ONS reveals full UK pension liabilities

David Kingman was present as the ONS officially announced the UK’s full pension liabilities for the first time at the Royal Statistical Society on 27 April

On Friday 27 April, the ONS held a seminar at the Royal Statistical Society headquarters in Errol Street, east London, where they officially announced the UK’s full public and private pension liabilities for the first time.

Complete liabilities

The results showed the extraordinary sums that Britain has committed to pay its future retirees. In total, the UK is committed to paying £7.1 trillion in pensions to people who are currently either already retired or still in the workforce.

This is equivalent to nearly five times the UK’s total economic output. Such a figure may be hard to put into proportion, as a trillion – a thousand billion – is obviously a huge number.

If you try to work out what a trillion pounds would look like you get some amazing statistics. A trillion one pound coins arranged next to each other would stretch around the equator over 78 times, and their combined weight would be 105,263 metric tons (or more than ten times the Eiffel Tower). Counting out that many one pound coins, at a rate of one coin per second, would take you 31,709 years.

This figure for the total liability includes private sector liabilities, which are less onerous on future generations because they are all funded. Private sector workplace pension schemes have total liabilities of £1.7 trillion, and this total is likely to decrease over time as so many private sector pension schemes have been closed to new entrants and stopped allowing further accrual by existing members. There is an additional £0.4 trillion worth of liabilities for individual private pensions, but these are also fully funded.

More important are the total government liabilities of £5 trillion. These break down as follows:

  • Government employee pensions: £1.2 trillion (unfunded: £0.9 trillion; funded: £0.3 trillion)
  • State pensions: £3.8 trillion (all unfunded)

The difference between the funded and unfunded liabilities is very significant. Funded liabilities refer to pension schemes where the money that people pay in as contributions is invested in a fund that floats on the financial markets, so that enough money to pay the pensions builds up over time.

Unfunded schemes work in a different way; with these, the money people pay in is paid out again straightaway on current pensioners, with any difference between incomings and outgoings being met through general taxation. In practice, they are a mechanism for transferring money directly between current workers and those who are in retirement.

Of the government’s liabilities, the most daunting is the £3.8 trillion that will have to be spent on state pensions, which is mostly accounted for the Basic State Pension (BSP). These work on an unfunded system, with only a very weak relationship between the amount of money an individual has paid in through their National Insurance contributions and the benefits they are eligible to receive.

The liability for state pensions is equal to 263% of Britain’s total GDP, which is actually slightly below the EU-level average of 278%. The scale of state pension liabilities is rather surprising given that Britain has a notoriously ungenerous state pension, a fact which will restrict the government’s political room for manoeuvre if they need to make changes to it in the future.

Most of the government employee pension liabilities of £1.2 trillion are unfunded, as only £0.3 trillion of them (largely in the Local Government Pension Scheme) are being run on a funded model. This represents a huge burden which the present generation is passing on to its children and grandchildren down the line.

Longevity assumptions and discount rates

It was a positive move by the ONS to disclose this information, as it means commentators and policy-makers have access to an official assessment of Britain’s pension commitments for the first time. The size of the challenge we are setting future generations to pay off these liabilities is clear. However, there is the possibility that the true picture could be even grimmer than these figures suggest.

Certain assumptions underpin these figures which could be open to questioning. Firstly, there is the discount rate. As pension liabilities naturally span long periods of time, amounts of money which will be paid in the future need to be converted into present-day money in order to estimate their cost. This is done using an accounting device called a discount rate.

As the discount rate which is chosen has a big impact on the overall size of the liabilities, it is a very important number. There is also a strong political element to the discount rate which is chosen, as using a higher one makes the future liabilities appear to be smaller, and thus the case for painful reforms in the present day less urgent.

In calculating these figures, the ONS used a discount rate of 3% as mandated by Eurostat, the European statistics body. However, this is convenient for the government, as the ONS also announced that reducing the discount rate by 1% made the liabilities one-third larger. A discount rate of 1% – potentially in line with our average rate of real economic growth over the next few years – would paint a bleaker picture still.

Longevity assumptions are also important when projecting the future cost of pension liabilities, as the cost of pensions obviously goes up the longer you expect people to live. Longevity assumptions have persistently been underestimated in previous estimations of pension costs, so it would provide better information if the ONS included projections of the liabilities using a range of different longevity assumptions in its figures.

When is a liability not really a liability?

Aside from the economics of the figures themselves, underpinning all this information are certain key questions over the nature of pension liabilities.

When it isn’t underpinned by a fund, a pension liability is essentially a promise to pay someone a certain pension when they reach a certain age, in return for contributions during the years beforehand. The government makes this promise to virtually all its citizens over the state pension, in return for National Insurance contributions, while government employee pensions also rely on the same principle.

The interesting question is whether the government can get out of any of these promises if it doesn’t think it can afford to honour all of them. If it comes down to competition for limited resources, which promises are more binding – those it’s made to general citizens, or its own employees? To put it bluntly, who gets first dibs on the money?

Dave Hobbs of the ONS gave a talk at the seminar in which he made the argument that pension liabilities are not the same as other debt commitments because they are non-contractual; people may be expecting a pension, but the government has the ability to change what they’re entitled to. He cited the recent changes made to public sector pensions as proof that the government can move the goalposts should it need to.

While this may be true to an extent, such a strategy surely has it limits. After all, the negative response from trade unions to the fairly modest reforms proposed by Lord Hutton has shown that the government’s powers are limited when it comes to changing the pension arrangements for its own workers. As for the state pension, what government would dare interfere with the benefits expected by the over-50s, given their willingness to vote? While in theory the government can wave a magic wand over its pension liabilities, in reality any government which tried to do this would surely be punished at the ballot box.

The ONS has enriched the debate over pensions by publishing this information, but they need to go even further next time, recognizing that these liabilities will have to be addressed, and providing a sensitivity analysis that includes a range of discount rates and longevity projections. Only then can we have a genuinely free and fair debate over the correct policies for solving Britain’s pensions crisis.