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 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).
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, average basic pay increases have been capped at 1 per cent a year in recent years, but in September 2017 the Government announced that the 1 per cent cap would be relaxed. The implications of this will only become clear once Pay Review Bodies have reported later in 2018 and employers responded to their recommendations. 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 £2.8 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 £2.2 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.