Tax by tax, spend by spend

Public service pension payments (net)

This Forecast in-depth page has been updated with information available at the time of the March 2023 Economic and fiscal outlook. We are aware of a technical issue with our tableau charts across the site. Access the data from our March 2023 forecast and our November 2023 forecast supplementary tables directly.

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 March 2023 forecast, we expect unfunded public sector pensions spending in 2023-24 to total £7.9 billion (reflecting £53.1 billion of total payments less £45.3 billion of contributions). That would represent around 0.7 per cent of total public spending, and is equivalent to £276 per household and less than 0.3 per cent of national income.

  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 from Treasury’s Workplace, Pay and Pensions Team. Forecasts are commissioned from the ‘big four’ pension schemes: the Civil Service Pension Scheme (CSPS), 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 the 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. Public sector pay policy is an important driver of wage settlements in most workforces – for example, the Government announced a public sector pay freeze in its 2020 Spending Review, with an exemption for NHS staff.

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. In our recent forecasts, population demographics have required further scrutiny. This was in order to account for the increase in mortality experienced in 2020-21 due to the coronavirus pandemic, as well as the marked deviation from normal retirement behaviour observed in the Armed Forces.

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 adjust 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. Paybills for the Scottish NHS and teachers’ schemes are assumed to grow at the same rates as the respective England and Wales schemes.
  • Contribution rates: our forecast assumes current employee and employer pension contribution rates, as amended by the final published results from pension schemes’ valuations. For example our October 2021 forecast included an upward revision to RDEL expenditure of around £37.7 billion in 2022-23, falling to £25.7 billion in 2024-25, compared to our March 2021 forecast. This can be expected to lead to an increase in contribution rates. This expected increase in contributions is indirectly reflected in our forecast, with the schemes’ forecast incomes uprated using OBR ready reckoners on wage and salary growth.
  • Mortality rates: our November 2020, March 2021 and October 2021 forecasts each included a judgement on mortality rates related to the coronavirus pandemic. This judgement was based on ONS excess mortality data and year-to-date data and judgements provided by some schemes, in particular the NHS pension scheme. We made the judgement that the majority of excess deaths would be felt among members currently receiving pensions (that is, receiving payment and no longer contributing to income), and that two-thirds of these excess deaths would be brought forward from the next five years. In our November 2022 forecast we returned to using the latest ONS mortality projections.

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  Previous forecasts

Our forecasts for public sector pensions spending continue to be 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 in the 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.

The past few forecasts have seen a return to volatility. This began with several pay deals in 2019-20 and then the March 2020 increase in planned DEL spending (and hence employer contribution rates) combining to reduce net pension expenditure. This was quickly followed by the onset of the coronavirus pandemic in 2020-21, which drove a rapid expansion of the NHS workforce and therefore scheme income, along with a significant decrease in the Armed Forces scheme expenditure due to reduced retirements. In November 2020 and March 2021 the Government forecast cuts to DEL spending, but these were then more than reversed in the 2021 Spending Review, with consequences for pay and therefore scheme contributions. Our October 2021 forecast also included an upward revision to net pension expenditure due to the removal of a double-counting error related to adjustments in previous forecasts. We expect to see further volatility in net public service pensions spending in our upcoming forecasts, because payments are highly sensitive to both changes in CPI and wage growth assumptions – both of which have seen large revisions in recent forecasts.

We 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 2020 and Spending Review 2021. 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, in 2019-20 there was a bulk transfer of members from the Students Loan Company into the Civil Service Pension Scheme (CSPS), which resulted in an increase in CSPS income of £223 million in 2019-20.

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  Policy measures

Since our first forecast in June 2010, governments have announced 16 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 of April 2012 and the change in employer contribution rates required to deliver on these pensions commitments.
  • A reduction in the discount rate used to set employer contributions in the unfunded public sector pension schemes from 3 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 assessment in the March 2018 EFO, this measure is forecast to increase employer contributions by a little over £2 billion a year from 2019-20.
  • A freeze to the pensions lifetime allowance until 2025-26, which was announced in the March 2021 EFO. This freeze maintained the tax-relieved lifetime pension savings limit at its current level of £1,073,100 up to 2025-26. This is expected to result in a gradual reduction in employee pension contributions as an increasing number of high lifetime earners fall within its scope.
  • The McCloud remedy, included as part of the October 2021 EFO policy measures. As discussed above, this policy addresses the age discrimination associated with the transitional protection that was offered to scheme members close to retirement, but not to younger scheme members. Payments for this policy are expected to begin in 2023-24 and will continue over the next six or more decades.
  • The new retirement flexibilities for NHS pensions, announced in Budget 2023, will offer 1995 Section members flexibility around how and when they can take pension benefits. It will be implemented in two phases: the first occurring on 1 April 2023 and the second on 1 October 2023. The policy impact on the Exchequer depends on how affected members respond, which is highly uncertain.

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  Ready reckoners

‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants, such as CPI inflation. 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 2023 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. They also do not necessarily capture all the impact of a change. The table below shows that:

  • A 1 percentage point increase in CPI inflation in the base quarter (Q3 of 2023) increases pensions expenditure by rising amounts over the forecast period, from £0.4 billion in 2023-24 to £0.5 billion in 2027-28. N.B. pensions are uprated according to the September inflation figures of the previous year – we use our Q3 CPI forecast as an approximation for September.
  • A 1 percentage point increase in average earnings in the base year (2023-24) increases pensions receipts (and therefore decreases net spending) by increasing amounts from £0.3 billion in 2023-24 to £0.5 billion in 2027-28. This assumes that increases in wages and salaries will result in proportionally higher pensions contributions.
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