One of the major issues highlighted in Scotland’s Pensions Future, a report by the Institute of Chartered Accountants of Scotland, was the implications of a ‘yes’ independence vote for many private sector defined benefit pension schemes which operate across the UK.
If Scotland became independent these would become cross-border schemes and would be subject to more onerous funding requirements under the European Union’s pensions directive.
Under EU law, as interpreted by UK legislation, such schemes have to fund their liabilities in full, so any underfunding would have to be rectified immediately.
They would also have to undertake annual actuarial valuations, rather than triennial, as they currently do, a change which would involve significantly increased regulatory burden and expense.
The aggregate deficit of the 6316 DB schemes in the Pension Protection Fund’s 7800 index was estimated to be £236.6bn at the end of March 2013, with 5080 schemes in deficit.
It is not clear how many of these schemes would be considered cross-border schemes as a result of a ‘yes’ vote.
However, as things stand, schemes across the UK would in the case of a ‘yes’ vote face sudden, enormous funding requirements. There would likely to be serious cash-flow implications for employers.
The Icas report called for more information from the UK and Scottish governments about how they would seek to mitigate the impact of cross-border rules, and what advice they would give to businesses to enable them to plan for any structural pension scheme changes that may be necessary.
The situation is further complicated by an EU consultation to impose Solvency II funding requirements on DB schemes.
These rules would increase the funds’ deficits to £450bn, according to preliminary figures submitted to the EU’s pensions authority by The Pensions Regulator.
The central issue to be considered in relation to the state pension is how entitlements built up before independence would be dealt with.
The amounts involved are extremely large: in 2011 alone the UK state pension bill was £82bn.
The Icas report called on the UK and Scottish governments to outline how they plan to deal with the entitlements built up. Would a future, independent Scotland be responsible for this entitlement for Scottish citizens?
If this were to be the case, what amounts, if any, would the UK government contribute to the Scottish government towards these costs? What would be the practicalities of this arrangement?
It should be possible to estimate the historic entitlement of Scots built up prior to any independence date and this would be vital to the Scottish government’s ability to assess its tax and borrowing requirements.
Such as many other issues, who pays would involve future negotiations following a ‘yes’ vote. However, as the outcome would significantly affect the financial planning assumptions of an independent Scotland, the Scottish government should be considering scenario planning well in advance of the referendum.
Moreover the UK government’s plans to introduce a single-tier state pension, with an implementation date of April 2016 envisaged, complicates matters further.
Does the Scottish government envisage a single-tier pension for an independent Scotland?
Unfunded public sector pensions represented 37 per cent (£893bn) of the UK’s overall liabilities, according to the most recent figures available.
An independent Scotland’s portion of these liabilities would only be a fraction of this figure and would likely be determined on the basis of whose pensions a future Scottish government would pay for.
Because of the amounts involved, any negotiations would have significant consequences for the opening balance sheet of an independent Scotland.
The Scottish Public Pensions Agency has identified £86bn in public sector pension liabilities that are based in Scotland. Of these £60bn are unfunded and £26bn funded. The overall figure for Scottish public sector pensions will be higher than £86bn, as a result of additional liabilities relating to Scotland-based members of UK-wide schemes.
Public sector employees, deferred members and pensioners would be looking to the government to ensure that there are robust transitional arrangements in place where responsibility for administering and paying pensions moves from the UK to an independent Scotland.
Because of the time it would take to set up a new regulatory system for pensions, Icas’s report recommends that an independent Scotland would be well advised to adopt the same regulatory approach as the rest of the UK in the short and medium term, following independence. In time the regulatory framework could evolve to be more suited to the perceived needs of Scotland’s pensions.
Information about the proposed protection arrangements for private sector pensions in an independent Scotland would be a welcome addition to the debate.
One protection fund for two states does not seem feasible as each country would have to protect the pensions of its own citizens. But how would the assets of the current UK Pension Protection Fund be split, and how would the new Scottish arrangements be likely to function in practice?
Also to be clarified in considering the question of Scotland’s pensions future is the issue of currency. Scots will have contributed to their pension pots in sterling so in what currency will they be paid? Who would be responsible for any future exchange-rate risk?
The UK government has stated it is unlikely to partake in any sterling zone. The Scottish government insists it would be possible to use sterling post-independence.
For evidence of the confusion and concern that exists in relation to pensions and Scottish independence, consider the case of Alasdair, a retired Icas member.
Alasdair has a state pension, two DB pensions from schemes sponsored by companies based in England which operate throughout the UK, and income from three annuities purchased from defined contribution pension pots paid through the Scottish operations of providers headquartered in England.
Alasdair asked Icas to clarify what independence would mean for his retirement.
What would happen to Alasdair’s DB pension if his schemes cannot meet new, more stringent funding requirements?
What payment arrangements would need to be made for Alasdair and others like him? Would he be paid in sterling? If Scotland chose to adopt the euro, or created its own currency, would Alasdair be paid in a ‘foreign’ currency?
Icas has taken a non-political stance in the debate about possible Scottish independence. Both the ‘yes’ and ‘no’ sides have welcomed the publication of Scotland’s Pensions Future, an indication of the importance of the subject and the need to raise these issues for debate.
In the event of a ‘yes’ vote, employers will want to avoid sudden, urgent funding requirements which might cause severe damage to their cash flow.
Individual pensioners will want to know that the funding for their retirement is secure and will want information on the currency to be used.
For the man and woman in the street there can be few more important considerations than how they will pay for their retirement.
There are less than 500 days until the referendum on Scottish independence. The Scottish electorate needs clear information as a basis for making its vote.
Scotland’s Pensions Future: What Pensions Arrangements Would Scotland Want is available to download at icas.org.uk/scotlandspensionsfuture.pdf
David Wood is executive director, technical policy of Icas
Key points
If Scotland became independent cross-border schemes would be subject to more onerous funding requirements under the EU’s pensions directive
Also to be clarified in considering the question of Scotland’s pensions future is the issue of currency. Scots will have contributed to their pension pots in sterling so in what currency will they be paid?
Information about the proposed protection arrangements for private sector pensions in an independent Scotland would be a welcome addition to the debate.