CHAPTER 4 - COST OF OCCUPATIONAL PENSIONS IN THE PUBLIC SERVICE

4.1 Introduction

4.1.1 Traditionally, the cost of public service pensions has been presented as part of the public service pay and pensions bill. The pension cost represents the current cost of pensions and lump sums in respect of former public servants, including those who retired or died in service in the current year, net of the pension contributions of serving staff, while the pay bill represents the current salary cost of serving staff. The true cost of pensions tends to be incompletely described in this approach, since no account is taken of the ongoing and accruing pensions liability in respect of serving staff. The long run effects of changes in pension terms, which could have major cost implications into the future, are also not fully captured in the annual pension cost statistics.

4.1.2 The Commission has initiated an actuarial project with the objective of providing a full picture of the current and emerging cost of public service pensions. The cost of the various claims for improvements in pension scheme terms is also being estimated. Work on this project is ongoing. The figures in this chapter draw on the information currently available, rather than on the results of the actuarial project.

4.2 Current Cost and Contribution Income of Public Service Pension Schemes

4.2.1 In 1996, the pay cost of 218,000 public servants was £4,925 million. A preliminary estimate of the pension cost is £608 million, broken down into pensions in payment, £499 million, and lump sums, £109 million. In general, all public servants are members of pension schemes, although a number, principally about 20,000 part-time staff, are not. A further 62,000 employees of the pension schemes of the commercial state companies, which are broadly financed on a pre-funded basis, are not included in these figures as they are outside the Commission's terms of reference. A breakdown of the figures into each area of the public service is given in Table 4.1.

Table 4.1 Public Service Staff, Pay, and Pension Costs, 1996

* It is important to note that the figures for public service numbers are not directly comparable with the Paybill figures in column 3. In the case of some expenditure which is classified as pay, corresponding numbers are not readily available (such as expenditure in relation to the General Medical Service) while in other cases only part of the pay costs of the employees in this column are met by the Exchequer.

** Includes the cost of lump sums.

4.2.2 Contribution income, representing the total of pension contributions made by individual employees in respect of the main pension scheme and the spouses' and children's contributory pension scheme, was estimated at £178 million in 1996. Hence, the net cost to the state of public service pensions in 1996 was £430 million.

4.2.3 A breakdown of estimated pensions expenditure and contribution income in 1996 is given in Table 4.2.

Table 4.2 Estimate of Public Service Pensions Costs and Contribution Income, 1996

Note: this table takes no account of pension contributions by means of a notional deduction from salary

4.3 Actuarial Projection of the long-term cost of Public Service Occupational Pension Schemes

4.3.1 The Commission has asked pension consultants, Irish Pensions Trust Actuarial Services Ltd., to carry out an actuarial projection of the long-term cost of public service pension schemes over the next 40 years. While an earlier partial actuarial valuation of pensions was done by the Department in Finance in 1986, the current project is the first independent actuarial valuation carried out on public service pensions as a whole since the establishment of the State. The project commenced in February 1997 and has yet to be completed. The terms of reference of the project are as follows:

"To design a computerised model capable of projecting the medium and long-term costs and contribution income of public service pension schemes across the whole public service and reporting the cost information required by the Commission as outlined below. The project involves seven components:

* to oversee the collection and verification of the data required, in respect of each public service group

* to design a computerised model capable of reporting the medium-term and long-term projection of cost and contribution income for each public service group and for the public service as a whole

* to carry out the required projections on the basis of existing pension terms and in accordance with reasonable actuarial assumptions

* to prepare separate projections of cost and contribution income arising out of variations in key actuarial assumptions and changes in pension terms

* to prepare costings in respect of the value of special pension terms held by certain public service groups, including Gardaí, Permanent Defence Forces, Teachers, Fire Brigade personnel in the Local Authorities, Prison Officers, and Psychiatric Nurses

* to provide a contribution rate in respect of a new entrant, which would be required to fund the pension benefits of each public service group

* to provide an actuarial valuation of the accrued pension liabilities of the State in respect of all public service pension schemes".

4.3.2 As part of the project, the Commission has asked the Consultants to provide cost figures in respect of certain changes to public service pension terms.

