Scotland's pensions - the enduring debate
Christine Scott, Assistant Director Charities & Pensions at ICAS, assesses implications for Scottish pensions now Westminster and Holyrood governments have outlined their positions.
In a recent BBC poll, pensions and welfare ranked as the second and third most important topics in the referendum debate behind the economy. The UK Government has just published its commentary on these topics in Scotland analysis: Work and pensions and ICAS has been assessing this latest contribution to the referendum debate.
The Scottish Government set out its policies on pensions back in September 2013 in its publication Pensions in an independent Scotland and these policies were reinforced in its white paper Scotland's Future – Your Guide to an Independent Scotland (November 2013).
Therefore the publication of the Scotland analysis paper gives cause for fresh consideration of the issues, not least because pensions and welfare are both policy areas which are currently reserved to the UK Government and, naturally, people are keen to know how the government of an independent Scotland would design the welfare state.
In terms of scale, social security expenditure, including pensioner benefits, is the largest single element of UK public sector expenditure. In 2012-13, expenditure was almost £209 billion, around 31% of total expenditure for that year.
Pensions arrangements are not limited to the State pension and encompass private and public service pensions and their regulation.
Both the Scottish Government and UK Government papers provide useful contributions to the debate and place more information in the public domain: this is to be welcomed. However, as we move towards the independence referendum it's becoming increasingly clear where areas of uncertainty still exist about Scotland's pensions future and that many of these won't be resolved before the referendum and possibly, depending on the outcome, for a considerable period beyond.
Continuing uncertainty is to be expected, it's just reality and the results of potential negotiations cannot be pre-empted by either party. This is therefore an opportunity to highlight that many of the questions we have raised in our two Scotland's Pensions Future papers , including the many questions on legacy issues, remain unanswered, at least for the time being.
ICAS takes a neutral stance on the referendum on Scottish independence. It has a duty to act in the public interest and therefore contributes information and insights to the debate and asks pertinent questions of both the Scottish and the UK governments.
The State Pension
Turning to the Scotland analysis paper, Scottish demographics and the cost of the additional policy positions taken by the Scottish Government are the main focus. The Scotland analysispaper estimates that the additional cost of Scottish Government policy commitments on welfare and the State pension, taking into account assumptions about demographic change, could equate to an additional £1.55 billion per year (at today's prices) by 2034. £1.4 billion, or nearly 97%, relates to pensioner benefits. Taking the paper's estimate of social security expenditure in Scotland in 2012-13 of £17.7 billion, £1.55 billion equates to an increase of 7.9%.
ICAS envisages that the independent commission the Scottish Government would set up to examine both the State pension age and the normal retirement age for public service pensions would examine the demographics carefully. Projected ratios of working age persons relative to those of pensionable age should be a key factor in assessing the affordability of delaying the increase in retirement age to 67 beyond 2026-28, the increase planned by the UK Government.
The Scotland analysis paper examines old age support ratios using different assumptions about life expectancy and immigration to make projections. Comparing Scotland to the UK, each variant shows that the demographic challenge for Scotland seems greater. The Scotland analysis report states that "Under the principal migration variant, in 20 years' time, there are projected to be 2.84 working age people per pensioner in Scotland compared to 2.98 in the whole UK [including Scotland]". The old age support ratios calculated by the DWP are based on 2012 Office of National Statistics population projections and take account of increases in the State pension age which have already been legislated for by the UK Parliament.
The impact of delaying the increase in State retirement age is factored into the £1.4 billion quoted above at an estimate of £0.6 billion or 43% of the estimated additional cost of pensioner benefits.
The Scottish Government has provided assurance that current pensioners would continue to receive their pensions as now, on time and in full and that accrued rights would be protected.
ICAS has raised questions about how this would be achieved. While the Scotland analysispaper doesn't rule out the sharing of DWP infrastructure, it makes it clear that there would be significant barriers to sharing which could ultimately make sharing unlikely.
The UK Government says that the government of a continuing UK would not be willing to make changes to existing systems to accommodate differences in policy. This could be overcome by delaying any changes until an independent Scotland developed its own infrastructure. A more intractable issue is that, according to the Scotland analysis paper, systems could not be shared if benefit payments in Scotland were made in a different currency. Therefore, taking the UK Government's stated position on a currency union as non-negotiable, unless an independent Scotland adopted sterling without a currency union, the conclusion to be drawn is that sharing arrangements even for a transitional period would not be possible. This is a significant concern as the paper also states, with regard to the State pension, that "It seems implausible that existing accounts could be separated cleanly so that people living in Scotland at the time of independence could have their state contributions records untangled to identify if pensions liability fell to either the government of the continuing UK or of an independent Scottish state".
