Tag: #pensions

ICAEW chart of the week: Whole of Government liabilities

My chart for ICAEW this week looks at how liabilities in the UK’s public balance sheet have risen significantly over the five years to March 2022.

Column chart: Whole of Government liabilities ICAEW chart of the week Employee pensions (blue) Payables and provisions (purple) Financial liabilities (orange) 31 Mar 2018: £2.1trn financial liabilities + £0.6trn payables and provisions + £1.9trn employee pensions = £4.6trn total 31 Mar 2019: £2.2trn + £0.5trn + £1.9trn = £4.6trn 31 Mar 2020: £2.2trn + £0.6trn + £2.2trn = £5.0trn 31 Mar 2021: £2.6trn + £0.6trn + £2.3trn = £5.5trn 31 Mar 2022: £2.9trn + £0.8trn + £2.6trn = £6.3trn 4 Apr 2024. Chart by Martin Wheatcroft FCA. Design by Sunday. Source: HM Treasury, 'Whole of Government Accounts 2017/18 to 2021/22'. (c) ICAEW 2024.

HM Treasury published the Whole of Government Accounts (WGA) 2021/22 on 26 March 2024, just under two years after the balance sheet date. This is a significant improvement from the 27 months it took to publish the 2020/21 edition, but is still a lot longer than the nine or 10 months HM Treasury is aiming for in the medium term, or the four months or less that it generally takes listed companies to publish their consolidated financial statements.

WGA are consolidated financial statements for more than 10,000 or so organisations in the UK public sector, including central government departments, devolved administrations, regional and local authorities, the Bank of England and other public corporations, government agencies, schools, hospitals, police and fire services, transport authorities and other public bodies. They are prepared in line with international generally accepted accounting practice – International Financial Reporting Standards – different to the statistical standards used by governments to report fiscal numbers in National Accounts.

My chart for ICAEW illustrates how the liability side of the balance sheet has grown over the five-year period, from £4.6trn on 31 March 2018 and 2019 to £5trn on 31 March 2020, £5.5trn on 31 March 2021 and £6.3trn on 31 March 2022.

This reflects how debt liabilities increased from £2.1trn to £2.9trn over that time, with huge sums borrowed in 2020/21 and 2021/22 during the coronavirus pandemic. 

The other big liability in the balance sheet is the net pension obligation for public sector employees, which was £1.9trn on 31 March 2018 but had risen to £2.6trn by 31 March 2022, with falling discount rates a key factor in that rise. The latter comprises liabilities of £2.5trn for unfunded pension schemes and net liabilities of £0.1trn (£0.5trn liabilities less £0.4trn in assets) for local government and other funded pension schemes.

The balance sheet does not include the much larger commitment to pay the state pension, which as a welfare benefit is accounted for when incurred.

Total liabilities of £6.3trn on 31 March 2022 are equivalent to £93,000 per person in the UK, comprising £43,000 in financial liabilities, £11,000 in payables and provisions, and £39,000 in for public sector employee pensions.

Not shown in the chart is the asset side of the balance sheet, with assets of £2.4trn on 31 March 2022 or £36,000 per person, comprising fixed assets of £1.4trn (£20,500 per person), investments of £0.5trn (£7,000), receivables and other of £0.2trn (£3,500) and cash and other financial assets of £0.3trn (£5,000). This results in an overall net liability position of £3.9trn or £57,000 per person on 31 March 2022. 

The good news is that HM Treasury is working hard to reduce the delays in producing the WGA, which means it shouldn’t be too long before we discover what is in the 31 March 2023 balance sheet. This is expected to show an improvement, as although the government has continued to borrow, pushing up financial liabilities, the net present value of pension obligations and provisions should fall significantly as discount rates have risen sharply since March 2022.

This chart was originally published by ICAEW.

ICAEW chart of the week: Receipts and spending by age

My chart this week looks at how receipts and spending vary by age, a key driver for public finances that new Chancellor Kwasi Kwarteng will need to factor into his fiscal plans.

Column chart - showing receipts by age group per person per month above the line and spending below the line. 0-9: £150 (receipts) - £550 (public services and interest), £290, (pensions and welfare), £270 (health and social care), £380 (education) 10-19: £210 - £620, £320, £110, £750 20-29: £1,150 - £440, £120, £160, £110 30-39: £1,930 - £430, £150, £180, £30 40-49: £2,200 - £430, £170, £200, £20 50-59: £1,960 - £450, £190, £300, £10 60-69: £1,240 - £480, £340, £370, - 70-79: £800 - £640, £1,170, £600, - 80+: £600 - £730, £1,400 - £1,270 Average: £1,220 - £510, £365, £310, £155

Kwasi Kwarteng’s first Budget will be an emergency one, not only setting out his plans for the financial year commencing on 1 April 2023, but also re-opening the budget for the current financial year. It will be dominated by the emergency support package for individuals and businesses already announced, alongside starting to deliver on Prime Minister Liz Truss’s commitments to cut taxes and ‘shrink the state’.

