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Is the Treasury understating pension liabilities?

Robert Peston | 17:18 UK time, Tuesday, 3 May 2011

Belatedly, I've got round to looking at the Treasury's recent decision to change how it calculates the necessary contributions that have to be made to cover the future costs of unfunded public service pensions.

HM Treasury

My interest was sparked by a letter sent to the chancellor by 23 pension experts, organised by the consultant John Ralfe. They argue that the Treasury has made a mistake in its choice of a new so-called discount rate.

If you think this is tedious abstruse stuff that has no relevance to you, think again. The aggregate public-sector net liability for pensions is so huge - perhaps £1 trillion - that it matters to all of us as taxpayers, especially those likely to be paying tax in 10 and 20 years time, that the government has a reliable and accurate valuation of pension promises.

Pensions represent, to coin the phrase, a massive off-balance-sheet debt. And as we've all learned to our cost from the financial crisis of 2007-8, it is a bad idea to carry on blithely pretending off-balance-sheet liabilities don't exist.

So what is this blessed discount rate? Well in the private sector it can be seen as the number used to translate into today's money a commitment to pay £650 a week pension (for example) for 30 years or so to a retired employee (till he or she dies), so that we can see whether there's enough money in the pension fund to pay that employee (and all the other employees) during his or her long retirement.

The point of the discount rate is to assess whether there's enough money in the pension fund - or whether it needs to be topped up.

Which is all very well, except that for most of the public sector, there are no funds or pots of money to pay for future pensions. Most of the pension promises are unfunded, payable out of employees' current contributions and out of general taxation.

That said, since public sector workers are increasingly expected to make a contribution to the costs of their own pensions, it would presumably be sensible for that contribution to be set at a level that is rationally related to the value of promised pensions.

So what is the best way of measuring the cost today of new pension promises?

Well the government has decided to "discount" those promises by the rate at which the economy is expected to grow.

Now there is some logic to that: the growth rate of the economy should determine the growth rate of tax revenues; and the growth rate of tax revenues will have a direct bearing on whether future pension promises will bankrupt us all or not.

But here's the thing. Any private sector chief executive might well be sent to prison if he or she decided to use the equivalent discount rate for a company, which would be the expected growth rate of that company's revenues or profits.

The reason is that although it might be possible to remove subjectivity (or in a worst case, manipulation) from any long-term forecast of the growth of GDP or of a company's turnover, it is not possible to remove considerable uncertainty.

To illustrate, the Treasury has chosen a GDP growth rate of 3% per annum as the discount rate for public sector pensions, which is considerably above the rate at which the UK economy has grown for years or indeed may grow for many years.

If we were growing at 3%, we would in practice be less worried about the off-balance-sheet liabilities of public-sector pensions, because the on-balance-sheet debt of the government would not be growing at an unsustainably fast rate.

To put it another way, in choosing its view of the long term growth rate of GDP as the discount rate, the Treasury is arguably understating the burden of future pensions to a considerable extent.

So what discount rate do companies use?

Well they are obliged to discount the liabilities at the yield or interest rate on AA rated corporate bonds.

Which may not be ideal, but has some advantages: there is a market price for AA corporate bonds, so the yield or discount rate is difficult to manipulate by unscrupulous employers; and it tells the company how much money would need to be in the pension pot, on the basis that all the money were invested in relatively safe investments (AA corporate bonds).

Now Ralfe and his chums believe that the discount rate for public sector promises should be the yield on long-term index linked gilts (gilts are bonds or debts of the British government) - partly because this too has a difficult-to-manipulate market price and because an index-linked government bond is a very similar liability to a public sector pension promise (both are protected against inflation, both are in effect debts of the government).

They point out that gilt interest and principal payments are paid out of future tax revenues, just as future pensions are. So if the value today of future pensions should be discounted at the GDP rate, that's how index linked gilts should be value on the government's balance sheet - which would be bonkers.

Anyway, if you've read this far (and many congratulations to you if you have), you may take the view that it would not be rational to impose a tougher discount rate on the government than on private-sector companies - which is what Ralfe et al seem to want, in that the yield on index linked gilts will always be lower than the yield on AA corporate bonds (because HMG, even with all its debts, is deemed to be more creditworthy than any British business).

But for a government and for a chancellor who have made it a badge of honour to bring transparency and prudence to public-sector finances, prospective GDP growth does look a slightly rum discount rate for valuing those enormous pension liabilities.

Comments

  • Comment number 1.

    'the necessary contributions that have to be made to cover the future costs of unfunded public service pensions'

    As the piece goes on to allude to, there is a lot inherent in that simple sentence.

  • Comment number 2.

