Examination of Witnesses (Questions 20-39)
MR CHRISTOPHER
DAYKIN, MR
ANDREW JOHNSTON
AND MR
KEVIN DOWN
1 NOVEMBER 2006
Q20 Peter Viggers: Actuaries navigate
by the rear view mirror, do they not? They look at statistics
from the past rather than trying to project those figures through
into the future.
Mr Daykin: They try to project
them into the future. What we do not have, I am sad to say, is
a crystal ball which tells us what the future will be. So, inevitably,
our view of the future has to be coloured by our view of the past,
but we attempt as far as possible to translate that into an understanding
of what the underlying processes are; not just an extrapolation
of the past but to understand what has happened in the past, how
it is changing and how that could affect the future.
Q21 Peter Viggers: Of course, the
actuaries were working until quite recently, were they not, on
what is known as the 92 series of continuous mortality investigation?
Those are statistics gathered between 1989 and 1992, and only
this year have they moved to the 00 series which, again, is only
based on statistics from 1999 to 2002.
Mr Daykin: That is true in relation
to the actuarial profession's tables based on insured pensioners
and annuitants, which are appropriate for use by insurance companies.
Q22 Peter Viggers: In the last eight/nine
years, from a situation when the pensions industry generally and
final salary schemes appeared to be buoyant three things have
hit them: one is an increase in longevity; the second is a weakness
in the Stock Exchange and the third one is the £3 billion
a year tax by the Chancellor of the Exchequer. Those things have
had a devastating effect on private sector final salary schemes
and a very large number have closed. So adjustments have had to
be made in the private sector—I think you will agree with
that.
Mr Daykin: I agree with that in
relation to the private sector, and I think it is true to say
that many actuaries in the private sector did not regard mortality
as the most important assumption they have to make for the future
because the results of actuarial evaluations were much more sensitive
to financial considerations. Also, many of the schemes that they
advised were of a modest size and did not, therefore, support
full demographic analysis. Our situation in the Government Actuary's
Department is somewhat different because we advise some of the
largest pension schemes in the country which have very large numbers
of members and pensioners, and our practice has always been to
analysis the mortality of the schemes in question, to compare
that with tables that are provided by the actuarial profession,
just to use that as a baseline. However, in principle what we
are doing is setting the mortality in relation to the scheme's
own experience and then, for the future, we are allowing for projections
based on our work in the national population projection area rather
than what the profession are doing, because we feel we are in
advance of the profession in understanding these issues.
Q23 Peter Viggers: Private sector
companies have had to make, in many cases, massive injections
into their pension funds—British Airways' pension fund,
for instance, is many millions of pounds short of the amount it
needs. Has the experience in the private sector been read across
into the government service and taken account of so that extra
reserves have been put aside in government?
Mr Daykin: It has not arisen so
much in the schemes that we advise because we have had a more
cautious approach in the past. We still have some schemes that
are in surplus. You mentioned a number of factors which led to
the problems in the private sector. I would put the single largest
factor as being the legislation in 1986 which encouraged employers
to take contribution holidays, because that instigated a whole
attitude within private sector schemes that you should fund at
as low a level as you could and take holidays for as long as you
could. On the whole, in the public sector that did not happen,
so we did not have that weakening of schemes taking place which
took place in the private sector over that period.
Q24 Peter Viggers: To take one example:
the Principal Civil Service Pension Scheme, which was I think
one of your larger clients, has now been passed over to Hewitt
Bacon & Woodrow, who are now the actuaries of that scheme.
I believe that is correct. The approach adopted by your office
was for Accruing Superannuation Liability Charges, because it
is an unfunded scheme. Passing this over to Hewitt Bacon &
Woodrow, they have recommended that there should be an increase
in the amount which is notionally set aside for future pensions.
It has been calculated that if this private sector actuary had
done its calculations on the basis that you would have done with
your previous method of evaluation a further 738 million would
have been required. What I am saying is that the private sector
actuary is applying different standards to yours and that less
has, therefore, been reserved.
Mr Daykin: Andrew is head of public
sector pensions at GAD, so it is really very much his field.
