The independence vote will have profound ramifications for pensions, public or private, with vital issues to be addressed as people plan life after work, writes David Wood
Scotland is getting older. The number of pensioners is growing. The number of working people providing for these pensions is decreasing.
Against this backdrop, the importance of the plans for future pension arrangements cannot be over-stated.
The Institute of Chartered Accountants of Scotland (Icas) paper, Scotland’s Pensions Future: What Pensions Arrangements Would Scotland Need? asks a series of fundamental questions of both the UK and Scottish governments about the possible consequences of next year’s independence referendum being passed.
It asks what both governments are doing to protect individuals’ pensions and pensions schemes. Whether it is the state pension, public sector or private sector, there are important issues to be addressed as people plan for their retirement.
Chief secretary to the treasury, Danny Alexander, claimed this week that by 2060, Scotland is expected to have fewer than two people of working age for every person over 65.
Work and pensions secretary, Iain Duncan Smith, said recently that in 50 years’ time, in today’s monetary terms, it would cost working-age people in Scotland £400 more to pay for state pensions than it would a person in the rest of the UK.
A leaked draft Scottish Cabinet paper from finance minister John Swinney appeared to grasp the significance of the issue. “Spending on state pensions and public sector pensions is also driven by demographics and is set to rise,” the paper is reported to have said.
Unsurprisingly, the SNP’s analysis of the pension situation differs. The Scottish Government has promised detailed analysis of its welfare and pensions plans for an independent Scotland. Earlier this month it released analysis in which it claimed that spending on social protection, of which pensions are a part, was “lower than the UK average in each year between 2007-08 and 2011-12”.
Deputy First Minister Nicola Sturgeon said that “a Yes vote in next year’s referendum will allow us to take welfare and pensions into Scotland’s hands and use the full strength of our economy to provide the support people across Scotland deserve”.
The Icas paper asks: in the case of a Yes vote, which government would be responsible for the state pension entitlements accrued before independence?
The amounts involved are enormous: the UK state pension bill was £82 billion in 2011; 40 per cent of the overall social benefit payments and 13 per cent of UK expenditure.
If the government of an independent Scotland was to be responsible for making state pension payments, agreement would need to be reached on how entitlements built up before independence would be funded. Would the UK government compensate the Scottish Government for taking these on?
It would not be in pensioners’ interests for both governments to engage in protracted negotiations.
The picture is further complicated by the UK government’s plans to introduce a single-tier state pension. This reform is due to be implemented in April 2016, a month after the Scottish Government envisages independence being achieved.
Does the Scottish Government envisage a single-tier pension for an independent Scotland? Are Scottish voters clear about what it is they will be voting for?
The paper points out that a Yes vote would have major implications for private sector defined benefit and hybrid schemes which currently operate across the UK. If the referendum is passed, these would be considered cross-border schemes.
UK defined benefit and hybrid pension schemes are governed by the solvency rules set out in the EU’s Pensions Directive, which include rules about the funding of cross-border schemes. Many of these schemes are currently under-funded, and are dealing with this over a number of years, through a staged recovery plan.
Under EU law (as interpreted by UK legislation), schemes which operate in more than one country must fund their liabilities in full and any underfunding must be rectified immediately.
Private sector employers could be confronted with substantial funding requirements, which would, of course, have major cash-flow implications.
These cross-border schemes would also have to undertake actuarial valuations every year, rather than every three years as they do at present. The regulatory burden would be greatly increased.
This would affect employers in Scotland and the rest of the UK: business will want more information about how the EU, the UK and Scottish governments intend to deal with this issue.
It’s also worth noting that, even if Scotland were to remain in the EU, the Prime Minister’s proposal for an “in/out” referendum on UK membership in 2017 further muddies the water.
The latest figure available for unfunded public sector pension liabilities – where the benefits are paid from employers’ and workers’ contributions and taxes – is £893bn. That’s 37 per cent of all UK liabilities.
While an independent Scotland’s share would be only a percentage of this figure, even a 1 per cent swing in the amount agreed would be £8.9bn, and would hugely affect the opening balance sheet of an independent Scotland. If the UK government’s attitude this week to a possible sterlingzone is any guide, the Scottish Government can expect difficult negotiations.
The Scottish Public Pensions Agency has identified £60bn in unfunded public sector pension liabilities which are Scotland-based. The overall figure will be higher; there would be additional liabilities relating to Scotland-based based members of UK-wide schemes.
In the last quarter of 2012, there were 580,400 people employed in the Scottish public sector. These figures do not take into account areas which had previously been reserved, such as the UK armed forces and the Foreign Office.
Proposals for protection of defined benefit schemes are yet to emerge. Currently, the UK Pensions Protection Fund is the oversight body. In an independent Scotland, a separate Scottish protection fund would likely be needed. This would pay compensation to pensioners of insolvent Scottish schemes. Agreement would need to be reached on the transfer of the assets and liabilities of Scottish schemes currently held by the UK Protection Fund. This would be a complex task indeed.
Currency, as we have read this week, would be a hot issue of debate. Current and future pensioners, who have paid national insurance and made pension contributions in sterling throughout their lives, will want to know the currency with which their retirement income is to be received.
The message from the UK government this week was that a sterling union between an independent Scotland and the rest of the UK is not considered likely. Informal use of sterling would also present difficulties.
Pensioners will want to know who is to bear any exchange rate risk. For those receiving income from a UK institution or employer, this would be a fundamental question. People paying into pensions want to know their retirement income is secure.
Icas’s report highlights a number of areas where profound uncertainty exists: in relation to state pensions, EU rules, public and private sector pensions. The spectre of massive, sudden funding requirements looms over the pension debate.
Complex negotiations lie ahead, which would be crucial in determining the opening balance sheet of any independent Scotland.
The Icas report calls on the Scottish Government to outlines its plans for Scotland’s pension future ahead of the outcome of the referendum.
This is a bigger issue than currency. To the man and woman on the street, there are few issues more important than how they will fund their retirement.
The clock is ticking on pensions.
• David Wood is ICAS executive director, technical policy