    Mr Peston fails to point out that the biggest public sector scheme for local government workers is fully funded, that is we have paid for our future pensions and he does not distinguish this from public sector pensions which include the Civil Service, Teachers, the Armed Forces and privatised services. Nor does he account for the millions taken out by government when the economy was booming.

  • Comment number 3.

    I can't think of any index-linked corporate bonds, though it should be possible to compare conventional long-dated corporate bonds with long-dated gilts, thereby suggesting a reasonable "premium" for the AAA government debt over AA corporates.

    However, I suspect that since this problem isn't going to become critical for many years, the current crop of civil servants and politicians are really leaving it for the next generation to sort out.

  • Comment number 4.

    I fear this is one of those "we'll be long gone by the time this comes home to roost" issues, and given that, Officials and esp Government think it best to use numbers that heavily soften the very worrying picture that is reality. It's always been that way on pension issues sadly, and given the unrest that would happen right here and now if they embraced measures that would REALLY address the Public Sector pensions crisis-to-come - summers/autumns/winters of discontent and all that - political cowardice is the better part of a few terms in office, or something like that!

    Great piece Robert - good for you for ploughing through the 'technicalness' to share it in plain English...

    Martin Campbell

  • Comment number 5.

    I wondered whether Robert Peston will finally bring us his insight knowledge to the not inconsiderable news, buried under Kate Middleton's veil last Friday, that the EU has started to investigate the banks on whether or not they manipulate the Credit Default Swap market.

    That is the betting market for Europeripherie countries going bust. the allegations are, that these CDS rates are rigged. Something anybody with any knowledge of the finance industry suspected all along.

    Robert Peston has heard of Credit Default Swaps, I am sure. Have you, Robert?

    Instead of that he worries us about a "discount rate" for public state pensions which is completely irrelevant. No matter what "pension experts" say - who are these "experts" anyway - and who is consultant John Ralfe? Never heard of him! Not somebody who is being paid to influence public opinion, surely not?

    Why should we not worry? If the state's discount rate is wrong, it can decide to impose new taxes on the rich, and wealthy, or any other sub-group it choses to pick on. It could, for example, decide to tax all pensions above £20,000 at 90%, to pay for the short fall in public sector pensions.

    So, where is the view on whether we are being ripped off with Credit Default Swaps?

  • Comment number 6.

    "...in that the yield on index linked gilts will always be lower than the yield on AA corporate bonds". Well, we hope it will. I've not checked, but would guess Irish government debt now yields more than some large AA corporate bonds of firms based there?

    @2 - true, the local government scheme is funded. Is it really the largest? (Bigger than the NHS?). Any idea of its size as a proportion of public sector schemes? I'm guessing 10-25% at most? Even if that (significant) bit is funded, that leaves a lot which isn't...

  • Comment number 7.

    "They point out that gilt interest and principal payments are paid out of future tax revenues, just as future pensions are."

    As you say " bonkers"

  • Comment number 8.

    They are right to be concerned, the GDP fans seemed to have wilfully discounted the fact that there is at least one recession every ten years, which will knock a huge hole in their growth predictions. And not all public sector pensions are 'unfunded', some of the better managed funds are in surplus, for instance the NHS fund. It's only where managers are taking 'contribution holidays' that future problems occur.

  • Comment number 9.

    @6
    LGPS has 4.6 million members
    Don't know about NHS but that only includes England and Wales and not contractors

  • Comment number 10.

    It makes absolutely no sense to pre-save for pension liabilities. Put it this way: if all the persons in the UK were to retire except one, would it matter if some fund would have enough money to pay for pension liabilities? Of course not, that one person cannot provide all the goods and services retirees need.

    If 60% of working age population were to suddenly retire, it would not matter if they had pre-saved all their pensions, because remaining 40% of the population could not provide those goods and services at those prices, and if they all tried to spend it, all the money would compete for limited resources and cause inflation. What would need to happen is to tax some spending power away from the workers so that that there would be real labor and resources available to pensioners to buy.

    Situation is essentially no different when smaller proportion of the population retires. Fruits of the productive capacity of the economy has to be divided among larger pool of consumers, that means consumption power had to be removed from workers and transferred to the pensioners. Simple tax to pay pensions is an income transfer that achieves this and there is no reason for anything more complicated.

  • Comment number 11.

    In the interest of clarity, what is the current yield on AA corporate bonds ?
    How does it compare with the discount rate used for the NHS pension scheme which was fully revised in 2008? At the time it was supposed to be self-financing and is I believe currently in surplus: nobody seems to mention this in all the talk of massive liabilities.

  • Comment number 12.

    Valiant attempt at explaining the discount rate, but gilt yields are currently inappropriate as a measure of social time preference as quantitative easing (the Bank of England buying them up) has pushed down the yield. So has a flight from assets perceived to be riskier, meaning that gilt prices don't reflect their true social value

  • Comment number 13.

