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

The reported liabilities of the five unfunded schemes have increased significantly over the last five years

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The reported liabilities of the five unfunded schemes have increased significantly over the last five years

63. In accounting for pensions cost, the principle is that an organisation should account for retirement benefits at the point at which it commits to paying them, even if actual payment will be made in future years. For annual accounts purposes therefore, each scheme prepares an estimate of the long-term cost of meeting its pension undertakings.

64. The reported pension liabilities for the five main unfunded schemes have increased significantly in real terms since 2006 (Exhibit 9). Some of this increase is a result of absolute changes in the liabilities – such as having to pay more because of increases in the numbers of members; increases in pay; and because of members living longer as a result of improving life expectancy. However, the main reason for recent increases has been changes in the financial assumptions that are used for the estimates. In particular, volatility in interest rates influence the discount rate that is used to estimate the reported pension liabilities each year. Consequently, historically low interest rates have had the effect of sharply increasing pension liabilities reported in accounts over the past year.

65. Despite the increase in the reported liabilities of the unfunded schemes, the contribution rate set for them has remained largely constant. This reflects the fact that in setting contribution rates for these schemes actuaries must follow guidance from HM Treasury. This guidance prescribes the discount rate of 3.5 per cent a year in real terms and this rate has remained unchanged over the past five years. This rate is higher than the rate that is currently used for valuing pension liabilities in annual accounts, which for the 2009/10 accounts was typically 1.6–1.9 per cent a year in real terms.

66. If the discount rate set by HM Treasury for the unfunded schemes falls, the overall pension contribution rate will need to increase. The UK government has accepted the recommendation of the interim report of the Independent Public Service Pensions Commission to review the use of the current discount rate. This review is now under way and is expected to conclude in March 2011. The Commission estimated that reducing the discount rate by 0.5 per cent a year could increase overall pension contribution rates by about three per cent.

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