UK public sector pension costs understated by £15bn a year


06 Feb, 2017

UK public sector pension costs understated by £15bn a year

Royal Mail has just announced plans to switch its very costly defined benefit pension, for 90,000 out of its 160,000 employees, to a much cheaper and less substantial defined contribution pension.

The mailing firm’s latest financial records show the existing DB pension costs 30% of pensionable salary after member contributions, compared to around 13% for the new DC plan.

Moving to DC will increase Royal Mail’s operating profits, down from just £150m in 2016 to around £230m in the first year and £300m after that.

When the UK government took control of Royal Mail’s existing pension liabilities in 2012, before privatisation, it effectively left a £1.6bn “dowry”. This was used for a partial contribution holiday, so the current DB cash contribution is less than the full 30% cost.

Almost all private sector companies have long since closed their DB pensions to new members, so the number of employee members continues to shrink as they retire or leave. The majority of smaller companies and many large companies, just like Royal Mail, have also closed to existing members.

Meanwhile, DB pensions — almost none existent in the private sector — are thriving in the public sector, with over 5m employee members. All schemes, including those for the NHS, the civil service teachers, local government and the armed forces, are still open to new members.

The previous government claimed to have worked to solve the public sector pensions problems raised by John Hutton, the Labour secretary of state for Work and Pensions between 2005 and 2007. However, the coalition government’s 2015 changes were merely an excuse, and did nothing to bridge the huge and increasing gulf between public sector DB and private sector DC.

The reformed pension did not lower the annual cost to taxpayers of new pension promises. Savings from imposing a higher retirement age and moving to a pension calculated on a career-average salary rather than a final salary, were more or less eradicated, because a higher pension is earned each year.

The government added further insult to injury by saying these changes should last for 25 years.

Public sector DB pensions cost so much less than private sector not because the government has some magic beans, but because it deliberately fiddles how it calculates annual costs. Rather than using bond yields — required by private sector accounting, and reflecting the underlying economics — the government uses a higher arbitrary rate to give a much lower annual cost.

Across the whole of the UK public sector, the official costs of new pension promises are understated by around £15bn a year, compared to the costs of calculating via bond yields. (Arguably using a corporate bond, not a gilt rate, understates the real cost).

To make the real costs more transparent to taxpayers, all public sector employers should use the same annual costing for new pension promises as private sector employers. Identifying annual costs properly would make it clear that public sector DB pensions are not sustainable, just like the private sector, and would lead to genuine reform.

Understating annual public sector pension costs means this generation of taxpayers are not paying the full cost of the public services it uses, but passing it on to be paid by future generations — taxation without representation on a massive scale.

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