4.4 Cost of Public Service Pensions - Cash Flow Projections, 1995 - 2045

4.4.1 An actuarial review of public service pension schemes was carried out as part of a study carried out in 1995. This found that in constant (1995) salary terms, gross expenditure on all public service occupational pension schemes would increase from £540 million per annum in 1995 to £1.4 billion per annum in 2025, an increase of 160%. This amounts to a compound rate of growth in costs of 3.2% per annum. Contribution income was not taken into account in these projections, nor was the impact of the reduction in occupational pensions which would result from the integration with the State Social Insurance system - the latter would reduce the cost of occupational pensions from the year 2025 onwards (see paragraph 4.5.5 below). The figures are outlined in Table 4.3, while a graph indicating the shape of the emerging cost profile over the period 1995 to 2045 is given in Appendix 4.1. Preliminary findings from the Commission's own actuarial review suggest that the increase in pension costs is likely to be of the order indicated in the 1995 study.

Table 4.3 Projection of Public Service Pension Costs, 1995 - 2045

* assuming public service pay per person increases at an annual rate of 1.5% higher than the rate of inflation.

4.4.2 The figures discussed above, and presented in the second column of Table 4.3 are given in constant (1995) salary terms. This means that while pay increases arising from annual increments, promotions, and allowances are taken into account, based on normal career progression through service, general pay rises on foot of national pay agreements, etc., are not included. In fact, general pay rises have been the norm for many decades. Public service pay per employee has tended to rise at an average annual rate of about 1.5% higher than the rate of inflation. But this 1.5% excess can vary between sub-periods and is sensitive to the base- and end-year chosen and to changes in the composition of the public service workforce. If pension projections were carried out in constant (1995) price terms, assuming continuation of this average annual rate of pay increase, public service pensions would cost about £2.2 billion in 2025 and £2.4 billion in 2030. These figures are given in the third column of Table 4.3 .

4.4.3 In order to consider the scale of the increase in costs it is useful to relate the projections of pension costs to some other measure which will also increase over time in line with economic growth. Table 4.3 does so both in relation to GNP and to the public service pay bill, which are expressed in constant price terms. For the purposes of this exercise, certain assumptions have been made in relation to annual growth figures for GNP: in constant price terms, 5% per annum for 1996 - 2006, 3% per annum for 2006 - 2016, and 2% per annum thereafter. It is assumed that public service pay increases at 1.5% per annum higher than the rate of inflation (public service numbers are assumed to remain constant). The figures show that, as a percentage of GNP, public service pensions will fall in the early period from a figure of 1.6% of GNP in 1995 to a low of 1.3% in 2005, reach a peak of 2.3% in 2025 before falling again to 1.8% by 2045. As a percentage of pay, gross pensions expenditure will increase from 11.5% in 1995 to a peak of 30.4% by 2030, before falling slightly to 25.9% of pay in 2045.

4.4.4 The size of the pension bill in the year 2025 will, of course, depend on the rate of pay increase between now and then. Given the length of the period involved, the terminal figure is highly sensitive to the assumed rate of increase in general pay levels. If, as approximates to the case between 1987 and 1995, average pay levels were to rise by 5.2% annually and prices by 2.7% annually, the pensions bill in 2025 would rise to £2.9 billion in constant prices. This is an increase of almost one-third on the estimate of £2.2 billion based on the assumption of a more "normal" growth in public service pay (and hence of associated pensions) of 1.5% per annum in excess of the rate of inflation. As mentioned earlier, the economic significance of such an increase would have to be assessed in the context of assumptions about growth in GNP and total government revenues and expenditure.

4.4.5 It is important to state that the future costs of public services pensions cannot be known in advance as their costs depend on uncertain future events which determine the future level of pension payments. These events relate to matters such as death rates among serving staff and among pensioners, patterns of retirement and withdrawals, and future salary increases. Therefore, in order to carry out cost projections into the future it is necessary to make assumptions about the future experience of public service staff and pensioners.

4.4.6 The main assumptions underlying these projections include the following:

* Mortality: standard mortality tables

* Age at retirement: average ages at retirement in line with recent experience

* Withdrawals: Nil

* Marriage rate: 90% married at age 55, and at later stages, consistent with that rate and standard mortality tables

* Salary progression: Arising from increments, promotions and allowances based on current average age related salary scales.