    The gigantic pensions deficit is directly the result of the combination of the long tern gross underestimation of life expectancy tables, and the dire incompetence of the Bank of England in setting the price of money. One of these by itself could possibly have been managed but both together are totally calamitous.

    Life expectancy has been increasing far more rapidly than the life industry's tables have acknowledged - this underestimates the liabilities for paying pensions.

    What pensions are paid with is the capital of the fund's investment and the return on guilts in which the fund is invested.

    The 'Fools of Threadneedle Street' have set interest rates idiotically low for over a decade and so the return on guilts is far too low. The Fools are not so ignorant as not to know that this policy would destroy pensions, savings and investment - one can only suspect that they thought that the zero/negative effective interest rates would not last long, so in the longer term they could get out of their bind. However real incomes are now falling, just as they did at the start of the 1870s Long Depression, in fact they are falling faster and deeper than in the 1870s - all because of the idiocy of the Bank of England! This current Long Depression will most probably last till 2040 - all due to the Bank of England's decade of idiocy!

    This by they way is something I have been banging on about for well over two years - nobody (or rather just a few) listened and now the chickens are coming home to roost!

    This week the Bank of England MUST raise interest rates - substantially - or we are all doomed (not just a few marginal borrowers!)

  • Comment number 14.

    #12. James Evans wrote:

    "...but gilt yields are currently inappropriate as a measure of social time preference as quantitative easing (the Bank of England buying them up) has pushed down the yield."

    But that is how pensions work! That is how the Bank of England knew that pensions worked!!!!!

    So the collapse of pensions (and savings) income is the direct result of propping up the banks and bankers excessive remuneration! We have quite literally spent our pensions before we retired on inflated property prices - all due the Bank of England's incompetence!

  • Comment number 15.

    #5 matt_us
    May I ask just who you are to decide what is and what is not irrelevant? We know about Robert Peston and have an idea of his knowledge but yours?
    I agree that the Credit Default Swaps investigation is important and all power to the EU for instigating it so maybe Robert would like to give us the benefit of his opinions on same.

  • Comment number 16.

    The Treasury, pensions experts and the public at large will continue to be perplexed as to how to solve this "financial" problem, for as long as it takes them to understand that taxes "pay" for precisely nothing, as does government debt issuance.

    As @10 zfvr is saying, the only thing that realy matters is whether there will be sufficient resources, goods and services produced by the working population, to prevent inflation when the people start spending their pensions.

    We can do something about that now, by public investment in education, technology and infrastructure, to boost the future availability of goods/services required by the elderly, and therefore its accounting reflection, long term trend growth in GDP.

    It's not about "government finances" (as this phrase is an oxymoron used by people who still mourn the loss of the gold standard and other "sound money"ists), it's about the availablity of real goods, services and resources.

    It's also the correct way to reduce the "structural deficit", because the structural problems in the economy are down to under-investment, rather than spending too much.

    If young people are not now being educated and trained in, for example, surgery to replace the hips of the elderly, or other skills pensioners will need, then this will just build up the potential for inflation and/or poverty later, as these skills become a scarce resource, and (as an accounting reflection) long term GDP growth therefore diminishes.

  • Comment number 17.

    "So, where is the view on whether we are being ripped off with Credit Default Swaps? " - is not really an important question - to buy or sell them you have to be a sophisticated investor and there are proably only a couple of thousand of these in the world. (you are assumed to be bright enough to be able to work out if you are being ripped off in the pricing of them - if you cant you should not be buying them - if you are stupid (AIG) then you deserve it)

    The more relevant is - will a sovereign default in the medium term (within 5 years)
    Greece - yes 70% - no 10% - Euro fudge 20% - should they? YES
    Ireland - yes 40% - no 20% - Euro fudge 40% - st? EU bailout of their banks then NO
    Portugal - yes 40% - no 30% - euro fudge 30% - sh? tidy up the banks then YES
    USA - yes 1% - no 99%
    UK - yes 2% - no 98%

  • Comment number 18.

    Local government schemes are fully funded but managed locally with enormously diverse management cost ratios - a case for rationalisation. The point about pensions liability well put above in the future resources available to generate the wealth (taxation) to sustain them. We do not have a nascent pension crisis we have contemporary employment crisis with nearly 8 million reservists in the army of the unemployed and economically inactive

  • Comment number 19.

    MASH with SOUP and if my luck in a TIN of CORN BEEF for my Sunday Roast.

  • Comment number 20.

    The problem will be solved as follows. Over the next 10 years price inflation will far outstrip wage inflation and this differential compounded year on year will ensure that the purchasing power of said pensions is affordable when they are paid out,

    Yours Aye,

    Graucho

  • Comment number 21.