Mr Johnston: I will not comment
on the detail of the valuation approach which HBW have adopted
but I think it is clouding an issue there to say that their approach
is radically different from our own. The financial structure in
which the Principal Civil Service Scheme was operating at the
time we were advising has since changed. The Treasury decided
it would adopt a system known as SCAPE—Superannuation Contributions
Adjusted for Past Experience—which essentially takes the
investment elements, as it were, out of the equation. In the days
when we were advising the PCSPS the Treasury's philosophy was
that the pension scheme of public service should adopt the approach
which mirrored very closely that applying to the private sector.
So it had a notional investment portfolio, which included, for
example, a sizeable element of equity content. As in the private
sector, back in the days when we were advising, it led to some
sizeable notional investment profits, so that there was some reduction
there for the contributions which were being paid in recognition
of this notional surplus that was said to exist in the scheme
following the Treasury's guidance and the way they wished the
scheme to operate. That changed at the same time as HBW came on
the scene, so all the public service schemes are now moving to
this SCAPE approach, which essentially takes away this idea of
mirroring the investment policies of the private sector and in
place of that put in place an asset scheme—it is a hypothetical
asset—which yields a fixed return of 3.5% after price inflation.
There is a philosophical difference there that has been masked,
but it has to be said that different actuaries take different
views, and as ourselves we review schemes on a three-yearly/four-yearly
basis and the demographic assumptions that we are making (we talked
about mortality) change; views change, views develop, and naturally
you would expect some movement as we move between schemes. You
will see with the schemes we have advised, both before the time
HBW and afterwards, a natural progression in the contribution
costs over time.
Q25 Peter Viggers: Would this change
in methodology have caused you problems if the Government Actuary's
Department had still been the actuary to the Principal Civil Service
Pension Scheme?
Mr Daykin: I do not see why it
should. We are using the same methodology for other public service
schemes because the Treasury introduced SCAPE for the other schemes
as well. So for teachers, for example, we have done valuations
under SCAPE and for the National Health Service also.
Q26 Peter Viggers: You are in a unique
position as the independent adviser. How confident are you that
the new SCAPE method is fairly valuing the public sector pension
liability?
Mr Daykin: I think the concept
is all part of the Treasury financing of public sector liabilities,
so whether it is a true value or not depends on your understanding
of what the cost to government of providing pensions would be.
The concept within SCAPE is that the cost to government of providing
pensions is not directly dependent in any way on the market; it
is to do with the Government's ability to raise taxes in the future
and to finance its long-term liabilities. So from one point of
view, from government liabilities, it should just be looked at
as a cash flow issue as to what the call on the budget and on
borrowing will be in the future—what the percentage of GDP
will be that is allocated to paying for these liabilities. From
another perspective the valuation process is intended to place
a discipline on the employers and employees of public sector pension
schemes, and the mechanism that we have does that without making
it unduly volatile. It does ensure that the costs are brought
home to the employers and employees at the time, whilst not subjecting
those changes to the volatility of using market interest rates.
Q27 Peter Viggers: I think you will
see the cause of my concern. In the private sector unprecedented,
massive amounts have needed to be injected into pension funds
and yet in the government sector there seems to have been devised
a method to reduce the amount of provision from what was previously
arranged.
Mr Daykin: I suppose there are
two aspects to that: one is that the Government has not withdrawn
funding in the past in the way that the private sector did, and
so it has not got a lot to make up. Many of the increases in private
sector funding have been necessary because of the under-funding
that has taken place in past years. The other aspect is that the
funding basis for private sector schemes is driven very much by
the precise position in the marketplace and the costs of buying
out liabilities with insurance companies, neither of which are
relevant factors for the Government in providing its benefits
to public sector workers.
Q28 Peter Viggers: So you are blaming
the under-funding of pension fund schemes in the private sector.
Who was the person responsible for advising the Government as
to whether private sector schemes were properly funded or not
in 1986?
Mr Daykin: The Government had
a very relaxed approach to funding. Under the pensions regulator
as was in place at the time—the OPRA—who were responsible
for overseeing the funding of private sector schemes, a whole
range of possible funding levels was permitted; there was a minimum
funding requirement but the minimum funding requirement, as has
been discussed on many occasions, was not a very strong requirement
and schemes did not find much difficulty in meeting the minimum
funding requirement, or working towards the minimum funding requirement,
whilst still maintaining quite a low level of assets relative
to the cost of buying those liabilities out. This partly reflected
the fact that until the last few years pension schemes have always
been regarded as long-term enterprises; things that would go on
almost forever—certainly for the long-term—and could
be thought of in going-concern terms. However, since the atmosphere
has changed quite dramatically in the last few years—employers
are closing schemes, they are thinking about buying them out—the
whole perspective and horizon has become much more short-term;
an entirely different approach because we are now looking at the
costs of buying out, the costs of rescue by the Pension Protection
Fund—all of which then become more immediate and quite different
issues from the long-term, going-concern financing issues that
were driving matters previously.
