The Treasury manages public spending within two ‘control totals’ of about equal size:

  • departmental expenditure limits (DELs) – mostly covering spending on public services, grants and administration (collectively termed ‘resource’ spending) and investment (‘capital’ spending). These are items that can be planned over extended periods.
  • annually managed expenditure (AME) – categories of spending less amenable to multi-year planning, such as social security spending and debt interest.

Public service pensions spending is part of AME. It covers many schemes and is measured in net terms – i.e. total payments to each scheme’s pensioners less total contributions (both employee and employer) in respect of public sector employees. (The corresponding spending on employer contributions is included within our departmental spending forecast.) The biggest schemes relate to the National Health Service, teachers, the armed forces and civil servants.

In our latest forecast, we expect public sector pensions spending in 2017-18 to total £12.1 billion (reflecting £41.1 billion of total payments less £29.0 billion of contributions). That would represent around 1.5 per cent of total public spending, and is equivalent to £430 per household and 0.6 per cent of national income.

  • Latest forecast

    Our latest fiscal forecast was published in March 2017. In cash terms, net public sector pensions spending is on a steady upward trend and is forecast to increase from £11.3 billion in 2015-16 to £15.7 billion in 2021-22. As a share of GDP, it rises only slightly from 0.6 per cent in 2015-16 to 0.7 per cent in 2021-22. The chart below shows how the gap between spending and receipts is gradually increasing over time (for local government schemes, police and firefighters, the breakdown of outturn data into expenditure and receipts is not available). The total number of pensioners receiving payments from public sector schemes is rising, as the generation of ‘baby boomers’ and other cohorts retire. Life expectancy is also increasing, which means that an increasing number of people are receiving pension payments for longer. This outstrips receipts from current workers, who are not fully replacing the retirees in numbers. In addition, the Government’s public sector pay policy, such as the 1 per cent cap on pay rises up to 2019-20 set in the Spending Review 2015, reduce growth in contributions relative to payments, which are not uprated by inflation.

    The breakdown of historical net expenditure in police and firefighters’ pension schemes into receipts and expenditure is not available.

    More detail on our latest forecast and how it was revised relative to our previous forecast in November 2016 was provided in paragraphs 4.124 to 4.127 of our March 2017 EFO.

    Expand to read the extract from our March 2017 EFO

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  • Forecast methodology

    Forecast process

    The public service pensions forecast covers net expenditure on benefits paid less employer and employee contributions received. It includes central government pay-as-you-go schemes and locally administered police and firefighters’ schemes (which are administered at a local level, but are funded from Home Office AME).

    We commission individual forecasts of expenditure and receipts from the main central government pension schemes for each forecast, and then compile the overall forecast by collating the forecasts that are returned. We scrutinise these returns at challenge meetings that are typically attended by representatives of the schemes and the relevant teams from the Treasury. Forecasts are commissioned from the ‘big four’ pension schemes: the Principal Civil Service Pension Scheme (PCSPS), the Armed Forces Pension Scheme (AFPS), the NHS Pension Scheme and the Teachers’ Pension Scheme. These schemes account for around three quarters of gross central government pension scheme spending. We also commission forecasts from the Scottish Executive and Northern Ireland Executive, which in turn collate the forecasts of their various central government pension schemes, and from the Home Office, which collates forecasts from the police and firefighters pension schemes. Finally, we also commission forecast returns from some other smaller schemes: the Royal Mail, the Department for International Development’s pension scheme for overseas staff, the judiciary, and the UK Atomic Energy Authority (UKAEA).

    Forecasting model

    Each scheme is forecast separately by the relevant pension schemes or departments using similar but not identical forecasting methodologies.

    The gross expenditure forecast reflects the latest information available on the demographics of each individual pension scheme, both for existing pensioners and the current workforce. The forecasts are then produced by models that roll the demographics forward by a year for each forecast year. In some cases the modelling is done by actuaries employed by the individual pension scheme – for example, by the Government Actuary’s Department (GAD).

    The income forecast is based on the expected employer and employee pension contributions. The key modelling here is around paybill growth, which directly determines changes in the level of pension contributions. Paybill growth is made up of two items: paybill per head growth (consisting of wage settlements and pay drift) and workforce change. All schemes have a settlement ceiling of 1 per cent up to 2019-20 in line with public sector pay policy, but assumptions on pay drift and workforce change vary by scheme.

    Main forecast determinants

    The main economic determinants driving the forecast are:

    • CPI inflation: our forecast for September CPI inflation affects the uprating of public service pensions, and hence expenditure, in the subsequent fiscal year; and
    • population demographics: the demographics of both the current workforce and the retired pensioner populations are important for forecasting the spending for each pension scheme. This includes, for example, modelling the retirement behaviour of membership cohorts by age, assumptions on mortality and pensions thus paid to contingent dependents, as well as how pay drift is affected as better-paid, older members retire and are replaced by younger (contributing) workers on lower pay.

