Until then, membership of the NPF will be a mix of auto-enrolled workers and workers who have transferred in and who will reach retirement age before the end of the 40-year transition to a fully mature NPF.
It is impossible to predict in advance what the cash flows in and out will be each year during the transition period, as they will be determined by the date of transfer, ages of those transferring in, their earnings and the value of the pensions they transfer in. However, during the first 10 years or so it is unlikely that the number of retiring workers will be large. It is during the later years of the transition period that the state guarantee is at greatest risk of being called upon to support short term liquidity requirements.
During the transition it is also likely that the NPF contribution rate would need to be adjusted. But, as the end of the 40-year transition is approached, the pay-as-you-go contribution rate can be calculated with greater certainty because the ratio of pensioners to working members will mirror national demographic trends.
The proposed system includes features which provide flexibility and adaptability. If necessary, contribution rates can be adjusted, the buffer funds (explained in part 2 of this series) can add liquidity to the Cash Fund, the state guarantee of liquidity to address cash flow imbalances can be called upon, and the contribution of the State Earnings Related Pension (SERP) to total pension can also be varied.
Public sector pension schemes
The funded Local Government Pension Scheme (LGPS) will continue for some time, but as all new local authority workers will be auto-enrolled in the NPF the contribution income into the LGPS will decline. Thus, additional liquidity will be required from the state until it becomes practical to merge the whole LGPS into the NPF.
A new statutory mandate governing LGPS investments will also be required to align with the mandate which is applied to the NPF.
Unfunded pension schemes cover NHS staff, teachers, police, and fire service. These are pay-as-you-go schemes where pensions are paid out of current contributions. Again, the contribution base will decline as new employees auto-enroll in the NPF. It will be necessary for the state to take over responsibility for the pensions of all existing employees and those who have already retired. Transfers into the NPF would not be practical, as no funds are available to transfer, unless the state provided additional funding to the NPF.
The Cash Fund, Buffer and Investment Funds in transition
During the early years of the transition, before the first NPF pensioners materialise, there will be no withdrawals from the Cash Fund to pay pension benefits. This means that the establishment of the two buffer funds (Funds A and C) can be delayed. Funds can, however, be allocated to Fund B (the investment fund) at an early stage, enabling the NPF to make a start with direct investment in support of the transformation of the Scottish economy into a wellbeing economy.
What happens to pensions already being paid?
When the NPF is launched there will already be a pensioner population in receipt of pensions. These will be a mix of the old UK state pension, which would now be paid by the Scottish Government in the Scottish currency, and benefits paid by workplace pension schemes. The state pension is likely to be increased by the Scottish Government to provide a more generous Scottish state pension than that inherited from the UK.
Pensions paid by UK based Defined Benefit (DB) pension schemes would continue to be paid, but they would be paid in GB pounds (GBP) unless the administrators of those schemes come to an arrangement to pay in Scottish currency. Scottish pensioners will have an option under the new currency arrangements to retain a GBP bank account and a Scottish currency account. This means they could choose to keep any pension paid in GBP in the former account or transfer some or all of it into their Scottish currency account.
Pensions paid from Defined Contributions (DC) schemes are likely to be transferred to Scottish based pension providers. All major UK based pension companies have Scottish subsidiaries, which means that administration of pension payments can be transferred to Scottish providers and paid in the Scottish currency.
The establishment of the NPF and an earnings-related system would not disrupt the pension rights of existing pensioners, but this group would continue to exist outside of the new system. The numbers will decline naturally over time to zero.
Demographic change during the transition
There will be changes in the composition of the population during the transition period. According to current trends, the ratio of pensioners to the working population will increase as life expectancy increases (or even remains stable) while birth rates fall. As the NPF contribution rate is based on the ratio of pensioners to workers, such demographic change has major implications for the pension system, whatever the design.
The NPF (pay as you go) contribution rate (C) is derived from the following equation:
C = R x (p/w), where R is the replacement rate (the desired level of pension relative to earnings), and p/w is the pensioner/worker ratio.
Currently the p/w ratio in Scotland is about 1:2.8. This would mean a contribution rate of about 18% to fund a replacement rate of 50%.
If the P/W ratio were to fall to 1:2, a 50% replacement rate would demand contributions of 25% (50% x ½). Such a scenario would trigger a political crisis because of the high level of contributions required from the working population and associated pressure to reduce the replacement rate, reducing the level of pension benefits. Cutting the NPF pension to the retiring population would constitute breaking the promise of a 50% NPF pension, made to them when they were paying pension contributions from their annual earnings.
The state as a currency issuer
Could the state as a currency issuer compensate for this reduction in NPF pension by increasing the level of the SERP? In theory the answer is “yes”. However, maintaining a total replacement rate of 90% (40% SERP plus 50% NPF) would create a high level of demand on the productive capacity of the economy at a time when a shrinking working population would be having a negative impact on that productive capacity. Workers with the necessary skills are the most important resource available in an economy. A currency issuer cannot simply continue to increase public spending when resources are limited, and the economy is at full capacity.
In this context it is critical that Scotland adopts a positive policy towards immigration to maintain an adequate working population with the necessary skills, so that sufficient pension contributions are maintained to fund the NPF. An adequate working population is also crucial to maintain and increase the productive capacity of the economy so that it can meet the needs of all citizens, regardless of their age.
Immigrant workers joining the Scottish workforce would be auto-enrolled into the NPF and the earnings-related pension system at the start of their employment.
Conclusion
Eventually the NPF will become a funded, universal earnings-related pension scheme. All workers will have enrolled in the scheme and will have the status of “universal beneficiaries”. This means that when the NPF invests its funds it would be society and the economy as a whole that benefits. There would no longer be a distinction between pension fund beneficiaries and everyone else. The NPF would belong to and function for the benefit of us all.
