BBC Pension Scheme last year?
And given the scheme's still increasing liabilities - up another billion pounds - despite the first tranche of subsidy, have we to look forward to another huge (secretive) transfer from licence fee payments to head that way shortly with all the reduced programming that results?

[It doesn't add up...]

To pretend that the highly distorted market for index linked gilts provides any kind of basis for assessing realistic discount rates is an absurdity. It merely reflects the fact that government investments tend to destroy value, and are busy doing so via inflation, QE, and compulsory investment in gilts for annuities.

[Local Tory]

We can all agree that, by any historical measure, there is a dislocation in the fixed-rate interest market most likely caused by QE.

Many would argue further that the pendulum has swung a bit too far in valuations and that the exaggerated dislocation will pull back a bit as the economy recovers.

So in the LGPS it makes no sense whatsoever to crystallise long-term 40 year liabilities on the basis of a short-term aggravating factors. To do so risks dramatically /overestimating/ liabilities with consequent knock-on effects to Council Tax Payers, who pay into the scheme.

Remember that, unlike the NHS, Police, Soldiers & Fire schemes, the 89 Local Government [LGPS] schemes are 'funded' schemes where benefits are paid from a £150bn investment pot just like private schemes.

So the proposed use of synthetic indicators that do not rely entirely on the [temporary] dislocation in the bond market for the 2013 LGPS revaluation and the use of factors take a longer-term view is not only sensible but avoids the risk of over-taxation by Councils at a time when the economy needs a reduction in public sector taxation and expenditure.

Otherwise we risk making the same mistake that Brown made in 1997/8.... but in reverse. - He crystallised a compounded reduction in long-term income. Let's not crystallise a compound increase in liabilities on a basis that was used in the Good Times.

[William MacDougall]

Private sector pensions were partly destroyed by this silly idea that the discount rate should be Gilts, rather than corporate bonds, or better long term equity returns; they were a AA promise at best, so why use a AAA bond rate, let alone the Gilt rate? To use Index Linked Gilts is even sillier given the narrowness of that market. And you are mistaken, the government pension is a public promise, not a private company commitment, so projected tax increases are not so unreasonable at all.

[anthony scholefield]

About the only writer on ConHome who is a must read. I will be printing this off and studying it..
However a first sweep does not seem to reveal that the EU discount rate is 'nominal 5% and reAL3%'. and that is the driver and the rate that applies to British state pensions. Neil would cut his throat if he gave us the figures for the old age pension on the sam basis.

[decorators]

It's remarkable in favor of me to have a web page, which is valuable in favor of my experience. thanks admin|

[make money online]

This is really cool blog, but there are few things that are wrong. Your blog isnt fully SEO optimized, and that means that you have to work harder to get #1 place on google , and its really hard if you know. If you get 1st spot on google it will skyrocket your incomes, it happened with me some time ago, when i was noob and 1 guy helped me with on page optimization, and yeah, i went #1 and i was earning 4x more then before. Here is cool on-page SEO plugin - http://bit.ly/xqj97z - it will save much time for you. Good luck and have a nice day sir !

[conversion optimisation]

SEO is not a shortcut to success, at least not for 99% of the companies. You won't win by fooling Google into listing you first for a common search term. You will win once you figure out the simple mechanics of turning strangers into friends and friends into customers.

[cheap baseball jerseys]

This is special for me to have a web page, it is valuable to support my experience. Thank management |

[nfl jerseys from china]

Private sector pension part is this stupid idea, the discount rate should be phnom penh bonds, rather than corporate bonds, or better long-term equity returns; AA, so why are they promise in it is best to use AAA bond interest rates, not to mention the plating rate?

[test]

You know with all the junk, spam, and cons out there I suspected this was one as well. And since it isn't done in the way of a question I was ready to push the abuse button. But it appears to be a righteous story and I hope others will go to the site and see for themselves.

[James]

At least it's the first step in getting to grips with public sector pensions. I agree with the premise of your article that the reforms don't go far enough just yet, however, the realisation is looming large that the subsidised public sector pension will have to come to an end sooner or later.