Q29 Peter Viggers: Have you made
any calculation of the amount of money that will be involved overall
if the Government had continued with its previous level of funding
prior to SCAPE?
Mr Daykin: Have we? I do not think
so.
Mr Johnston: The liability has
remained unchanged as far as government is concerned; it has made
promises, it has passed legislation to pay benefits to public
servants in various forms. That liability has remained intact.
In a sense the call on the economy in the future, as shown in
the Long-Term Public Finance Report, has remained there regardless
of the methodology used for assessing the contribution costs which
should be borne by employers at the time the benefits are accruing.
In that sense, although it may have affected the charges made
to employers, it would not have affected the outcome, in the sense
that employees would still have achieved the same benefit promises
and the burden which falls on the economy would remain the same.
Peter Viggers: The taxpayer is always
there, at the end of the day?
Q30 Mr Newmark: What we are saying
is that what we should really be bringing is the same disciplines
we are asking of the private sector to the public sector. For
shareholders in ABC Co, the obligation of the company is to let
them know what those pension liabilities are today. The shareholders
of UK plc are the taxpayers and surely they should be expecting
the same idea—we call for greater transparency in government—as
to what those liabilities are.
Mr Daykin: Yes, and we have that.
Q31 Mr Newmark: No, you do not say,
because your answer is the taxpayer is there at the end of the
day, so it does not really matter how much we owe them.
Mr Daykin: I do not think that
is what I said. I said that the considerations that enter into
the Government's financing are different considerations from those
that apply in a private sector scheme. However, we have full transparency
of the resource account liabilities; we have projections of the
public sector costs of pensions in the Chancellor's Budget Report.
Q32 Mr Newmark: We do not have transparency
because those numbers are not on balance sheet. So public sector
pension liabilities are held off balance sheet, so there is not
that transparency.
Mr Daykin: They are published
in the resource accounts.
Q33 Mr Newmark: If it were the Chancellor
sitting in front of me and I said to him: "What is the current
state of the balance sheet today?" he will say: "There's
£450 billion of debt." Actually, public sector pension
liabilities adds almost another trillion pounds of liabilities
there, yet the public are not aware of that.
Mr Daykin: That is quite small
compared to the social security debt and the education debt and
the defence debt. This goes into a whole different area of public
sector balance sheets, and at the moment there is not such a thing
as a comprehensive balance sheet of government liabilities.
Q34 Mr Newmark: Do you think there
should be a comprehensive balance sheet?
Mr Daykin: Quite possibly, but
it goes well beyond my area of responsibility.
Q35 Mr Newmark: I will ask an easier
question now. I am going to look at the discount rate now. How
appropriate is it that public sector pension liabilities and the
current pension contribution rates are being calculated using
the AA Corporate Bond discounting rate, rather than the lower
index-linked gilts rate?
Mr Daykin: The Corporate Bond
rate is that which is required under FRS17, and I think the process
has been for Treasury, as advised by an organisation called FRAB,
to move towards using the same approach for the Government as
for the private sector in relation to that.
Q36 Mr Newmark: But the risks with
government are less than with companies, though. Is it not?
Mr Daykin: You could argue the
other way round. There is a perfectly respectable argument that
they should be calculated on the 3.5% basis of SCAPE.
Q37 Mr Newmark: Why?
Mr Daykin: Because that is deemed
by the Treasury to be the long-term costs of financing—
Q38 Mr Newmark: But it is not, because
the long-term gilts rate, we know, is 1.2% or 1.12%
Mr Daykin: That is not the long-term
cost to government, that is the marginal cost of transactions
taking place in the index-linked gilts market.
Q39 Mr Newmark: That is where risk
is today. That is where risk is assessed.
Mr Daykin: It is if you want to
buy an index-linked gilt but the Government does not want to buy
an index-linked gilt. If it were to issue explicit securities
to cover all of these debts it would massively transform the whole
securities market; it would be quite a different market from where
it is at the moment. So there is no direct relevance of the current
market yield to government liabilities.
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