The cost of public sector pensions in Scotland Prepared for the Auditor General for Scotland and the Accounts Commission

Pension payments are rising because there are more pensioners

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Pension payments are rising because there are more pensioners

53. Payments to pensioners and their dependants for the unfunded schemes have increased by 32 per cent in real terms over the past five years from £1,468 million to £1,936 million (Exhibit 7). This increase in pension payments reflects an increase in the numbers of people reaching retirement combined with underlying pay growth over time.

54. In March 2010, there were 172,300 pensioners and dependants in the five main unfunded schemes, 13 per cent more than in 2005. This increase is due to the earlier growth in public sector employment and because pensioners are living longer than had been forecast. In addition, the average payment to pensioners is increasing because newly retired pensioners have higher pensions reflecting earlier increases in pay. This is the result of long-term demographic change and decisions on public spending over many years and needs to be considered in this context.

55. Spending on pensions includes both recurring expenditure on the annual pension and spending on one-off tax-free lump sums payable on retirement. For all the unfunded schemes, lump sums have increased from around 20 per cent of total pension payments in 2005/06 to around 25 per cent in 2009/10. Spending on lump sums varies from around 21 per cent of the total in the NHS and teachers’ schemes to around 28 per cent in police and firefighters’. This may reflect differences in commutation rates. In the NHS, teachers’ and new firefighters’ schemes pensioners get £12 added to their lump sum for every pound of pension they give up, while in the old police and firefighters’ schemes this is around £17 because they retire earlier and are in effect giving up more pension.

56. For the NHS, teachers’ and civil service schemes, staff taking part of their pension as a lump sum represents a cost saving to the schemes as the cost is on average less than the expected amount of pension exchanged. In the police and firefighters’ schemes, the lump sum is calculated to be cost neutral.

57. The cost of pensions being paid will continue to rise. The SPPA estimates that total payments to pensioners for the NHS and teachers’ schemes will exceed employers’ and employees’ contributions after 2010/11. This gap is projected to rise to £489 million by 2014/15 (Exhibit 8, next page). There is also a risk that pension costs will increase further if the rate of inflation rises because pensions are increased annually by the rate of inflation.

58. The £1,936 million a year now spent on paying pensions of the five main unfunded schemes is a large public spending commitment. However, its impact on the spending power of the Scottish Government is affected by

the different budget arrangements for paying pensions for each scheme. HM Treasury pays the pensions of the (UK-wide) civil service scheme. Pensions for the remaining four unfunded schemes are paid from different parts of the Scottish budget. The Scottish budget is split into Annually Managed Expenditure (AME) and Departmental Expenditure Limits (DEL):

• Spending on teachers’ and NHS pension payments is part of AME. AME accounts for around 15 per cent of the Scottish budget and contains those elements of expenditure that are not readily predictable. Under UK government funding policy, the Scottish Government is not normally required to find offsetting savings from elsewhere within its budgets to cover increases in AME. Increased spending on teachers’ and NHS pensions in the short term does not therefore immediately affect the Scottish Government’s discretionary spending power.

Police and firefighters’ pensions are paid for out of DEL, which forms about 85 per cent of the Scottish Government’s budget and include revenue and capital expenditure. DEL is included in the Barnett Formula and UK government spending decisions therefore determine the total DEL allocation. The Scottish Government decides how to spend DEL. However, it has to fund any increased spending on police and firefighters’ pensions, which directly affects its spending power.

59. Classifying any spending between AME and DEL is not permanent and in the past spending has been switched between them. The effect of switching NHS and teachers’ pension payments from AME to DEL would have a significant impact on the Scottish Government’s spending power, although there are no plans to do so.

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