Pensions black hole set to reach £1 trillion

The Government's public sector pension deficit is set to exceed £1 trillion for the first time this year, according to the actuarial consultants Watson Wyatt, almost double the most recent estimates from the Treasury.

Sharp falls in long-term interest rates, and continued increases in life expectancy have helped raise Government pension liabilities by hundreds of billions of pounds a year since the start of the decade.

Although the Government has acknowledged a small proportion of these increases, Stephen Yeo, a partner at Watson Wyatt, says the true size of unfunded public sector pension liabilities is 80 per cent higher than the £530bn the Treasury acknowledges.

Watson Wyatt estimates unfunded liabilities are now £960bn, and are likely to top £1 trillion over the next few months.

Although the Government recently reduced the discount rate which it uses to calculate pension liabilities from 3.5 to 2.8 per cent, Mr Yeo said after recent falls in gilt yields, a more realistic rate of about 1 per cent should be used. He added that if the private sector was allowed to apply a similar discount rate to its pension scheme liabilities, the combined £78bn pension deficit among FTSE 100 companies would be wiped out immediately.

Public sector pensions cost the Government about 1.5 per cent of GDP a year - about £18bn. It conceded that this is set to rise 40 per cent over the next 30 years to 2.1 per cent of GDP. "Pensions have become more expensive in recent years because people are living longer, and the amount that can be expected to be earned on investments has gone down," Mr Yeo said. "The most recent official estimate puts the present value of the accrued liabilities in all unfunded public sector schemes at £530bn at March 2005. This is a significant underestimate because it doesn't take account of falls in long-term interest rates that have pushed up the cost of pensions. The Government is taking a rosy view of the cost of public sector pensions."

The majority of the Government pension liabilities lies in just four schemes - teachers, NHS, civil service and armed forces. Last year, these accounted for 77 per cent of the total estimated liability.

Although the Government has committed to try to reduce its public sector pension commitments, talks with civil service unions last year concluded with the Government backing down over a proposed rise in civil servant retirement ages to 65. After discussions, the Government agreed to allow existing civil servants to retire at 60, with all new recruits retiring at 65.

A majority of local authority workers, who were excluded from the civil service settlement, voted to strike this week, in response to Government plans to axe the "rule of 85", which allows workers to retire at 60 if they have 25 years' service with their employer.

The Government will unveil a new pension scheme for police officers today, which will slash its long-term bill. The scheme will pay officers up to half their final salary when they retire, rather than the two-thirds which they can currently receive. It will also pay them a lump sum worth four times their annual pension.