From the TUC

The CBI on public sector pensions (2)

16 Apr 2010, by in Pensions & Investment, Public services

In my first post on the CBI report on public sector pensions I looked at how they try to undermine public sector pensions by calculating future liabilities. I argued that this figure provides little useful information about their future affordability or sustainability. Much better is the approach taken by the Treasury, and endorsed by a recent NAO report, of looking at how affordable future pension payments will be. 

This is a familiar argument for those who follow public sector pensions. It’s a basic choice between the way that economists and those who actually have to pay the pensions think, and how the actuaries and accountants who understand private sector pensions approach the very different world of pay-as-you-go public pensions.

In this post I want to look at what the CBI have to say about the net cost of public sector pensions. This is the difference between pensions in payment each year and the the contributions paid by employers and employees. Here I think they not only make some very strange assumptions about how this should work, but also have some very odd figures. Either I do not understand what the CBI is saying (which is entirely possible) or they have made an uncharacteristic mistake with their figures.

This is the section of the report I analyse today:

In 2007/8 the government paid out £29 billion in benefits to pensioners, but collected only £19 billion in contributions from public sector employers and employees. Given the larger size of today’s public sector workforce compared to that of three decades ago, these figures should if anything be the other way round.

The cumulative taxpayer subsidy grows year by year, unmeasured by public sector employees and unexplained by government. This practice must end. After taking account of employee contributions, public sector employers must be charged the full cost of the pensions they provide. “

For a start this is a little disingenuous. The report’s introductory account of public sector pensions rightly includes the local government scheme (LGPS), but these paragraphs ignore it. 

The LGPS is in fact the biggest public sector scheme with 37 per cent of public sector pension scheme members. Unlike the pay-as-you-go teachers, civil-service, NHS and services pensions schemes (which the NAO report examine)  the LGPS does have a pension fund, investing £100 billion  in assets in the same way that private sector pension schemes do.

It also has a healthy £4-5 billion surplus of contributions over pensions in payment. The figures in these two CBI paragraphs should have made clear that they only refer to the unfunded schemes.

But there is an even bigger problem. I do not think the figures in the CBI report are right. I certainly cannot work out where the figure for the costs of pensions in payment come from.

In trying to track down an accurate figure for the net cost of pensions this PQ sent me here to the Public Expenditure Statistical Analyses 2009

I’ve extracted these figures from Table D1 Pay as you go public service pensions schemes in AME and in TME, 2003-04 to 2010-11 (All figures are £1,ooos):

year

03/04

04/05

05/06

06/07

Pensions in payment

£16,080

£16,377

£17,641

£19,080

Contributions received

-£14,279

-£15,119

-£17,368

-£17,934

net cost

£1,801

£1,258

£273

£1,146

 

year

07/08

08/09 estimate

09/10 plan

10/11 plan

Pensions in payment

£21,356

£22,562

£24,151

£25,286

Contributions received

-£19,066

-£19,500

-£20,033

-£20,684

net cost

£2,290

£3,062

£4,118

£4,602

These figures agree with the CBI for contributions. But HMT says the cost of pensions in payment for 07/08 was £21 billion , while the CBI says that it was £29 billion. £8 billion is a whopping difference.

I do not understand this. While I often disagree with the CBI, I would always accept that they try to get this kind of thing right. It may be there is an explanation for this, and the comments box is open. And if it’s an honest mistake or typo, I’ve got the t-shirt – but it is an important building brick in their argument. (The NAO report also includes some graphs showing pensions in payment from the four big PAYG schemes – these are in line with the HMT figure.)

One thing is immediately apparent if we take the Treasury figure as accurate. The net cost of the unfunded schemes was smaller than the net surplus in the LGPS. As a whole therefore the public finances made a profit on pensions in 2007/2008 if you want to think that way.

But I don’t – let me explain why.

Of course the Treasury needs to know what it can expect to receive in contributions and pay-out each year in pensions. This is a real world figure that must inform public spending planning.

However this does not mean that it is right to describe the taxpayer contribution to pay-as-you-go pensions in payment over and above employer and employee contributions as a “subsidy” as the CBI do.

This can only be based on an idea that contributions should equal payments every year. This does not happen in the private sector, and it is equally wrong to expect it to happen in the public sector. There are two very different reasons for this.

First, the purpose of current pension contributions is not to pay current pensions but fund the future pensions of those contributing. Think of the life of any pension scheme.