The new Chancellor is likely to find that cutting public spending is not going to be easy given the increasing financial commitments made by successive governments since the Second World War on education, pensions, health and social care, the areas that now dominate public spending. He supported adding to those commitments only a couple of years ago when then Prime Minister Boris Johnson decided to expand eligibility for social care, and former Chancellor Rishi Sunak re-committed to the ‘triple-lock’ that guarantees increases in the state pension every year.

As our chart this week illustrates, receipts and spending vary significantly across age groups, with spending on education higher on the young, who pay very little in taxes, and spending on pensions, health and social care much higher for older generations who contribute less than the average, especially after reaching retirement age. This contrasts with the profile for those of working age who pay the most into the system while on average taking the least out.

Derived from an analysis from the Office for Budget Responsibility’s fiscal risks and sustainability report published in July, the chart shows how – before the emergency Budget scheduled for 21 September – budgeted tax and other receipts for the current financial year 2022/23 are equivalent to £1,220 per person per month, based on forecast receipts of £988bn and a population of 67.5m. This is below budgeted public spending of £1,340 per person per month (£1,087bn/67.5m people/12 months), with the deficit of £120 per person per month (£99bn in total) funded by borrowing.

Average receipts per person per month by age group are estimated to be in the order of £150, £210, £1,150, £1,930, £2,200, £1,960, £1,240, £800 respectively for those aged 0-9, 10-19, 20-29, 30-39, 40-49, 50-59, 60-69, 70-79 and 80+ respectively. These numbers include £115 per person per month of non-tax receipts spread evenly across everyone. 

Spending on public services and interest in the order of £510 per person per month, or £550, £620, £440, £430, £430, £450, £480, £640, £730 by age group, is less variable across age groups because it much of this spending is incurred on behalf of everyone, including £125 in interest, £73 on defence and security and £53 on policing, justice and safety for example.

Spending on pensions and welfare of £365 per person per month is less evenly spread, with £290 and £320 per month spent on those in their first two decades and £440, £430, £430 and £450 on those in their twenties, thirties, forties and fifties respectively. This increases to average spending per person per month of £480, £640 and £730 on those in their sixties, seventies and eighties or over. 

Health and social care spending of £310 is biased towards older generations, with per person per month spending of £270, £110, £160, £180 and £200 for the first five decades of life contrasting with the £300, £370, £600 and £1,270 spent on average on those in their fifties, sixties, seventies and eighties or over. 

As you would expect, education spending of £155 per person per month on average is mostly spent on the young, with around £380 per person per month spent on the under-10s, £750 spent on those between 10 and 19, £110 spent on those in their twenties, and £30, £20 and £10 respectively spent on those in their thirties, forties and fifties.

The reason this chart is so critical is because demographics are not in a steady state, with the ONS projecting that there will be an additional 3.3m pensioners in 20 years’ time, a 27% increase. This will have significant cost implications for this and future governments over a period when the working-age population – who pay most of the taxes to fund public spending – is projected to grow by just 4% in total. 

While a declining birth rate might relieve some of the pressure on education spending over the next 20 years, spending on the state pension, the NHS and on social care will grow significantly if the commitments made by the current and previous governments to provide for income in retirement, universal free health care and an increasing level of social care provision are to be met, at the same time as running public services to the standard required.

Kwasi Kwarteng’s predecessors have been able to cover the expanding share of public spending going on pensions and health and social care without raising taxes above 40% of the economy by cutting spending on public services, in particular the defence budget, which has declined from in the order of 10% of GDP to around 2% over the last half century. However, with defence already at the NATO minimum, and many public services under significant pressure to improve delivery, there is much less scope to find savings than there has been in the past.

This poses a very big challenge for the Chancellor as he puts together his medium-term fiscal plans. Economic growth needs to be much higher than it has been in recent years, not only to cover the cost of tax cuts that he hopes will generate that growth, but also to generate the extra tax receipts needed to fund pensions and health and social care as more people live longer lives.

This chart was originally published by ICAEW.