    There must be something really wrong in the reasoning. The fact is, the higher the discount rate, the smaller the liabilities' present value will appear to be. Suppose the rate on gilts rises because of too much public deficit, and that's the discount rate applied -- hey presto, the pensions will suddenly look more affordable. Let runaway inflation raise the growth in /nominal/ GDP, and pension liabilities are not revalued, and they'll start to look insignificant.

  • Comment number 22.

    #21. Pan Albert wrote:

    "Suppose the rate on gilts rises because of too much public deficit, and that's the discount rate applied -- hey presto, the pensions will suddenly look more affordable"

    Your logic is correct.... However the 'Fools' have got themselves into the position that they cannot permit interest rates to rise ever again as the banks will almost instantaneously go bust! This neatly describes the idiocy of the whole of the last decade! (and why Mervyn King is the most destructive force in the Kingdom!)

  • Comment number 23.

    Have been led to believe that for every £1 paid by the the public sector towards their pensions (for those who do), the taxpayer - at local (council tax) and national (income tax) - was subbing that circa £6 toward the cost

    Some councils (as I understand it) actually need between 15 and 20% of their council tax to meet immediate and imminent pension commitments; And that figure is set to rise after the last administration made various promises in the two years, or so, before losing the last election

    The bottom line, of course, is that if the private sector doesn't make enough money to cover the 'burden', it doesn't matter how big the public sector pensions are. Some won't get paid, or more will get paid less. It's that simple

    Unless the public sector can teach the rest of us the secret of alchemy, they are going to have to find another way. The way the rest of the world finds it - out of their own pocket

  • Comment number 24.

    Before we get too hung up on exactly what discount rate to use to value them, can the government please stop hiding these pension liabilities off balance sheet?

    Companies have been forced (quite rightly) to put pensions on the balance sheet for years.

    If we can afford the pensions, put them on the balance sheet now. If we can't, let's confront the problem now, not wait until the whole system collapses.

  • Comment number 25.

    So, as I understand it (correct me if I'm wrong) the Government is going to estimate the book cost of their pension liabilities - in current pounds - on the basis that we're going to have 3% compound growth for ever after?

    I recall that they're estimating that the deficit will be reduced becuase we're going to see something like 7% compound growth (in tax revenues) over the next 5 years or so.

    So, we can all agree that as long as growth picks up we're OK - and the bigger the upswing the more OK we'll be. The black hole of future pension contributions, and the deficit, will disappear.

    So where is the growth going to come from?

  • Comment number 26.

    2. At 18:02pm 3rd May 2011, AHB1 wrote: "Mr Peston fails to point out that the biggest public sector scheme for local government workers is fully funded, that is we have paid for our future pensions and he does not distinguish this from public sector pensions which include the Civil Service, Teachers, the Armed Forces and privatised services."

    The article is perfectly clear that only some public sector schemes are unfunded. The opening sentence identifies the topic as calculations of the cost of "unfunded public service pensions". Further into the article, it is stated explicitly that not all public service pensions are unfunded: "... for most of the public sector, there are no funds or pots of money to pay for future pensions. Most of the pension promises are unfunded..."

    Do you really think it's necessary to identify the funded and unfunded schemes by name?

  • Comment number 27.

    One problem is that is is easier to outsource well paid jobs of the kind that pay taxes than to export the older population. Employers are happy to pay lower wages, but whoops! This also means lower amount of collectable taxes. However a previous generation have contracts involving noncontributory pensions. One reason why crimes against pensioners increased in the 1980a recession was that even a regular pension was riches in the eyes of unemployed youth.

  • Comment number 28.

    In answer to the question in the headline I think you will find, in years to come, the answer is yes.

  • Comment number 29.

  • Comment number 30.

    The issue of pensions isn't just public sector ones - it's chronic in the private sector too.

    The downward slope is getting steeper rapidly...

    1. Imported inflation is eroding the value of incomes and as food, energy and manufactured goods get in ever scarcer supply, living standards are going to go on falling whilst pension incomes fail to keep pace.

    2. The credit crisis is now a permanent fixture, with interest rates pegged low for the foreseeable future, so cash deposits have a negative return.

    3. There isn't going ot be 3% growth - MINUS 13% is more like it when the Uk economy goes off the same cliff as Eire by following the same recessionary policies.

    4. The pressure on public spending is bound to result in public pensions being scalled back - its happening already - things will get really bad when those who have already retired see their pensions being cut too, not only those still in work.

    5. The notion of pension funds invested in stocks producing growth used to be tenable - it is not going to be so in the future - QE is inflating asset prices way beyond the underlying reality - there is going to be another big stock market crash, as sure as night follows day.

