A Small Number with Surprisingly Large Consequences

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Angus Hanton


4 May 2011

How much will the pension promises which we are making today cost us in the future? In this fascinating new analysis, Angus Hanton argues that the government has been guilty of systematically undervaluing the cost of its pension liabilities towards public sector workers in order to avoid having to make difficult political decisions about how much we can really afford to promise them.

In order to work out the cost in today’s money of a financial liability which will have to be paid in the future, economists use a device called a “discount rate” to express it in terms of “net present value.” The higher the rate which is chosen, the smaller the cost of the liabilities appears to be in the present. When it comes to massive liabilities – such as paying the unfunded pensions of today’s public sector workers – it is clearly in the government’s interests to make these liabilities appear to be as small as possible by choosing a higher discount rate. The losers from this deception will be future generations of taxpayers, who are being handed an enormous bill without being given any say in the matter.

The sums involved are vast: the current liabilities to provide pensions for teachers, civil servants, NHS workers and the armed forces are already officially worth £800 billion and growing, and would be much bigger if a lower discount rate were being used. This paper calls attention to the way we are robbing our children by passing on these unfunded burdens, and it deserves to be read by anyone who cares about promoting justice for future generations.



Posted on: 4 May, 2011

3 thoughts on “A Small Number with Surprisingly Large Consequences

  1. Rupert Read

    Good stuff Angus.
    The bottom line is that we MUST reduce the discount rate as the govt proposes, and further, as you imply: for not to do so is (a) to assume absurd projections of economic growth into the future and (b) is literally to discount future people.

  2. Neil Davies

    Interesting point, well made.

    Two observations:

    1) Yesterrday the real yield on 50 year UK government debt fell to 0.08%. Is there any likelihood that state pension liabilities could be met under a discount rate that’s practically zero? What are the implications of a negative discount rate?

    2) We also need to consider the implications for public sector investments. The discount rate must be used to estimate the potential benefits and costs of government projects. If the discount rate falls then the present value of future returns to investments increases. So projects such as high speed rail or nuclear power plants, and investment in research will be more likely to be cost effective.

    Surely the correct response to a fall in the discount rate is for the government to increase investment and decrease current consumption? I.e. Increase government saving and investment in order to meet it’s future liabities. Isn’t this precisely the opposite of what the government is doing?

    Oh have a look at the government actuary departments report on the solvency of the basic state pension. Their base case assumed a real investment return of 2%, (currently 0.08%) and real earnings growth of 2% (currently -3%, it’s not been above 1% for the last decade). I have real doubts whether these schemes are solvent under sensible actuarial assumptions.

  3. IanV

    The 3.5% Discount factor includes (you say 2%pa for p.c income growth – ie 57% of the discount factor) . Given the current financial climate and global redistribution , is this not over-stated ?
    How can inflation be seperated off , if it also included in the on-going pension amount calculation (eg annual increase asessed at half of RPI , or CPI ??)

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