Richard Weatherhead says understanding better what clients need when they retire is a major opportunity for financial planners.
I have just returned from a trip to the United Kingdom which was memorable, not only for the fantastic weather throughout my time there, but also for the familiarity of some of the key issues facing that country.
The three biggest topics on the news were:
• The demise of the News of the World and the attendant phone hacking scandals, with Rupert Murdoch appearing regularly on TV screens;
• The industrial actions by public servants protesting against the Government’s proposal to modify and reduce their pension entitlements; and
• The release of the Dilnot Report into the financing of adult social care (or long-term care). The phone hacking scandal was well covered in Australia. The other two issues were not so well covered here, but they have significant parallels with issues in Australia – so it is worth considering them to see if there are any lessons for our industry.
PUBLIC SECTOR SUPERANNUATION
There is a range of public sector pension schemes in the UK covering civil servants, the armed forces, National Health Service employees, teachers, local government employees, the police, fire-fighters, atomic energy industry workers, judges and those working for other government organisations.
Overall, the public service schemes paid out £32 billion of benefits in 2008/09, which was about two-thirds of the cost of the basic State pension paid to all UK pensioners on reaching State pension age (currently age 65).
The issue facing the UK Government is the growing cost of these public sector pensions. The gap between pension pay- ments and contributions was around £3 billion in 2009/10 but is expected to grow to £9 billion over the next four years.
This cost is financed through overall government revenue, so is paid for by all citizens through their taxes.
The proposed solution to reducing these underfunded state liabilities has three main components:
• An increase in the age at which public sector workers are entitled to draw their pension to the same as the State pension age, which will reach 66 for both men and women by April 2020. The current public sector retirement age is 60 for most employees but has recently been raised to 65 for new employees;
• A move away from the current final-salary-based pension formula to one based on the member’s career average salary. This would reduce the pension entitlements of those who have enjoyed progressive promotional increases in salaries over their careers; and
• A cap on the Government’s fund- ing of public sector pensions, which presumably would mean that any remaining funding requirements would be met through higher employee contributions. UK public sector pensions are, on average, significantly higher than those enjoyed by people who worked in the pri- vate sector, partly because public sector superannuation pension arrangements have retained a defined benefit structure whereas much of the private sector has moved to defined contributions or accumulation arrangements similar to those that operate in Australia.
Those in the public sector often justify these higher pension entitlements on the basis that they receive lower salaries than their counterparts in the private sector during their working lives. However, the UK Office of National Statistics recently released figures that appear to show public sector workers are, on average, earning more than those in equivalent private sector jobs!
The debate about public sector pensions is an example of the broader issue of intergenerational equity, with many observers questioning the fair- ness of non-public-sector workers and younger workers more generally funding higher pension benefits for those nearing retirement in the public sector. Headlines such as,“The state sector burden is too much to bear”, are typical of some of the comments.
The cost blowout in public sector pensions is driven partly by the large numbers of the ageing baby boomers and increasing longevity. These are issues that the UK has in common with Australia and, indeed, most developed countries excluding Japan. The UK Prime Minister, David Cameron, recently made the fol- lowing statement, which illustrates the issue:
“In the 1970s, when a civil servant retired at 60, they could expect to claim a pension for around 20 years. Today, when they retire at 60 they can expect to claim a pension for nearly 30 years – about a 50 per cent increase on before.”
The UK’s ticking time bomb of public sector pension funding is, thankfully, not mirrored in Australia. Here, most public sector, defined benefit superannuation funds have been closed to new members for some years, with new members joining accumulation funds. Nevertheless, there were still $129.2 billion of unfunded public sector superannuation liabilities at June 30, 2011, net of funding through the Future Fund.
LONGEVITY
A key measure of longevity and its impact on public finances is the dependency ratio – the number of workers for every person over age 65. In the UK there are currently 3.9 workers for every person over age 65 and this is expected to reduce to 2.5 by 2041. In Australia, there are currently five workers for every person aged over 65 and this is expected to reduce to 2.9 by 2041.
If anything, the impact of the ageing population, driven both by the bulge of baby boomers and by improved longevity, is likely to be less severe in Australia than in the UK, given the already lower dependency ratio. However, in both cases there will clearly be significant strains on public finances as the relatively fewer working-age people have to finance the government pensions and additional health services required by the growing proportion of retirees.