ICAEW chart of the week: Pensions triple lock

The triple lock has helped the state pension grow faster than inflation or earnings over the last decade, but will the Chancellor break it for next year’s pension increase?

Pensions triple lock Basic state pension in 2011-12: £5,512 + Triple lock £1,843 = £7,155 in 2021-22. Compares with increase based on earnings of £1,108, on CPI of £1,144 or 2.5% a year of £1,487. New state pension (extrapolated back) in 2011-12: £6,932 + triple lock £2,408 = £9,339. Compares with increase based on earnings of £1,443, CPI of £1,492 and 2.5% a year of £1,940. Based on a projected 8.3% annual increase in average earnings in 2021, the basic state pension would by £593 to £7,748 and the new state pension would increase by £775 to £10,114.

ICAEW’s chart of the week illustrates just how much of a boost the triple lock has been to the state pension since its introduction a decade ago compared with what would have happened if it had risen in line with one of the components of the triple lock formula alone.

It also illustrates how much pensioners might get in April next year if the government continues with the current formula and doesn’t adjust for the distortions in the official statistics caused by the pandemic. With average earnings for the three months to July 2021 projected to be in the order of 8.3% higher than a year previously, the incremental cost would be significant given that the state pension is the second biggest line item in the government’s spending bill at over £105bn a year.

With the statistic distorted by effects of the pandemic, the Chancellor may decide to adopt an ‘adjusted’ percentage to eliminate the effects of the furlough scheme and lockdowns, likely to be somewhere in region of 3.5% to 5%, or potentially he could opt to use the annualised average rise over two years that is expected to be closer to 3.5%. Or he could abandon the triple lock completely and choose another basis for determining how much pensioners will have to live on next year.

EarningsCPI2.5%
2012-132.8%5.2%2.5%
2013-141.6%2.2%2.5%
2014-151.2%2.7%2.5%
2015-160.6%1.2%2.5%
2016-172.9%-0.1%2.5%
2017-182.4%1.0%2.5%
2018-192.2%3.0%2.5%
2019-202.6%2.4%2.5%
2020-213.9%1.7%2.5%
2021-22-1.0%0.5%2.5%

The basic state pension, payable in full to those with 30 years of national insurance credits, increased from £5,312 (£102.15 per week) in 2011-12 to £7,155 (£137.60 per week) in 2021-22, an increase of £1,843 (£35.45 a week). This contrasts with the increases that would have been seen if pensions had been uprated over that period in line with average earnings (£1,108 or £21.30 per week), CPI (£1,144 or £22.00 per week) or 2.5% (£1,487 or £28.60 per week). By selecting the highest of the average earnings or inflation and with a floor of 2.5%, the result has been to uplift the basic state pension above the legally required increase in line with earnings.

This does not mean that pensioners have received this level of increase for the whole of their pension, as many of those who retired before 2016 are entitled to an additional state pension linked to their national insurance contributions (also known as the state earnings related pension or SERPs) that has been uprated each year over the last decade in line with CPI.

Since 6 April 2016, the basic and additional pensions have been replaced for those retiring after that date by the new state pension, which requires 35 years of national insurance credits to receive the full amount. This provides a higher income for most pensioners than the basic plus additional state pension system but less for those with higher career earnings who – the theory goes – should also have company or private pensions to support them in retirement. 

The chart illustrates the effect of the triple lock on the new state pension as if it had been in place since 2011-12, with the triple lock increase of £2,408 (£46.35 per week) to reach the current level of £9,339 (£179.60 per week) contrasting with average earnings (£1,443 or £27.75 per week), CPI (£1,492 or £28.70 per week) or 2.5% (£1,940 or £37.30 per week).

The ratchet effect of the triple lock will be put to the test for the coming state pension rise, as the statistic used to measure the rise in average earningsstood at 8.8% as at June 2021 and is expected to be somewhere in the region of 8.3% (plus or minus) when July 2021 statistic is announced later this month. As the chart indicates this would result in a £593 (£11.40 per week) increase in the basic state pension to £7,748 (£149.00 per week) and a £775 (£14.90 per week) increase in the new state pension to £10,114 (£194.50 per week).

The distortion in the average earnings statistic is because of the combination of fewer lower paid employees in the workforce a year ago altering the make-up of the working population used to measure pay rises and the furlough scheme where many employees received a temporary pay cut of 20% if their employers didn’t make up the difference. However, there is some genuine wage inflation going on, with the ONS estimating that the ‘underlying’ annual rise in average earnings for the three months to June 2021 was somewhere between 3.5% and 4.9%.