    6. Personal debt levels are soaring - everything from mortgages through credit cards to student loans - the idea that people can save enough for a pension to lift them above the benefits level is a delusion.

    7. Company pensions are becoming an endangered species - can't see them recovering.

    8. Many see their houses are their pension pot - yet the OECD says Uk prices are 40% too high - in Eire, the USA, Spain etc there have been falls of this scale already - odds are sooner or later there will be a major realignment here too and the asset will simply not be worth anywhere near what people expected.

    We need to wake up to the impending collapse in the standard of living and quality of life which is comig rapidly towards us - WE'RE SLEEPWALKING TOWARDS A TOTAL MELTDOWN.

  • Comment number 31.

    There are never any pots of money in a nation with a sovereign currency. Even private sector pensions are essentially backed by gilts, which are little more than a government annuity paid to a private sector company gross so that they can cream an amount off the top and stay in business.

    Little more than a publicly funded job creation scheme for insurance men in other words. The government would be much better off if it just offered annuities directly to the individual pensioners and cut the insurance companies out of the loop.

    Comparing a sovereign government to companies is a meaningless exercise. The government owns the Bank of England and the currency that real output is denominated in. It can commandeer whatever it wants whenever it wants it. There are no financial limits on a sovereign government - only real ones.

    Once again this entire article concentrates on meaningless financial numbers and misses what pensions actually are - an allocation of all the real items produced that can be bought in Sterling.

    There is no issue with public sector pensions or private sector pensions if the production system of the UK is efficient enough to generate enough output for these people to buy.

    Rather than constantly worrying about how big the slice of the pie is, what we need to be doing is ensuring that the pie is as big as possible. And you don't do that by cutting education or investment today.

  • Comment number 32.

    "The article is perfectly clear that only some public sector schemes are unfunded."

    All pension schemes are unfunded. In payment they are backed by government gilts.

    If those didn't exist then the government would have to offer a direct annuity to pensioners in exchange for their pot of cash as a replacement - as there is insufficient dividend or investment income from the private sector of sufficient quality to replace gilts.

    That's why gilts (and in the US Treasuries) continue to be issued even when the government is running a surplus. That's why index linked gilts exist.

  • Comment number 33.

    ALCHEMY.........See they can turn GOLD into LEAD!!

  • Comment number 34.

    Future public sector pension costs where no ring-fenced fund exists to pay these costs are simply one of many parts of future government expenditure. They will require to be funded from future taxation and pension contributions where these exist. I do not recall seeing future NHS spending or Education spending being pushed as 'off balance sheet' debt, yet they are as certain as pension payments and infinitely higher in terms of probable future cost. What is important is that the government has properly calculated and robust projections of net pension outgo (ie pensions less any contributions) as part of the data it receives when making fiscal decisions. It can choose to discount these at whatever rate it likes, but its meaningless in that it has no intention of putting in place a lump sum now to cover those future payments.

  • Comment number 35.

    15. At 20:21pm 3rd May 2011, Tim0thy wrote:
    "May I ask just who you are to decide what is and what is not irrelevant? We know about Robert Peston and have an idea of his knowledge but yours?
    I agree that the Credit Default Swaps investigation is important and all power to the EU for instigating it so maybe Robert would like to give us the benefit of his opinions on same."

    I am just trying to point out the power the BBC Business Editor, Robert Peston, has in setting the news agenda.

    He decides that an old story about pensions liabilities (yawn!), which might or might not be fully funded, is a story worth worrying about. More so than the fact that the EU is investigating all the big banks world wide for collusion in the market for credit default swaps, which results in yields in countries being driven up, enormous profits for hedge funds and speculators and untold misery to lots of Greeks, Irish and Portuguese. And additional taxpayer liabilities in the EU. But he keeps very quiet about that.

    Which story to run is his judgement - and I just think his judgement is a bit suspect in this instance. I am trying to point that out.

    We are potentially being ripped off by hedge funds and investment banks through credit default swaps in this "Eurocrisis", and the business editor of the BBC has nothing to say about it. A bit odd, don't you think?

    In fact all the commentators in the papers are suspiciously quiet about that "EU investigates crooked banks for collusion in CDS market" story. No follow ups, nothing in the Sunday Telegraph, for example. That is very, very odd, indeed, don't you think?

  • Comment number 36.

    What is really disgusting is that this problem has been known about since the 60’s and no government has done anything about it because like Martin Campbell posted when the problem hits the politicians will be long gone and any change would have been political suicide and that’s why I hate our party politics system which is full of bumbling amateurs who like the current lot are demonstrating that they simply do not have a clue about economics.

  • Comment number 37.