When it is first established there will be no pensioners, only employees. They and their employer make contributions that will pay for their pensions when they retire. If they were funding current pensioners then there would be no need to start paying contributions until people start retiring and pensions need to be paid. At the other end of a scheme’s life if the employer shuts down it will no longer have any employees to pay contributions or employer profits from which they can be taken. To keep on paying pensions it must have therefore built up and invested contributions when the pensioners were working.

Even when there are both employees and pensioners their numbers will not move together. If a scheme sponsor takes on staff it does not reduce pension contributions, although it could if all it had to do was fund current pensions from current contributions. 

It is therefore absurd to expect pensions schemes to be in balance on a year to year basis – or talk about years when there there is a net cost as subsidies.

Secondly, opposition to a taxpayer contribution on top of employee and employer contributions fails  to understand how pay-as-you-go pensions work. While they do not have their own separate funds managed (for a fee) by investment specialists, it does not mean that they do not have a fund – simply that is put into the general public spending and tax pot.

This benefits the tax-payer. Think again about the life of our pension scheme. In its early years only contributions are being paid and there are no pensions in payment. If this money is paid into the public purse these are funds that the Treasury does not need to raise in other ways – either through borrowing or increased tax. The cumulative surplus over the fund’s early years before there are any or many pensions to pay is essentially a loan from the scheme’s members to the tax payer. Both sides benefit from this. The tax-payer gets an additional source of funds, while the scheme members escape the risks and costs of conventional investments. But it is right that the tax-payer pays for these funds.

In a scheme with its own funds the scheme gets income not just from employee and employer contributions but also from investments. In a PAYG scheme the tax payer makes these payments in return for the benefit it gets from the payment of contributions upfront many years before they are paid back in pensions.

AS the NAO report puts it:

Payments and contributions are driven by different populations and are not designed to balance in any one year. Overall, contributions to mature pension schemes in the private and public sectors are generally less than pension payments over the long term. Investment income and capital gains make up the difference in the case of funded schemes. In pay-as‑you‑go schemes, again over the long term, Treasury payments reflect the benefit of past alternative use of pension contributions to fund government activities without additional taxation or borrowing.

So the CBI’s argument in the second paragraph does not stand up.

First they say, “the cumulative taxpayer subsidy grows year by year, unmeasured by public sector employees and unexplained by government.”

We say they appear to take miscalculated the net cost-  and if you include all public sector pensions the public finances are running a surplus. Nor is a tax payer contribution a subsidy, simply a return on the loan of public sector pension contributions to the public purse.

Next they say, “This practice must end. After taking account of employee contributions, public sector employers must be charged the full cost of the pensions they provide. ”  This again refuses to take account what the NAO says are “Treasury payments (that) reflect the benefit of past alternative use of pension contributions to fund government activities without additional taxation or borrowing.”

Public sector employers are charged the costs of the pensions they provide through a system run by the Treasury called SCAPE (‘superannuation contributions adjusted for past experience’). Even the harshest critics of public sector pensions think the SCAPE process is sound:

(contributions) are arrived at by an actuarial calculation of how much has to be put aside today to ensure that if it were invested in index-linked gilts, it would be enough to cover all future pensions, including increases in future longevity and earnings (to which pensions are linked before retirement). This calculation cannot be exact (since longevity and earnings change), but an actuary can make a good stab at forecasting future changes, and incorporate these into the current cost calculation. Indeed all the main public sector schemes publish annual accounts (called resource accounts) which include an actuarial report, and many use a model called SCAPE (‘superannuation contributions adjusted for past experience’), developed to cope with the unusual situation of valuing a pension promise with no fund. The theory is unimpeachable the technique asks the question ‘what value of (notional) index-linked gilts does this fund need at date X to fully cover all the future liabilities in the pension scheme valued at date X?’.

Their complaint is about the discount rates used in the SCAPE formula, not the methodology – but that was the subject of my first post.

2 Responses to The CBI on public sector pensions (2)

  1. Tweets that mention The CBI on public sector pensions (2) | ToUChstone blog: A public policy blog from the TUC — Topsy.com
    Apr 16th 2010, 2:54 pm

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  2. The CBI on public sector pensions (3) | ToUChstone blog: A public policy blog from the TUC
    Apr 16th 2010, 4:38 pm

    […] But this return is exactly the kind of taxpayer “subsidy” that the CBI object to under the current  arrangements, which I analysed in my previous post.  […]