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Uk Public Sector Pension Liabilities

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This report from the British-North American Committee is interesting reading.

The net public employee pension liabilities1 (i.e. pension assets less pension liabilities) of

the respective Governments (as a % of GDP and in US Dollars2), based on schemes’ own

quoted discount rates 3, are as follows:

Table 1

Net Public Pension Liability

at schemes own discount rates

Country % of GDP4 US Dollars (billion)

US 15% $2,088

UK 64% $1,267

Canada 12% $151

The shape and structure of the assets and liabilities, and the analysis of their sensitivities,

are set out in the main body of this paper. However, in summary, it is clear that the UK

stands out as having a major, and distinctive, problem in relation to its public sector

pension promises. This has been brought about because a large majority of the UK public

workforce have generous, fully index-linked final salary pensions which are completely

unfunded, whereas funded (partially or fully) public schemes are the norm in the US and

Canada.

However, we have found that all three countries use discount rates in their pension

calculations that are higher than their own (sovereign) market-based interest rates. This

produces the effect of reducing headline liability calculations below what they would be

under a market rate calculation.

We have estimated (in Table 3) the net liability based on market interest rates. A

description of the methodology we used for the ‘market rate’ calculation is set out in the

main text.

Table 3

Net Public Pension Liability at market rates

Country % of GDP US Dollars (billion)

US 28% $3,869

UK 85% $1,683

Canada 27% $335

Public sector employers are generally required annually to calculate the full running cost

of each additional year’s pension rights for their employees. This calculation is called the

‘current service cost’, and for almost all public pension schemes, the employer and

employee together are required to make annual cash contributions to the pension fund (or

direct to the Government if the scheme is unfunded) of this amount.

These costs/payments [expressed as an average percentage of the annual salary bill

(payroll)] are published by each employer as the ‘current service cost’. Table 4 below

shows the average current service cost across the three countries based on the respective

Government’s assumed (or artificial) discount rate, and compared to the cost calculated at

market discount rates.

Table 4

Current Service Cost of Public Pensions as % of Payroll

Country Governments’ assumed rates Market rates

US 18% 29%

UK 18% 44%

Canada 17% 37%

The values in Table 4 are startling: on these calculations, the Governments of all three

countries are recording the annual cost of the pensions they provide to be about half the

cost if the pension was priced at market prices.

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