    17. At 21:21pm 3rd May 2011, okeen wrote:
    "So, where is the view on whether we are being ripped off with Credit Default Swaps? " - is not really an important question - to buy or sell them you have to be a sophisticated investor and there are proably only a couple of thousand of these in the world. (you are assumed to be bright enough to be able to work out if you are being ripped off in the pricing of them - if you cant you should not be buying them - if you are stupid (AIG) then you deserve it)"

    Well, okeen, I disagree. AIB, the biggest american insurance company, was stupid enough to write credit default swaps on Lehman, and it cost the US taxpayer $200bn to bail AIG out. That led to the biggest financial crisis since the thirties of the last century!

    A bail out of banks which wrote CDS insurance on European countries would be a lot more expensive!

    We do not want to let that happen to our stupid banks in the "Eurocrisis", do we? Because that is who has written CDS insurance on Euro countries in this crisis. Banks, too big to fail, which will have to be bailed out by the taxpayer.

    Now that CDS is in the news, given that the EU has launched an investigation whether the market is rigged, it is a perfect time to advocate the complete ban of these destructive products. They do not serve any purpose. They make rich people richer by worsening a situation which is already bad, and by taking away money from the taxpayer to stuff it into the pockets of greedy speculators and sscrupulous hedge funds.

    The BBC business editor should write about this scam, sooner rather than later, and campaign for the ban of CDS - what does everybody else think?

  • Comment number 38.

    Not only did I read the item to the end but I understood most of it .Having drawn my pensions for a good number of years clearly the problem will bot effect me but one thing I have learned most polititians are more honest out of office. Knowing a problem is one thing curing it is quite another, thanks for doing your bit.

  • Comment number 39.

    31. At 06:29am 4th May 2011, Neil Wilson wrote:
    "There is no issue with public sector pensions or private sector pensions if the production system of the UK is efficient enough to generate enough output for these people to buy. - Rather than constantly worrying about how big the slice of the pie is, what we need to be doing is ensuring that the pie is as big as possible. And you don't do that by cutting education or investment today."

    Absolutely right - this discussion about state pension liabilities is a discussion which is meaningless. State government has always the power to allocation funds through the tax and benefit system. So they can never be underfunded, as schools can never be underfunded, universitities can never be underfunded, the cost of climate change can never be underfunded.

    They are only underfunded, if the government of the day chooses to do so. So there is no point putting pension liabilities on the "UK's balance sheet", as there is no "balance sheet". Countries are not companies. They cannot disappear overnight, companies frequently do, when they go bust.

    That is an elementary bit of knowledge, which should not have escaped the business editor of the BBC!

    So why is this story worth even mentioning by the BBC business editor, I am intrigued?

  • Comment number 40.

    A branch of the civil service called RBS is paying one "Sir" Greedie hundreds of thousands each _year_ from an unfunded pension scheme. And he has contributed far less than zero to the nation during his entire life.

    Discount that!

  • Comment number 41.

    No, you can keep on going matt_us. It's the what you say not the who you are.

    I can see that these crazy speculations are a fundamental problem in the seismic uncertainties throbbing through the Global economies. I happened on the US National Debt Clock recently where the CDS economy seems to have value of 572Trillion dollars whereas their GDP is a mere 15 Trillion, about the same as their national debt and their mortgage debt. With inbalances like that in our system whether we draw any pension at all seems both irrelevant and totally unpredictable

  • Comment number 42.

    We assume that there is a finite source of money and therefore more money cannot be created to fund shortfalls. The banking bailout has proven that money can be created quite easily to fund any shortfall. QE also disproves assumptions of finite sources

    There probably is specific amount of money that can be created before demand inflation kicks in, but we are certainly not acknowledging it as part of the current discourse. Production capacity (imported and local) and therefore available energy should determine requisite money supply.

    Encouraging distortions in the natural distribution of money and therewith its efficiency through complex and toxic financial products shifts the inflationary point inward. This is the devil that we should be fighting.

  • Comment number 43.

    I fear the pension liability is more serious than Mr Peston's concern about its calculation. As far as I can tell the public pension obligations are not included as a liability when the national debt figures are quoted. It is assumed that these will be paid from future taxation.
    Future generations may conclude that this is a bad deal and renege either by capping pensions or taking more extreme actions. Who could blame them?

  • Comment number 44.

    37. At 09:14am 4th May 2011, matt_us wrote:

    > Now that CDS is in the news, given that the EU has launched an investigation
    > whether the market is rigged, it is a perfect time to advocate the complete ban
    > of these destructive products.

    Just tax them very heavily, but allow them. If too many get sold, tax them more.

  • Comment number 45.