    Main forecast judgements

    As the forecasts for net public service pension expenditure are commissioned from the pension schemes directly, each scheme’s assumptions are important and we scrutinise them in detail. The main common issues cover:

    • retirement age distribution: since scheme members will choose to retire at different ages, each scheme must make assumptions about the retirement age distribution;
    • lump sum commutation rates: the timing of pensions expenditure assumed by schemes depends heavily on the lump sum commutation rate that is assumed. (Lump sums are a particularly volatile area of the forecast, as the potential sums are large and underpinned by uncertain assumptions on the number of retirees, the lump sums to which these retirees are entitled and behaviour in respect of the amount of lump sum commuted);
    • receipts adjustments: we scrutinise the ‘big four’ schemes’ assumptions for paybill growth rates and adjusts our forecasts where necessary to ensure that these paybill growth rates are consistent with the latest DEL (and therefore workforce) plans and the public sector budget projections. The same is also done for the police scheme. Paybill growth for the Scottish NHS and teachers’ schemes is assumed to grow at the same rate as the respective England and Wales schemes; and
    • contribution rates: our forecast assumes current employee and employer pension contribution rates, as amended by the final published results from pension schemes’ valuations. Our March 2016 forecast included a policy measure that estimated the impact of setting a lower discount rate, which is to be used in the upcoming scheme valuations and will increase employer contributions to the covered schemes. Absent any response from public sector employers, that would reduce net spending by around £2.5 billion a year from 2019-20 onwards. However, we expect the additional pressure on departmental budgets to prompt lower workforce growth, offsetting part of the saving. The effect of the policy therefore reduces net spending by £2.0 billion a year. This remains only an estimate of the effect on scheme contribution rates – final contribution rates will be decided and set based on the forthcoming scheme valuations.

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  • Previous forecasts

    Our forecasts for public sector pensions spending have been volatile. Some elements, in particular payments of lump sums at the point of retirement, are particularly difficult to forecast. Other sources of error or uncertainty over the recent past include the modelling of pensionable paybill growth across schemes – especially in the June 2010 forecast when departmental budgets had not been set – and early retirements and redundancies. For example, a jump in 2012-13 mainly reflected revised NHS workforce and redundancy plans as the NHS reform was progressing, reducing member contributions, and also increased estimates for pensions spending. In the subsequent forecasts, contributions were raised to implement the recommendations of the Hutton reform – but then offset by the inclusion of the Royal Mail pension scheme in the forecast, which is expenditure-only.

    We now take a view on the growth in contributions based on the departmental pay settlements and on workforce growth assumptions provided to us by relevant departments and agreed in Spending Review 2015. Beyond the Spending Review period, we tie contributions to our general government employment forecast, which in turn is tied to the expected path of departmental spending. Machinery of Government changes, other Government policy decisions and bulk transfers (when all members of a scheme are transferred to another scheme, which will affect net public service pensions if the transfers are not contained within the public sector, and therefore are not neutral) can all affect our pensions forecast. For example, employer contributions went up from 2015, implementing a Budget 2014 measure that raised employer contribution rates for the biggest pensions’ schemes in light of the emerging actuarial valuation results.

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  • Policy measures

    Since our first forecast in June 2010, governments have announced ten policy measures affecting our forecast for public sector pensions. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking was set out in Annex A of the relevant Economic and fiscal outlook.

    Key changes in the policy on public sector pensions since 2010 have included:

    • a switch from RPI to CPI inflation for the price indexation of all benefits, tax credits and public sector pensions from April 2011, announced in Summer Budget 2010;
    • an increase in employee contribution rates, phased in from 2012. This measure was introduced in the 2010 Spending Review in response to the recommendations set out in the report of the Independent Public Service Pensions Commission on affordability and sustainability of public sector pensions (Hutton reform);
    • an increase in employer contribution rates from 2015-16 in all unfunded public sector schemes, except police and firefighters, announced in Budget 2014 and Autumn Statement 2014. This was an outcome of scheme actuarial valuations, carried out for the purpose of determining scheme net financial liabilities as at April 2012 and the change in employer contribution rates required to deliver on these pensions commitments; and
    • a reduction in the discount rate used to set employer contributions in the unfunded public sector pension schemes from 3 per cent to 2.8 per cent from 2019-20, announced in Budget 2016. This reform followed the Government’s commitment to review the discount rate every five years since its introduction in 2011 and was based on the 2012 scheme actuarial valuations. According to our latest assessment in the March 2017 EFO, this measure is forecast to increase employer contributions by around £2 billion a year from 2019-20.

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  • Ready reckoners

    ‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants. They are stylised quantifications that reflect the typical impact of changes in economic variables on receipts and spending. These estimates are specific to our March 2017 forecast and we would expect them to become outdated over time, as the economy and public finances, and the policy setting, continue to evolve. They are subject to uncertainty because they are based on models that draw on historical relationships or simulations of policy settings. The table below shows estimates for the impact of changes in CPI inflation on our public service pensions forecast. (Section 59 of the Social Security Pensions Act 1975 (as amended) provides for public service pensions to be increased annually by the same percentage as additional pensions (State Earnings Related Pension and State Second Pension), which at present are uprated in line with CPI inflation in the 12 months to September of the preceding year. This is our default assumption for the whole forecast period.) Higher CPI inflation would increase gross and net pensions expenditure. Specifically, the table shows that:

    • a 1 percentage point increase in 2017-18 only would increase public service pensions net expenditure by amounts rising from £0.3 billion in 2018-19 (the year in which 2017-18 CPI inflation would affect pensions uprating) up to £0.4 billion by the end of the forecast period; and
    • a 0.1 percentage point increase in each forecast year from 2017-18 would increase public service pensions net expenditure by rising amounts from less than £0.1 billion in 2018-19 up to £0.2 billion by the end of the forecast period.

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