[Nicolas Morrison]

So, this has helped me, but what has helped me more, was this software...

http://ForMarketingPros.com/

[labor lawyer]

Sorry, I don”t need people knowing where I am 24/7. I find it odd that people would feel there is v alue add to their friends knowing where they are all the time. Oh well, to each his own.I agree with the 3 bucks being too much. I remember when Cydia apps were almost all free. It almost feels like they are charging for everything on there anymore. It”s slightly depressing.haha. “Well said?” Uh, no. He”s full of crap. The two websites look WAY too similar, and shows a complete lack of design originality on Google”s part. Did either of you even look at them? Technically it is not a free service because you still need to pay for a very expensive iphone 4 when the other iphones cannot get the service for free even though they are capable of it. ^the lag is thanks to the introduction of ios4.x. I couldn”t stand it on my 3GS and had to upgrade to ip4, yet ip4 still lags, the memory management is so horrible. Sj messed up big time…

[kexinvesk]

I was really pleased to acquire this web-site.I wanted to thanks for your time for this terrific read!! I surely enjoying every single small bit of it and I've you bookmarked to have a look at new stuff you weblog post.

christian louboutin store online

[carpinteyroayi]

Hello.
Wow,Fantastic article,it's so helpful to me,and your blog is very good,I've learned a lot from your blog here,Keep on going,my friend,I will keep an eye on it,One more thing,thanks for your post!
wedding dresses 2013
wedding dresses
cheap prom dresses
cheap evening dresses
bridesmaid dresses 2013

[buidaemboda]

I'd have to check with you here. Which just isn't something I in most cases do! I enjoy reading a post that will make people believe. Also, thanks for permitting me to comment!

cheap hats

[buidaemboda]

Nice post. I discover something much more difficult on distinct blogs everyday. It will continually be stimulating to read content from other writers and practice a little something from their store. I'd prefer to make use of some using the content on my weblog no matter if you don't mind. Natually I'll provide you with a link on your web weblog. Thanks for sharing.

new era caps

[Michael Kors Handbag]

We are a group of volunteers and opening a new scheme in our community. Your site provided us with valuable info to work on. You've done an impressive job and our whole community will be grateful to you. Michael Kors Handbag http://www.handbagsbags-michaelkors.com/

[Cheap Oakley Sunglasses]

Public sector pension reforms - ConservativeHome | Thinkers' Corner

[louis vuitton taschen]

What makes a present special? It is not just the present itself; it is also the way in which it is given.

[kclbshwy]

[url=http://www.g4mg6tztp9454c5m0696ba80v46o6iics.com/]kclbshwy[/url]
kclbshwy
kclbshwy http://www.g4mg6tztp9454c5m0696ba80v46o6iics.com/

[qMLmLrRC]

qMLmLrRC
[url=http://www.03n9GqWB95EiVc8X725bwW.com/]qMLmLrRC[/url]
qMLmLrRC http://www.03n9GqWB95EiVc8X725bwW.com/

[gucci mens sneakers]

gucci hobo bag
gucci loafers
gucci by gucci
authentic gucci outlet
GUCCI SNEAKERS FOR WOMEN
gucci shoes outlet
gucci tennis shoes
GUCCI SHOES SALE
gucci satchel
gucci shirt
AUTHENTIC GUCCI HANDBAGS
gucci jacket
discount gucci handbags
GUCCI BY GUCCI FOR WOMEN
Mens Gucci Shoes
GUCCI DUFFLE BAG
Gucci Purse
Gucci Bags For Cheap
Gucci Outlet Online Store
gucci sunglasses
Gucci Clothes
cheap gucci belts
GUCCI STORE
gucci usa
GUCCI BELT BAG
gucci handbags
Gucci Shoulder Bag
Discount Gucci
GUCCI HAND BAGS
Gucci Travel Bag
Gucci Sukey
GUCCI UK
gucci luggage
GUCCI SHOES
gucci mens sneakers

[Gucci Spa]

bauletti gucci
borse gucci bauletto
STIVALETTI GUCCI
GUCCI FIRENZE
gucci prezzi
spaccio gucci
JEANS GUCCI
Cintura Uomo Gucci
gucci calzature
Occhiali Gucci
Shopping Gucci
GUCCI SCANDICCI
gucci bauletto
gucci outlet biella
gucci abiti
Marsupio Gucci
scarpe gucci donna
scarpe gucci donne
pochette gucci
borse gucci saldi
simbolo gucci
Infradito Gucci
BORSE GUCCI PREZZI
Costume Gucci Uomo
cinture uomo gucci
gucci scarpe uomo
Gucci Padova
outlet gucci
Gucci Via Montenapoleone
Outlet Gucci Toscana
SCARPE GUCCI OUTLET
Gucci Spa