    We have a nation full of parasites that expect to live off others. Take the teachers, keen to strike over reductions in pensions. I know that they cannot teach, as only 49% of 18 year olds (yes, 18, not 16) have a GCSE pass at Maths and English. Yet they expect to retire at 60 and live on average to 89 (men) or 90 (women). Have you seen how little they contribute? It is not hard to do the maths to work out how much you need to save over 40 years working to pay for 30 years of not working.... and it isn't a couple of percent of your salary!

    Well, in years to come the children will be adults. They will remember that a large proportion of their teachers just read from the text books to teach them. I'm sure they will enjoy using their voting power to strike revenge!

  • Comment number 46.

    Robert,

    Is it true that the BOE/Treasury were fortunate enough to obtain index linked securities for their pension funds before they were withdrawn?

  • Comment number 47.

    The question isn't about gmta understanding, it should be about The misrepresentation of economic facts by the government and the press.

    It is a category error to consider government finances as a zero sum game where debts have to be "paid off". See for example:-

    http://pragcap.com/resources/understanding-modern-monetary-system

    Just because the current crop of Euro Governments including ours, for political reasons, are explaining Government finances to a gullible press and public by a ridiculous analogy to household spending doesn't mean we should give such gibberish the time of day.

    Government debt bears an accounting relationship with private sector debt-

    Government debt = private sector surplus + current account

    When the economy is running at below full capacity (as it is now) and the private sector is in massive surplus (as it is now) the Government has to run a debt or the economy will collapse. This is what will happen over the next couple of years as a result of Osbornes plans. Its an accounting certainty.

    Governments have to run debts to allow growth. The UK Government has been running a debt for as far back as the records go. Never has the debt level been below 40% of GDP in the last 100 years of recording. Prior to the 1970s debts were always above 50% and as high as 200% after WW2. Government debt levels correlate with higher growth and lower unemployment.

    The same is true in all other countries working with fractional reserve banking systems. Look at Japan- debts currently over 200% of GDP and bond yields of less than 1%; or the US.

    And you know what- the level of government debt is not and never has been a crisis. It is a necessary lever for growth in the economy. The only time that governments need to worry about the level of government spending is when inflation picks up. At this point, governments need to raise taxes to reduce the level of money supply. However, the growth in governemnt debt is a small fraction of the money supply, with the majority of credit created by private banks. Controlling this side (through contingent capital levels) is a much better way to fight inflation than controlling government spending. One way or the other, it is gibberish to talk of governments needing to raise taxes to "pay off government debt". Governments raise taxes to destroy money to constrain inflation.

    The interesting question to ask is why does the government fund its debt as interest bearing gilts to the private sector (largely the private pension industry). The government debt (like for example QE) could be funded directly by the Bank of England directly creating the money to fund Government spending. This is no more inflationairy than covering government debt by issuing interest bearing bonds.

    The only obvious advantage of issuing gilts appears to be that it acts as a hidden subsidy worth many many billions of pounds a year to private sector pensions industry.

  • Comment number 48.

    #22. I wrote: in response to #21. Pan Albert who wrote:"the higher the discount rate, the smaller the liabilities' present value will appear to be".

    I presume that something in my agreeing with #21 riled the moderators! How agreeing with a statement of common-sense basic arithmetic could I am unsure, perhaps it was my vehement condemnation of the Bank of England for knowingly causing and perpetuating the situation!

    It is a simple fact of arithmetic that low interest rates = low returns on guilts = completely unfundable/unaffordable future pension liabilities, a destruction of money and making saving pointless. The Bank of England will have understood this - it has 200 economists and a few must be able to do arithmetic - perhaps the Governor and the MPC can't, and are so all powerful they can overrule arithmetic certainties.

    Make no mistake the Bank of England is firmly set on a policy of national economic destruction and they know it!. They must break free from this idiocy and put up rates this week!

  • Comment number 49.

    "34. At 08:28am 4th May 2011, TheGingerF wrote:

    I do not recall seeing future NHS spending or Education spending being pushed as 'off balance sheet' debt, yet they are as certain as pension payments and infinitely higher in terms of probable future cost.

    Isn't that what PFI has done? Building Schools, Hospitals without spending the money now and leaving the bill for future governments to pay?

  • Comment number 50.

    AndyScientist@49

    In a sense yes Andy. Take a new hospital and the maintenance/cleaning contract over say 30 years. PFI swaps government borrowing at gilt rates plus future govt spending (maintenance etc) for borrowing at market internal rate of returns and paying market maintenance prices. Result - poor deal for the taxpayer thanks to Tory idea slavishly followed and upgraded by Labour. Note some PFI is actually 'on balance sheet', but not sure how much.

    However this pales into insignificance against the >£100bn per year health budget remaining in government spending (current overall PFI costs are of the order £10bn each year, reducing over time, over next 30 years - hm-treasury.gov.uk has figures).

