Public sector pensions are seen as compensation for a lifetime of hard underpaid, under-appreciated labour.
However, a recent Office for National Statistics (ONS) survey showed that public sector workers retire with pensions worth up to eight times that of their private sector equivalents.The anomaly is the way that pension schemes work in the public sector, which should have been blindingly obvious from the minute they were formulated, are unaffordable.
If you are lucky enough to have accumulated some money in a private pension, the pension company is legally obliged to keep reserves of cash or liquid assets in order to fund these pension schemes. They also invest in a wide portfolio of things which make a return, paying interest on your savings, and increasing the value of your pot, and thus your pension payments.
A lot of major companies will have their own pension departments that work on assets for these funds. A good example of this would be General Motors, who have seen a massive reduction in employment over the years, but are now having to pay pensions to the thousands of workers they once had. This has become such a massive liability for the company that they are often referred to as “a massive pension company with a small car manufacturer attached.”
The government has no such requirement. All current pensions are paid by current income. This means that today’s pensioners never actually had a pot with their name on it, and they were in fact paying for current pensions.
In the years following the baby boom this was sustainable, as there would have been plenty of fresh blood coming in to replace those who are just becoming of pensionable age, but we have seen a decline in the birth rate of the UK, as well as the children born in the baby boom generation coming up to retirement themselves. This has led to a change in what is known as the dependency ratio. A government report which looked at the statistics said:
“One notable trend is past and projected ageing within the pensioner population. In 1971, persons aged 65+ comprised 13.2 per cent of the total UK population, and persons aged 80+ comprised 2.3 per cent of this total. By 2000, the 65+ population had grown to 15.6 per cent of the total, but the 80+ population had almost doubled its proportionate share to 4.0 per cent. Over the 50 years to 2050, the Government Actuary’s Department projects that the 65+ age group will have expanded to 24.4 per cent of the total UK population, but that the 80+ age group will have more than doubled to reach 9.1 per cent of this total.”
This clearly means that there needs to be serious pension reform and fast. We are going to see a lot more people claiming money, and fewer people supporting them.
But how do we solve this problem? One of the main things that has happened in the private sector is almost the complete abolition of a defined benefit pension scheme, where what a person is paid based on time at the company, earnings history and age, and moved to a defined contribution scheme, where employees pay a specific amount every month, which then goes into a pot which is invested.
The public sector however has lagged far behind this, and although many of the new employees will be on a defined contribution scheme, there are a lot of people still on a defined benefit scheme, which is a lot more costly.
As in most cases where the government fails to provide correctly, the solution is the private sector. Margaret Thatcher decided to give those who would agree to provide for themselves incentives, by giving tax relief on private pensions, which saw the amount of people taking private pensions increase significantly. This became tricky when Gordon Brown decided he would take £5 billion from pension funds every year in tax -Something which was a slap in the face to Thatcher’s idea of self provision.
The way forward is one of two things. Either the government removes itself from the role of pension provision, and instead brings in private companies to manage pensions (which can involve as much or as little risk as you like), or it could become what is known as a “funded” pension provider, where they do not fund current pensions out of current income.
The current system effectively makes the government one of the biggest pyramid schemes in the world. Your payment depends on those joining, if the government were to source this out to several private funds, they could continue to pay only a basic state pension as a safety net, and significantly reduce National Insurance contributions which people could spend themselves on a private pension.
As much as those who went on strike last week will not like to admit it: it’s either that, or we go bust.