4.5 Factors Underlying the Growth in Public Service Pension Costs

4.5.1 The main factor in the growth of public service pension costs is the current age profile of serving staff, which is illustrated in the graph given in Appendix 4.2. Recruitment to the public service increased significantly in the late 1970s and early 1980s, with the result that a major cohort of public servants are currently in the age bracket 30 - 45 years, and will reach retirement age over the period 2015 to 2030. This retirement bulge will impose a heavy additional cost.

4.5.2 A second factor is the greater number of female public servants in employment than has been the case in the past (this is apparent in the graph in Appendix 4.2). Actuarial tables show that, on average, females retiring today at age 60 will live almost five years longer than males at the same age. As pensions to females will be in payment for a longer period than pensions to males, the greater number of females serving until retirement age will increase the total cost of pensions over the long run. While fewer spouses will qualify for spouses' pensions in respect of female public servants compared with male public servants, the overall effect on pensions will be an increase in costs.

4.5.3 Third, life expectancy is projected to improve over the medium term. The Central Statistics Office in their 1995 Population and Labour Force Projections assumed a significant improvement in life expectancy for men and women over the next 30 years. Improved life expectancy will increase the period over which pensions are paid, and so will contribute to increased pension costs.

4.5.4 The projections assume no change in public service pension terms.

4.5.5 The cost of occupational pensions is projected to peak around 2025, as the major cohort of public servants currently in the age bracket 30 - 45 years reach retirement age. As a further comment, it is clear that following the extension of full PRSI to all public servants with effect from April 1995 the integration between occupational and State Social Insurance pensions will reduce the occupational public service pensions bill from about 2025 on. However, it should be noted that the total cost to the State of the pensions of public servants, combining the cost of occupational and Social Insurance pensions, will continue to increase.

4.5.6 The overall pension cost implications for the State of extending full PRSI to all public servants will probably be adverse for two reasons:

(i) the uprating of salaries by 1/19th consequent upon the simultaneous introduction of occupational pension scheme contributions will give a higher remuneration base for calculation of pension, and thus higher pension benefits, compared with a public servant paying modified PRSI

(ii) public servants paying full PRSI will be entitled to greater pension benefits compared with public servants paying modified PRSI, where pensionable service is less than 40 years (see paragraph 9.6.3 below); there is also the possibility that adult and child dependants' additions (as outlined at paragraph 9.6.4 below) will be paid, although the impact of this is likely to be marginal by 2025.

However, the increased PRSI contributions being made by the public servants in question would also have to be taken into account in assessing the overall cost position following the 1995 changes.

4.6 Cost of Public Service Pensions - New Entrant Contribution Rate

4.6.1 In addition to cash flow, the cost of a pension scheme may be expressed in terms of a new entrant contribution rate. It has been estimated that, on reasonable actuarial assumptions, a contribution rate throughout service of about 15% would fund a civil service pension for a 20 year old male in modified PRSI class, retiring at age 65. A significantly higher contribution rate would apply in the case of a pension scheme which offered more favourable retirement arrangements, for example, the Permanent Defence Forces or Garda scheme.

4.7 Actuarial Approach to Costing Public Service Pensions

4.7.1 The Commission considers that the proper management of public service pension schemes would require an ongoing assessment of the incidence of emerging pension costs, carried out using reasonable actuarial assumptions. As public service pension costs increase, as they are projected to do over the coming years, it will become more important to have such a picture, and the actuarial project being carried out by the Commission will be significant in this respect.

4.8 Escalating Cost of Public Service Pensions

4.8.1 There is no single "right" way of assessing the future cost of public service pensions. Rather, a number of approaches can be deployed. One considers the increases in the pensions bill at various dates in the future and relates that bill to economic aggregates such as GNP, the public service pay bill, or government expenditure. Another approach estimates the cost in terms of the contribution rate required to sustain it. Finally, actuarial reviews capitalise the value of future pensions liabilities into present values. Regardless of which measure is used, the estimates indicate a rapidly escalating cost over time. From its present modest level of 11% of the public service pay bill, it could rise to 30% over the next 30 years, before falling slightly to 26% of pay. While to speak of a public service pensions "time-bomb" may be deemed alarmist, there is little doubt that the evolution of pensions costs requires careful monitoring.