The Scotland analysis paper very much contradicts the assurances about the State pension made by the Scottish Government on the reliability of payment arrangements. Yet the commentary on the migration of data does seem to indicate that a significant level of co-operation between both governments over an extended period would be highly desirable, indeed required, to ensure that this task was undertaken thoroughly and as accurately as possible. ICAS would look to both governments, in the event of a vote in favour of independence, to ensure that no citizen experienced a delay in receiving their State pension as a consequence of constitutional change.
Public service pensions
The issues which would arise around managing public service pension legacy issues and establishing new or developing existing infrastructure to deliver public service pensions are very similar to those which would arise for the State pension. In terms of new information, the Scotland analysis paper reports that an independent Scotland's share of public service pension liabilities would be in the region of £100 billion. This is broadly consistent with the £86 billion of liabilities already identified by the Scottish Public Pensions Agency for schemes relating to the majority of devolved activities. It is important to note that around £25 billion of the £100 billion relates to the Scottish local government pension scheme which is a funded scheme and pays pensions from scheme income and/or assets.
The additional £14 billion an independent Scotland could inherit has been arrived at on a population-based share of UK-wide activities. However, the Scotland analysis paper acknowledges that much greater analysis would be needed to assess the liabilities during negotiations. ICAS believes that following any negotiations, the net liabilities to be borne by an independent Scotland would be the sum of the contractual commitments to the individual public service scheme members and beneficiaries sitting with the Scottish public sector at the date of independence less any contribution from the continuing UK to reflect the past service of any scheme members to the UK.
Regulation and protection
The Scotland analysis paper is helpful in setting out the extent of UK infrastructure which supports the delivery of pension policy, including the delivery of the State pension and the regulation and protection of private pensions. The Scottish Government in its paper on Pensions in an independent Scotland has indicated that its starting point for a Scottish pensions system would be the current UK system, albeit with some additional commitments around the State pension, and also gives a sense of the infrastructure which would be required to support a Scottish pensions system.
As things currently stand the estimated cost of establishing a pensions infrastructure in an independent Scotland has not been calculated nor have the estimated running costs. While the Scotland analysis paper does touch on this important issue, it is quite correct that the UK Government does not set out the detailed costings for an independent Scotland's pensions system: this is something that the Scottish Government is yet to do and ICAS would welcome this. However, what the Scotland analysis paper can do is give an indication of where scope for sharing institutions is unlikely to be agreed. For example, the Scottish Government has proposed sharing pension protection arrangements through a shared Pensions Protection Fund (PPF) but the UK Government has ruled this out. (There are, however, examples elsewhere in Europe of smaller nations sharing neighbouring nations' equivalent protection funds, such as Finland with Sweden and Luxembourg with Germany.)
ICAS has suggested that if it could be made to work, retaining a combined PPF would be the most favourable, possibly interim, solution for an independent Scotland. However, ICAS recognises that such an approach would tie an independent Scotland to the UK system of pension law and regulation while such an arrangement existed. Unravelling the UK PPF would be a challenging task which the Scotland analysis paper fails to address. While ICAS understands that the detail will be left to negotiation, it would seem reasonable for the UK Government to consider now in broad terms how separation could be achieved.
Turning to perhaps the pensions issue which has received the most attention, the impact of the solvency rules for private sector defined benefit schemes which would become cross-border in the event of Scottish independence. The Scotland analysis paper touches on this issue stating that "An independent Scottish state would also need to consider cross-border funding requirements and operations." However, what it does not do is recognise that this is as much of a challenge for the UK Government and that the continuing UK would need to do the same. This is an area of policy where ICAS believes that the UK and Scottish governments should be preparing to engage in dialogue with the European Commission, as well as the UK pensions regulator and the European-wide pensions regulator EIOPA. Also, it should be possible to elevate any discussions beyond the scope of the referendum on Scottish independence to a discussion on the merits of pension schemes operating across national borders.
The EU has recently published a draft of its second IORP (pensions) directive which had been widely expected to remove the cross-border solvency rules to encourage the establishment of more cross-border pension schemes. As things have transpired no changes to these "pillar 1" rules have emerged.
The first pensions directive, issued in 2003, was supposed to encourage cross-border operations but the numbers indicate otherwise. According to the most recent figures published by the EU in July 2013 only 82 schemes currently operate cross-border between EU member states. With EU policy on the prudential solvency rules for cross-border schemes in a muddle, there must be some scope to seek change.
Both the Scottish and UK governments have now set out in detail their views on pensions in an independent Scotland. Does this mean that we now know what pensions arrangements an independent Scotland would need? We know that an independent Scotland would need arrangements which would support pension rights built up prior to independence and a comprehensive system of law and regulation which could not vary too much from the UK arrangements in place at the date of independence. However, it is also clear that there is much about the detail of how this would be achieved that we do not yet know and are unlikely to know unless or until negotiations take place between the Scottish and UK governments and the pervasive issues of currency and EU membership are also resolved.