The hidden cost of coronavirus

Governments have supported companies and individuals and families to an unprecedented extent with record peacetime borrowing.

The UK government expects to borrow £390bn in the 2020-21 financial year, more than 50 per cent of revenue. The significant financial impact of the pandemic on public sector pensions, however, appears to have gone unnoticed. 

Reducing public sector pension benefits, later retirement, increased contributions or some combination thereof is not politically attractive, so a Royal Commission is arguably required

Most funded private sector pension arrangements suffered a fall in asset values in the first quarter; this was reversed in the second quarter following government intervention in the form of quantitative easing. 

Unfunded public sector pension schemes involve a similar scale of future payment commitments or liabilities. These unfunded liabilities have unfortunately not received any attention. Indeed, the Pensions Regulator does not have any remit to consider the finances or sustainability of these occupational pensions.

These approximately 6m defined benefit pensions still have to be paid for. The NHS staff, teachers, police officers, firefighters, civil servants and the armed forces deserve a DB pension. They are paid out of the fund that is the UK economy, or more precisely, they are paid out of the future taxation levied on the economy.

These index-linked pension promises are calculated or costed on the basis of the economy growing every year at between the retail price index plus 3.5 per cent for contractual benefits earned pre-2015 service, and the consumer price index plus 2.4 per cent — current accrual.

Huge tab for the future

UK gross domestic product has not achieved anything like that for decades and Covid-19 will cause a massive hit on the UK economy. Sadly, there is no actuarial valuation to assess progress and, put bluntly, future taxpayers will be left to pick up the tab.

I suggest this is a very big tab and intergenerational transfer. The Whole of Government Accounts estimates the accrued unfunded public sector pension liability at £2.1tn (April 2020). Expected growth at approximately plus 3 per cent has unfortunately to be compared with the actual 11.2 per cent GDP drop — call it £300bn (14.2 per cent of £2.1tn).

That is quite a deficit and is equivalent to around an extra 2p on the basic rate of income tax for almost a decade — or 5 per cent on value added tax for 15 years. Alternatively, it is 80 £1m lottery winners, every day for 10 years.

Public pensions lack ongoing measurements

The unfunded pensions framework ignores the basis of original promises, with no public measurement of actual versus expected experience in respect of the crucial underlying discount rate, or investment return assumed.

What is not measured is not managed, well at least not publicly, and from my investigations:

• Most politicians are totally unaware of how these future promises are made and they leave it all to the Treasury.

• The Treasury currently uses the “reasonable” assumption and advice of the government actuary.

• The government actuary currently refers to the long-term GDP assumption from the Office for Budget Responsibility on GDP growth.

• The OBR refers the UK’s very historic GDP growth (after 1761) — when opium wars filled some commercial coffers, diplomacy involved gunboats, slavery was not modern, Britannia ruled the waves and the sun never set on the empire.

This does not guarantee future austerity, but unachieved growth must lead to higher taxation or reduced services or both. Squeezed budgets can be equated with longer NHS waiting times, increased class sizes, uninvestigated crimes, fires left to burn, and so on.

It is worth noting that the RPI to CPI indexation change — as applied after the GDP hit of the 2009-10 financial crisis — is not likely to be available again. That took about £100bn off the accrued liabilities.

Reducing public sector pension benefits, later retirement, increased contributions or some combination thereof is not politically attractive, so a Royal Commission is arguably required.

All pensions saving at personal, corporate or national level should be fair and sustainable. Unfunded public sector pensions unfortunately reflect massive ignorance of the crucial economic growth assumption, lack a framework of measurement and management, involve conflicted stakeholders, and have suffered a huge coronavirus hit that very few appreciate.

Allan Martin is a director at ACMCA