  • Comment number 51.

    How typical to pick a subject that he disagrees with (occupational pensions for millions of generally low paid public sector "tax payers") and illustrate his arguement with a 600% exaggerated example of the average pension earned. Very poor journalism, biased, subjective and the major reason I read less and less of his outpourings.

  • Comment number 52.

    Nice article but surely the bigger issue is why the obligation is off balance sheet in the first place? The corporate sector only wised up to the true cost of defined benefit promises when it had to account for them, it's hard to see our politicians being any better.

    We'll only get a sensible debate on public sector pensions when we start to see the cost of civil servants' longevity increases, early retirement schemes, CPI protection etc impacting on deficit reduction targets.

  • Comment number 53.

    "5. At 18:36pm 3rd May 2011, matt_us wrote:
    I wondered whether Robert Peston will finally bring us his insight knowledge to the not inconsiderable news, buried under Kate Middleton's veil last Friday, that the EU has started to investigate the banks on whether or not they manipulate the Credit Default Swap market."

    My basic understanding of C.D.S are they act as Insurance against bonds
    What I'm not aware of is if you can purchase one without an insurable interest.


    But overall Insurance seems like a good thing.

    AS to the matter at hand Defined Benefit (DB) ( which is the unfunded liability ) should be stopped now. Pensions should be based on Contributions (DC)

    DB = a promise
    DC = a fact

    Close all the DB schemes to new joiners, close off the DB scheme beneits to existing contributers now and divert future contributions to DC limit the damage to our futures

  • Comment number 54.

    #53 Totally agree with your formula i.e.

    'Close all the DB schemes to new joiners, close off the DB scheme beneits to existing contributers now and divert future contributions to DC limit the damage to our futures'

    but also suspect we cannot morally avoid a guarantee the pension promises already earned - perhaps this is what you meant anyway. If so its still expensive (depending on the inflation clause) - but I feel unavoidable and at least we would have stopped digging the hole.

    Of course its basically what nearly every private sector company has been forced to do by both market forces and proper accounting of the liability. Should be done across the whole public sector tomorrow. No ifs no buts.

  • Comment number 55.

    An albatross named Ponzi firmly clasped round all our necks.

  • Comment number 56.

    10. At 19:23pm 3rd May 2011, zfvr wrote:
    It makes absolutely no sense to pre-save for pension liabilities. Put it this way: if all the persons in the UK were to retire except one, would it matter if some fund would have enough money to pay for pension liabilities? Of course not, that one person cannot provide all the goods and services retirees need.

    If 60% of working age population were to suddenly retire, it would not matter if they had pre-saved all their pensions, because remaining 40% of the population could not provide those goods and services at those prices, and if they all tried to spend it, all the money would compete for limited resources and cause inflation. What would need to happen is to tax some spending power away from the workers so that that there would be real labor and resources available to pensioners to buy.

    Situation is essentially no different when smaller proportion of the population retires. Fruits of the productive capacity of the economy has to be divided among larger pool of consumers, that means consumption power had to be removed from workers and transferred to the pensioners. Simple tax to pay pensions is an income transfer that achieves this and there is no reason for anything more complicated.

    _______________________________________________________________________________

    A very good starting point. Money is an instrument. It is subject to design. Well designed money can help as well economical development as general social well being. Ill designed money obfuscates count of social profits and losses. The argument quoted can be extended in both ways.
    If we are to go 200 years back in time the “pension liabilities” will be these that were placed upon family members, mainly sons. These led to several problems including most callous...
    As a solution national schemes of provision for some groups of subjects, then citizens were introduced. The schemes were a great success in reducing conflicts within families. At the same time they threw families apart. (among others it was a German way of freeing up new labour)
    In the last three decades investment was massively redirected from some of developed countries into what was then called the “third world”. This implies that our pension liabilities were transferred too. Now, this is a situation that no sovereign state would be able to accept for long.
    These are two ends of the scale. Is the solution in a return to the economical function of a family? Is it in more globalised ways of taxation? It should be a mixture of both. Divorcing parent with a child by making higher education un-viable as “private investment” for the lower earners is, in my opinion a step in a wrong direction. It amplifies greatly a social chasm between those, who are able to fund education of their children, at the same time not being in need of support in retirement, and the other part of society, where weak enough family links are further undermined by narrowing scope for possible connection. (upper classes higher sentiments grow on quite a rich economical background, don't they?).
    If one can free imagination from a one directional spin, some interesting solutions do emerge... But first of all, money, as a human construct needs rethinking. (Because in the system that we enjoy somebody has to wipe the blackboard clean from time to time. Stealth or in a broad daylight, by small chunks, or totally... as of now I see it as the wrong corner being wiped clean and the dust falling into externalities again.)

 

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