As we enter a second lockdown, finding an effective answer to the impact of the pandemic is not the only pressure facing government.
Covid has also curtailed our daily routines in a manner few would scarcely have foreseen. The daily commute has become a memory for most – certainly for the rail companies.
In the first quarter 2020-21, 35m passenger journeys were made across the UK, compared to 439m for the same quarter in the previous year. A fall of 91.9 per cent. Consequently the government has implicitly, if not explicitly, nationalised the rail industry (including Transport for London).
State guaranteed benefits
In a letter I had published in the Financial Times in September, I outlined a proposal to bring the assets and liabilities of these organisations under government ownership into which I’ll go into more detail with this blog.
The same logic applies to any institution where, in reality, the government would step in to prevent collapse. This includes the banks, as proven in 2008, the national network utilities and the local authorities.
And because of the special structure of the University Superannuation Scheme, where the last surviving university would be responsible for pensions for all failed universities, it probably applies here as well!
In that respect, while being under great strain, there’s some comfort to be had from the fact that some organisations are too big to fail.
To those who suggest that the government may also fail I would ask them to consider the catalogue of events that might precede that circumstance, and what would be happening to any financial structure at that time.
Were we to ever reach that point one might suspect that pension promises made many years ago would not be the primary concern.
So let us take a step back to consider the security of benefits as we stand today.
Security is not simply provided by assets held in a scheme, there are two other levels of security. Firstly the sponsoring employer MUST support the scheme until it falls into bankruptcy (or the scheme is fully discharged through a buyout).
Until that point all benefits are paid in full. Secondly , for most schemes, although not local authorities, the Pension Protection Fund provided support for most, but not all benefits.
Hence for schemes in this group of quasi-government backed institutions which cannot fail, the benefits will be paid in full, regardless of return on assets or size of fund.
Put simply, the trustees have a substantial “call option” on the government.
That is the real economic position, albeit not reflected in either funding or accounting approaches commonly used and the option has real economic value.
As an aside, we note here that the civil service and teachers’ pension schemes manage with no assets (unfunded, in the argot) – just government backing - and nobody questions their security.
Recognising economic reality
So why not simply take the assets and liabilities of these bodies (rail c£30bn; universities c£74bn local authorities £280bn) onto the state’s balance sheet?
For different reasons, that’s what happened with Royal Mail when, ironically, it was privatised.
It doesn’t change the economic reality for either the state of these sectors, nor the pension benefits that will be paid once one accepts the “too big to fail” case.
Indeed, from an accounting perspective, it removes the liabilities from these organisations accounted on a “mark to market” basis while adding assets to the Treasury for liabilities currently reported on an expected cost basis.
But markets know all of this so we see this is simply arbitrage between accounting regimes, not an inflated economic gain. True accounting, if there were such a thing, would price in the call option as well. Common sense, not sleight of hand.
Centralising management in this way would also produce significant cost savings, as we’re beginning to see in the continuing consolidation in local government pension schemes.
One could also take the opportunity to addresses two broader points in the pensions sphere.
Firstly it places the onus on the government to address the future cost of pensions that it is guaranteeing in an era when the private sector has deserted defined benefit.
Presently this cost is disguised in debates amongst lay trustees about artificial funding levels which do not address the true security and value being provided. As I have said before, if pensions were gold bars rather than gold plated, we would understand their cost much easier.
Secondly, it addresses the question of those entities – such as train companies and universities – caught up in the obligation to provide defined benefit schemes when they themselves are not public sector.
There is now a path to explore how they can move forward without the distraction of funding for past promises, again an approach adopted in the Royal Mail privatisation.
In summary my proposal is that at least some consideration is given to swapping into the treasury at least some of these quasi-public sector schemes at a time when the country needs more short-term flexibility than ever.
There are undoubtedly some difficulties to be addressed and public expenditure should always be accountable to the electorate, but it is worth asking who loses under such an approach ? Certainly not the members of these schemes.
And while we’re in exploration mode, who’s to say that this isn’t a model for what will become Britain’s biggest DB scheme: the Pension Protection Fund? Current assets: £32bn.
Despite being funded by a levy paid by every DB pension scheme, it is a quasi-publicly backed fund, in reality, what are the circumstances that would lead a Secretary of State to reduce benefits being paid to members who have already had benefits reduced or restricted ?.
If this status is recognised, it’s a short step to removing the distinction in favour of a pragmatic solution.