Pensions should be boring and public sector pensions doubly so. But to judge from the last few weeks, the subject keeps bubbling into the headlines and proving a headache for policymakers. University lecturers are suing the Universities Superannuation Scheme for trying to cut benefits (it’s actually the universities, not the scheme, that are trying to save money). A think tank (this time the Institute of Economic Affairs, but it could have been any of a number) published yet another excoriation of the public service pension system, suggesting that the true cost has been underestimated by tens
of billions.
Rishi Sunak has broken, temporarily but maybe permanently, the triple lock by which the simplified state pension is increased each year by the highest of inflation, wage inflation or 2.5 per cent. The annual cost of state pensions is nudging £100bn, around 12 per cent of normal public spending. And doctors are refusing to work extra hours because they have to pay tax at over 100 per cent on their notional pension contributions, following added complications to the arcane pensions taxation rules.
It’s no secret why the system is under strain. Public money is very short at present (like always). While the cost of the NHS is about to reach 44 per cent of public spending—an astonishing figure—the state pension alone costs around one-third of the total social security bill. If you then add the cost of pensions for civil servants, regulators and local government employees, the costs look pretty scary.
How did we get into this expensive morass? And where is it likely to end up? Decent pensions for the public sector (state pensions apart) were intended to compensate for the modest salaries for people who thought public service was a vocation. It is why the system of defined benefit pensions survives to this day in government and local government, even though it is on its last legs in the private sector. And despite occasional demands to cap public sector pensions, no one wants to see nurses struggle in old age.
The background to these pressures is well known. First, the demographics. Although, with Covid and other pressures, advances in life expectancy have taken a breather, advances in medicine are likely to extend lifespans significantly in coming decades.
Secondly, as we have seen with the HGV driver shortage, the population is not producing enough indigenous workers to support the increasing percentage of old people of the future. We need women of childbearing age to have 2.04 babies on average to maintain a level population—and the current number stands at around 1.63.
“We now have around 200,000 pages of pensions regulation and around 6,000 pages of pensions taxation rules. This is too much”
Meanwhile, the political environment is against using immigration as a way to moderate the problem. This triple whammy of increased longevity, reduced birth rates and controlled immigration is conspiring to make pensions in the public sector hard to fund. And the fact that economic growth is predicted to be modest for the foreseeable future suggests we are going to struggle to earn our way out of
the challenge.
But the worst damage is self-inflicted, through dysfunctional short-term public policy. The excessive regulatory framework for—and double-taxing of—pensions has made private provision of salary-related pensions too expensive and too complicated for most employers. It has also provoked a sense of jealousy. Why should the public sector, for which I pay my taxes, have better pensions than me, who cannot afford them?
Many of these pressures may continue; the birth rate is lower than a good pensions system demands. Immigration is unlikely to save the situation. Inflation may increase pressures on pension provision. And every morning bears fresh pages of regulation and constraining tax rules.
But there are signs that some of these pressures may be about to ease. Increases in interest rates might ease the regulatory foolishness of excessive risk management. Regulators insist that pension liabilities are measured by government interest rates: when rates are low, liabilities are high, and vice versa. So increasing interest rates may paradoxically yet save public sector pensions.
Second, the possible introduction of “collective defined contribution” workplace schemes—a lighter version of defined benefit schemes being partly pioneered by Royal Mail, and made legal under the Pension Schemes Act 2021—may reduce feelings of jealousy from the private sector. With current labour shortages, the use of pension schemes, especially salary-related systems, may again become a recruitment and retention tool. And recent government initiatives to shred unnecessary regulation and regulators may make it easier for private sector employers to offer public-sector-like pensions.
We now have around 200,000 pages of pensions regulation and around 6,000 pages of pensions taxation rules. This is too much. It needs to be reduced. We could stop measuring liabilities according to artificially repressed interest rates; we could encourage the private and public sectors to offer salary-related benefits without imposing unmanageable guarantees; we could change the mindset about retirement ages to encourage most of us to work until 75 (at least).
We could then allow nurses, town planners, teachers, MPs, civil servants and lecturers to enjoy a stress-free and comfortable—not to mention affordable—retirement.
