UK, March 8, 2006 – Britain's unfunded public sector pension liabilities will be approximately £960 billion in March 2006, according to consultants Watson Wyatt. This is over 80 per cent higher than the most recent Government estimate and amounts to £40,000 per household in the UK.
Stephen Yeo, a senior consultant at Watson Wyatt, said: "Pensions have become more expensive in recent years because people are living longer and the amount that can be expected to be earned on investments has gone down. Public sector pensions are backed by the Government, so they are especially valuable.
"The most recent official estimate put the present value of the accrued liabilities in all unfunded public sector pension schemes at £530 billion at March 2005. This is a significant underestimate because it doesn’t take account of falls in long-term interest rates that have pushed up the cost of pensions. Once account is taken of current interest rates, a year’s extra pension and improving longevity, this figure increases by over 80 per cent to £960 billion.
'The Government is taking a rosy view of the cost of public sector pensions. If the private sector were allowed to use public sector methods to value their own pension liabilities, the £78 billion deficit for the companies in the FTSE 350 index would be completely wiped out."
Notes to editors
- The most recent estimate of the accrued unfunded public sector pension liability was £530 billion as at March 2005 (Des Browne, Chief Secretary to the Treasury, Commons Oral Questions, 2 March 2006: Column 388W) For most schemes this is based on an interest rate of 3.5 per cent in excess of inflation. It excludes the cost of any pensions earned after March 2005
- The bulk of the liability for unfunded pension schemes relates to four large schemes: Teachers, NHS, Civil Service and Armed Forces. In 2005 these accounted for 77 per cent of the total estimated liability. Smaller schemes exist for police, the fire service, various Scottish bodies and other public sector bodies. The Local Government Pension Scheme is funded and is excluded from the figures.
- The Government Actuary’s Department has accepted that the interest rate that should be used to calculate the liability for Whole of Government Accounts purposes will be reduced from 3.5 per cent to 2.8 per cent from 2005-06 (Financial Reporting Advisory Board Report for the Period April 2003 to March 2004 paragraph 2.11). This rate, of 2.8 per cent is similar to the rate that was used in early 2004 by the private sector under accounting standard FRS17. We believe this interest rate is too high to be used to assess the current public sector liability for two reasons. First, it was based on AA rated corporate bonds, which can default. Public sector pensions are backed by the Government, so the appropriate rate at which to discount their liability is the (risk-free) yield on index-linked Government stock. The Government already uses the index-linked stock yield to discount other liabilities of a similar duration, such as nuclear decommissioning liabilities. Second, the yield on all forms of bonds, whether corporate or Government, has fallen sharply in the last two years.
- The yield on long-dated index-linked Government stock is published daily based on two different expected rates of inflation: 0 per cent and 5 per cent. Inflation is expected to average just over 2.5 per cent so for practical purposes we have taken the average of the two. The yields on 6 March are 1.03 per cent and 0.90 per cent, giving an average of 0.965 per cent. We have used 1.00 per cent for our calculations to avoid overstating the liability. Using this interest rate, rather than 3.5 per cent, we estimate that the value of the liability at March 2005 rises from £530 billion to £885 billion. (At 31 March 2005 the yields were 1.75 per cent and 1.59 per cent, respectively, so we believe the appropriate interest rate at that date would have been 1.67 per cent.)
- Making allowance for the lower interest rate, the value of a year’s accrual would be about £47 billion. Adding this gives an estimate of the liability at March 2006 of £932 billion.
- It is some years since full mortality analyses were carried out for most public sector schemes, and it is unclear what allowance for mortality improvements has been made. It is likely that some further allowance is appropriate. If a 3 per cent adjustment was appropriate, the total liability at March 2006 would be approximately £960 billion.
- In February 2005 we published an estimate of the liability as at March 2005 of £690 billion). The £270 billion difference between this and £960 billion is attributable to use of a lower interest rate (£190 billion) an extra year’s accrual (£48 billion) and changes in the data and events during 2004/5 (£48 billion) offset by a lower adjustment for unanticipated improvements in longevity (£19 billion)
For further information contact
Watson Wyatt Limited
+44 (0) 20 7227 2370
+44 (0) 7903 349712
Head of Public Relations
Watson Wyatt Limited
+44 (0) 1737 273370
Visit Watson Wyatt's online press office:
Watson Wyatt Worldwide
Watson Wyatt is a leading global human capital and financial management consulting firm. The firm specialises in employee benefits, human capital strategies, technology solutions, and insurance and financial services and has more than 6,000 associates in 30 countries. The firm is located on the web at www.watsonwyatt.com