The UK’s National Audit Office (NAO) has revealed that benefits paid out by the UK’s four largest pay-as-you-go public service pension schemes — the “unfunded” pensions of the armed forces, civil service, NHS and teachers — have doubled in real terms over the last 20 years to £33.5 billion in 2019-20.
The NAO said £10.1 billion of this increase is a result of a 69% rise in the number of pensioners in the schemes to 2.8 million between 1999-2000 and 2019-20.
Total employee contributions in 2019-20 at the four largest pay-as-you-go schemes amounted to £8.2 billion, 44% higher than 2009-10 in real terms.
The UK taxpayer funds about 75% of the costs of the four largest pay-as-you-go “unfunded” schemes, a similar percentage to 10 years ago.
“In cash terms this was £25.4 billion in 2019-20,” said the NAO.
“Of this, £23.3 billion came from employer contributions – up £6.4 billion on the previous year – and the rest came from HM Treasury.”
Most UK public service pension schemes operate on a pay-as-you-go or “unfunded” basis with payroll contributions from current employees and their employers, and additional funding from HM Treasury, used to pay pension benefits to those members already in retirement.
By contrast, “funded” public service pension schemes including the Local Government Pension Scheme use employer and employee contributions to create investment assets in a pension fund, with those assets and associated returns used to pay for future pensions.
“The average annual pension for members of these four (pay-as-you-go) schemes has also increased over the past 20 years, by 16% in real terms to around £10,000 in 2019-20,” said the NAO.
“A range of factors impact the value of pension payments, including the characteristics of different schemes, length of service and salary.
“For example, based on the latest data from 2016, male scheme members receive £14,100 on average annually, whereas female scheme members receive £7,750 – a 45% difference.
“On average, male scheme members earn more over their careers and therefore build up a higher pension than female members.
“Scheme members who receive higher pay make higher contributions.
“Between 2011 and 2015, HM Treasury implemented reforms designed to make the cost of public service pensions sustainable, while ensuring a good level of retirement income for public service workers.
“The reforms aimed to balance the cost of pensions fairly between scheme members and taxpayers.
“As a result of the 2011-2015 reforms, employees are contributing substantially more to their pensions, around £2,700 on average in 2019-20, or 8.5% of the average salary.
“This is a 33% increase in real terms from 2009-2010.
“During the same period, average pay decreased in real terms by 12%, reflecting that total pay has not kept pace with inflation.
“Even though total employee contributions have increased, the taxpayer’s proportion of total pension funding (£25.4 billion in 2019-20) remains the same as 10 years ago, at around 75% of the total costs.
“HM Treasury expects that pensions will become more affordable and sustainable over time, as an increasing proportion of retiring scheme members draw on the (cheaper to the taxpayer) reformed schemes, rather than the more expensive legacy schemes.
“The most recent projections from 2018 indicate that costs are expected to fall over the long-term from 2.0% of GDP in 2019-20, to around 1.5% of GDP from 2064-65.
“However, the government’s affordability measure is sensitive to changes in projections of GDP, which are now less certain because of the economic impacts of the COVID-19 pandemic, EU Exit and climate change.
“Government introduced measures as part of the 2011-2015 reforms to protect those closest to retirement, but these were ruled unlawful in 2018 on the grounds of age discrimination (the McCloud judgment).
“The government’s proposed remedies for the McCloud judgment are currently estimated to cost around £17 billion and are likely to present a significant administration challenge.
“The government has decided that current scheme members will meet the costs.
“Government is concerned that a mechanism it put in place to control cost increases is not working as intended.
“Provisional results from the most recent valuations indicated that pension benefits would likely have increased under the mechanism had it not been paused in 2019.
“In July 2020, HM Treasury announced the pause would be lifted, but it has asked the Government Actuary to review whether the mechanism is working as it should.
“HM Treasury’s objectives for public service pensions do not consider the role of pensions in supporting the recruitment and retention of staff across public services.
“Some public employers told the NAO they find the pension arrangements inflexible for supporting their plans for staff recruitment and retention.
“The only real choice for most employees in the public sector is to stay in their pension scheme or to opt out.
“There is some evidence to suggest that those in lower age and income groups are more likely to opt out as they view contributions as unaffordable.
“The NAO recommends that HM Treasury, in conjunction with the Cabinet Office, should work closely with employers to understand how public service pensions can help them recruit and retain the staff they need.”
Gareth Davies, head of the NAO, said: “Public service pensions have become more expensive over time as the number of people receiving them has increased, with more members entering retirement and living longer.
“HM Treasury’s reforms will help to contain future increases in costs for taxpayers …
“As well as managing the implementation of the changes made necessary by the McCloud judgment, HM Treasury should consider how to ensure that pensions remain attractive to public servants, particular younger staff and those on lower incomes.”