The Chancellor is expected to announce his decision on the triple lock at the fiscal event on 27 October, although there is a chance that he might make an announcement later this month in order to avoid getting pensioners’ hopes up when the average earnings rise is released on 14 September – only to then dash them a few weeks later.

This chart was originally published by ICAEW.

£31 billion charge shines spotlight on £2.2tn pounds public sector pension liability

21 August 2020: Ministers insulated older employees from public sector pension reforms in 2015, despite advice saying not to. The courts found this was age discrimination, resulting in a £31bn charge in the Whole of Government Accounts.

When the Hutton review on public sector pensions reported in 2011, it recommended retaining the defined-benefit pensions provided to public sector employees. However, it wanted to reform how public sector pensions are calculated to reduce the cost to taxpayers, while at the same making them fairer for lower-paid employees. 

Recommendations included switching from final salary to career average for calculating pension entitlements, aligning the retirement age for most public sector employees with the state pension age, and increasing employee contributions.

The Hutton reforms followed a major cost saving already achieved in switching from RPI to CPI-linked increases for pensions in retirement, which resulted in a one-off gain of £126bn in the 2010-11 Whole of Government Accounts (equivalent to a 10% reduction in the gross pension liability at that time) as well as reducing the cost of providing pensions going forward. 

To protect existing employees, Hutton recommended that accrued rights at the date of the switch should still be calculated on final salaries, with only subsequent years of service accruing on an average salary basis. Retaining existing rights meant there was no significant gain or loss recorded when the reforms to existing pension arrangements were implemented in 2014 and 2015, with any cost savings arising in future years.

Despite the Hutton report explicitly stating that “age discrimination legislation … means that it is not possible in practice to provide protection from change for members who are already above a certain age”, the Government decided to provide transitional protection for older members. Full transitional protection was offered to workers 10 years or less away from retirement in 2012, with partial protection on a sliding scale tapering away to zero for those with 14 or more years to go until retirement at that point.

As might have been expected, given the clear advice in the Hutton review that this would constitute unlawful age discrimination, the UK Government lost in the Supreme Court in 2019 in the McCloud and Sargeant cases. As a consequence, employees that have lost out because the transitional protections did not apply to them will receive an uplift in their pensions when they reach retirement.

Illustrative example

To illustrate the issue, consider the case of fictional civil servants Sarah and Maxine who were 20 and 10 years away from retirement respectively in 2012 and who were moved into the new career-average ‘alpha’ pension scheme in 2015. Each is expected to retire with 30 years’ service on a final year salary of £80,000, following rapid promotions in their final 10 years of service.

Image of table with worked example. Click on link at the end of this post to for the article on the ICAEW website containing the table itself.

In this illustration, Maxine, who in 2012 had 10 years to go before retirement, should receive an initial pension of £40,000 a year when she retires in 2022, including a £500 transitional protection uplift. 

Without transitional protection, Sarah would expect to receive £34,000 a year when she retires in 2032. Although the precise details of the remedy in response to the court judgements is still being worked out (see HM Treasury consultation), it is likely that Sarah will now receive a transitional protection uplift covering the period from 2015 to 2022, potentially adding around £4,000 (based on our illustrative assumptions) to her pension on retirement, but still below what she would have received without the changes.

The court ruling will only affect employees who would have got more under the final salary arrangements. For a significant proportion of public sector workers, the faster accrual rate on a career average basis will provide them with a higher pension than they would have received under the slower accrual rate applied to final salary under the old arrangements. They will not have lost out from not having had transitional protection.

Spotlight on the £2.2tn public sector pension liability

The £31bn past service cost recorded in the Whole of Government Accounts in 2018-19 added 1.4% to the amounts owed to current and former public sector employees for their accrued pension rights, increasing the gross liability recorded to £2.2tn at 31 March 2019. (The Government separately reported that the court judgements would cost £17bn but did not explain how this number reconciled with the £31bn reported in the accounts.)

£2.2tn is a huge amount of money, equivalent to around £80,000 for each household in the UK. Most public sector schemes are unfunded (£1,756bn out of the £2,244bn gross liability) with pension payments funded out of future taxation. Local authority and other funded public sector schemes (£488bn) do have pension fund investments (£350bn at 31 March 2019) set aside to pay pensions, but they will need to increase their contributions to those funds to cover the cost of extending transitional protections to affected employees. 

There are no doubt many morals to be drawn from this story, but what it does highlight is the sheer scale of the pension obligations that public sector employers have built up over the years, and just how much a single ministerial decision can end up costing taxpayers.

This article was originally published on the ICAEW website.