Public Sector Pensions Discount Rate
Signed Letter to UK’s Chancellor of the Exchequer, George Osborne

Rt Hon George Osborne MP

Chancellor of the Exchequer

HM Treasury

Horse Guards Road

London SW1A 2HQ


Dear Mr Osborne,

You announced in the Budget that the annual cost of new public sector pension promises would be calculated using a discount rate of expected GDP growth above inflation and the formal reasons for this were published on April 6th.

We are writing to ask that you re-consider this decision which we believe fundamentally misrepresents the economics of public sector pensions and has serious pernicious consequences.

In our view the correct discount rate should be based on the yield on long-dated index-linked gilts, (adjusted for the difference between consumer price inflation and retail price inflation), since public sector pensions and index-linked gilts share similar characteristics. Both are obligations of the UK government, both are contractually committed, legally-binding and both are inflation-linked.
The Consultation suggests the argument for using expected GDP growth is that pensions are "paid for out of future tax revenues".

But gilt interest and principal payments are also paid for out of future tax revenues. This clearly does not mean that new gilt issues should be valued by discounting payments in line with expected GDP growth, rather than the market gilt rate.
In using expected GDP growth, the Treasury has not explained how an obligation to pay a public sector pension differs from an obligation to pay gilts. If there is no difference, then pensions should be discounted at the gilt rate. The other possibility, that gilt payments should be discounted at the expected GDP growth rate, is immediately contradicted by the market.

The government's approach implies that it is cheaper for it to promise an inflation-linked pension payment to a public sector employee than it is to pay the coupon and principal on an index-linked bond.

By overstating the discount rate we understate both the current economic cost of public sector pensions and the real economic savings from the Hutton Report's recommendations. It also means that the efficiency of individual public sector bodies is overstated, as employment costs are understated and at the macro-level, the current generation of taxpayers is passing on an economic cost to be paid by future generations.

We must be clear that public sector pensions are not discretionary government spending, like health or education, which, subject to the ballot box, can be reduced to maintain affordability. They are deferred pay earned as part of a legally binding contract of employment, the equivalent of giving gilts to be redeemed at retirement and we believe their true cost should be properly measured. In light of this we ask you to re-consider this decision.


Yours sincerely,


[This letter is signed in a personal capacity and any institutional affiliation does not imply endorsement by that institution]


Lawrence Bader

Fellow of the Society of Actuaries



Andrew G. Biggs

Resident Scholar

The American Enterprise Institute


Zvi Bodie

Professor of Management, Finance and Economics

Boston University School of Management


Jeffrey R. Brown

William G. Karnes Professor of Finance and

Director of the Center for Business & Public Policy

University of Illinois


Jeremy I. Bulow

Richard Stepp Professor of Economics

Graduate School of Business

Stanford University


Wayne Cannon

Fellow of the Institute of Actuaries of Australia


Bernard Casey

Principal Research Fellow

Warwick Institute for Employment Research


Daniel Clarke

Departmental Lecturer in Actuarial Science

Department of Statistics

University of Oxford


Tony Day


Scarce Capital


Jon Exley

Fellow of The Institute of Actuaries

Thornton Steward

Jeremy Gold

Jeremy Gold Pensions


Philip Lawlor


David A. Love

Assistant Professor of Economics

Williams College

Jon Palin

Fellow of The Institute of Actuaries


George G. Pennacchi

Professor of Finance

University of Illinois


John Ralfe

John Ralfe Consulting


Neil Record

Institute of Economic Affairs

Ronald J. Ryan, CFA

Chief Executive Officer

Ryan ALM, Inc.

Crispin Southgate

55 Calton Avenue

London, SE21 7DF

Cliff Speed

Fellow of the Faculty of Actuaries

David Starkie

Senior Associate

Case Associates

Ian Sykes

Fellow of The Institute of Actuaries


Peter Tompkins

Fellow of the Institute and Faculty of Actuaries



Simon Scarpa

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