Exploding the pensions myth

Anthony Mayer speaks to the Torquay pension managers conference 2009

Thank you for inviting me.

In my following remarks, I want to address the myth of the long-term sustainability of public sector pension funds.

The misinformation and disinformation being bandied about in the press and by some commentators is frankly, astonishing.

To paraphrase a typical headline. "£1 trillion hole in gold-plated public sector pension schemes." Hole? No more than a contingent actuarial hole as it were. The hole is the actuarially estimated difference between long term future liabilities of pension funds and future income - crucially, if you do nothing. Gold plated? The average pension of an LPFA pensioner is £4,000 p.a.

The reality is that all public sector pension funds are always sustainable . provided that benefits to pensioners, employer/employee contributions and qualifying retirement ages are set at the right level.

You could never guess it from the media, but the Local Government Pension Scheme is currently strongly cash positive. Employer contributions, employee contributions and investment returns totalled £10.2 billion in 2008/09. Benefits payable totalled £5.6 billion. There was a surplus of £4.6 billion. To put it another way, contributions and investment income exceeded benefits payable by over 80%. There is no immediate cash flow problem. I repeat, there is no immediate cash flow problem. So what is the problem? Easy. It has little or nothing to do with investment returns over the long term. Even in the last six months, these are moving back to long term trends which are hugely positive compared with investing in cash or bonds.

The problem is entirely good news for us in our real lives. We are living longer. Every decade since the war, our average death age is increasing by two years. Put more dramatically, for every hour we live, our average death age is increasing by 12 minutes. Put even more dramatically, the average death age of the 63½ year old, overweight, non-smoking male living in South West London is now 87.

So what do you do to fix the problem of us living longer as it applies to pensions? The nettle we all know. The snag is that successive Governments have failed to grasp it.

You can tweak the benefits of pension schemes here and there. You can close pension schemes to new entrants; you can go for combined Defined Contribution and Defined Benefit Schemes; you can go for basing pensions on career average salaries; you can cap pensions at £50,000 p.a.

All of these tweaks doubtless deserve serious consideration. But there are downsides. Closing pension schemes to new entrant reduces the required contribution from employers. But it loses employee contributions therefore bringing forward the date schemes fall into deficit. Combined Defined Contribution and Defined Benefit schemes halve the burden on employers. But they bring the date funds move into deficit that much further forward. And people with lower pensions than they need because they have not put enough into their pots will inevitably look to the State to bail them out.

Career averaging sounds good; in reality less than 10% of employees earn significantly more at the end of their careers than they do in mid-career. And as for the £50,000 cap on public sector pensions, this is no more than political window dressing. In the LPFA scheme, of 27,000 pensioners, currently abut 80 get pensions of more than £50,000 p.a.: 0.3% of the total. The remaining 99.7% of pensioners either have not earned enough or do not have enough years service.

So yes, let us look at these possible changes to the benefit structure of the LGPS. But let us not lose focus on the two big beast elements of the equation for making funded public sector pension schemes sustainable over the long term.

First, we need to give serious consideration to increasing employee contributions, The current average contribution rates of employees to funded public sector schemes is 6.3% of salary. Increase it to 10% then roughly, the date at which for instance the LPFA fund for instance goes into deficit would extend from 2021 - 2024 to beyond 2030. All sorts of tunes are playable: rather than a big bang, you could for instance increase the contributions of new entrants to 10% and phase the increase in contributions over time for existing members. That of itself would make a major contribution to securing sustainability. Yes we will need to effectively make the case that the LGPS still provides excellent value for money at those levels of contribution but, whatever else, the principle of increasing employee contributions is straightforward. If we all have more years getting a pension, we must pay more for it. There are no free lunches. And there is no persuasive case for the general taxpayer further to subsidise public sector pensions by increasing employer contributions.

Second, if we want to make funded public sector pension schemes sustainable in the longer term we need to give serious consideration to increasing the age at which you can take your pension. An increase to 70 would immediately make all pension funds sustainable in the longer term. In the 1950s the average period between retirement and death was 10-15 years. Now, it is 25-30 years. We need a profound cultural shift to recognise this reality. First if we die later we need to work longer. Second, and again, there are no free lunches. Employees need to pay more for their pensions. Pensions from employers are not a right. Once again tunes can be played. For instance, make the retirement age 68 and combine it with higher employee contributions. Whatever the tune, it is both possible and highly desirable to make pensions funds sustainable. The cost of doing nothing is the almost inevitable closure of pension schemes and heavier reliance on Government for higher state pensions.