How “Me First” pensions make the UK’s debt more expensive

Exploring the connection between risky pension investments and the UK’s rising debt payments.

Image Source: Unsplash

This week has been an overwhelming one when it comes to trying to work out what news to focus on. If you’re a subscriber to our new Daily Briefings you’ll have received an email every weekday this week with a short article with our take on an important news story that day (If you haven’t subscribed - click here).

What you won’t have seen is that every day this week we’ve had to choose between three or four stories, each of which would been a shoe-in on any “normal” day. Even in well covered stories that you will have seen elsewhere, there are nuggets of information that caught our eye that were perhaps glossed over.

Earlier this week there was a strong set of headlines about the sudden spike in the UK’s debt interest. It’s not just that the UK’s total amount of public debt is still rising, but the amount that it pays in interest to service that debt is getting much more expensive. While interest rates have been rising across the developed world since the period of unusually low interest rates between the 2008 Financial Crisis and the 2019 Covid pandemic, the UK is expected to end up with the highest debt interest rates in the G7 in the near future.

There are nuances around how much that will actually affect us. The surface level explanation is that if more public money goes into servicing debt interest then it means less to spend on other public services. A layer down though shows that not all debt interest is created equal.

Particularly, interest payments paid to service debt held by the Bank of England is booked as a revenue for the bank but, as the bank is a publicly owned Central Bank, all profits from the bank are paid back to the UK Government. So it’s a bit like you owning your own house but still insisting on paying rent to the owner. At best, it’s just shuffling money between different bank accounts.

Another layer down is to ask who owns the rest of the debt. Where bonds are held by people or companies overseas, that could be a problem because that represents public money being extracted out of the country. Where it’s held by UK companies, it might be less of a problem because those companies will be spending that money into the UK economy somehow – and thus you can think of the debt interest as acting more like a public subsidy towards those companies (whether or not they are companies that you want to see subsidised is a different question).

And then there are savers and investors. The interest your bank pays you on your savings (“What interest? What savings?”, I hear you say; I know., but that’s a different question too) is, from their perspective, the same “cost” to them as the debt interest is to the UK Government. We don’t see it as that though. We see it as a benefit of saving money. Their cost is our gain.

The same goes when your pension (“What pen…”, OK, I get it!) invests in government bonds. That debt interest payment is your savings growing into something you can spend in retirement to sustain a decent lifestyle.

But why have the UK’s interest rates shot up so much and why have they shot up higher than the rest of the G7?

Part of the explanation affects all of those nations – rebounds from the global pandemic, climate related supply issues, global conflicts and Trump’s trade wars all play a part – though the UK appears to be particularly exposed to some of them, especially – since Brexit – to Trump.

Other impacts are more local. Since Liz Truss and arguably before that, the UK has seen a slew of unstable and uncertain governments that have reduced confidence in the investors who want to buy UK debt, which pushes up the price they demand in order to bear the risk of a default. Some of it is that those investors are highly neoliberal and have seen the UK Government – particularly Starmer, Sunak and Johnston – as being not nearly neoliberal enough and thus are applying pressure for the UK to abandon what they see as “loose fiscal policy” and return to more Austerity.

But there’s one reason that was mentioned in passing in both the FT and BBC that caught my eye and that’s the changing patterns in those pension investments I just mentioned.

“An average British worker now retires with something like 11 different pension pots spread over 9 different pension providers.”

It used to be that most pensions were “defined benefit” pensions. That is, your workplace pension payment was based on some fraction of your salary at the point of retirement. This ensured that you could maintain your lifestyle at the point of retirement without too much of a drop in income and provided a stable financial floor for the rest of your life. But it was hard to manage for companies and pension funds, often led to headlines about companies creating shortfalls in their funds, and was difficult to extract a lot of profit from.

Over the course of the 1990s onwards, there was a push to move workers out of defined benefit pension schemes into defined contribution schemes. These are essentially just glorified bank savings accounts. You final pension is dependent not on your final salary but on how much you are able to save over the course of your working life.

In an age of fragmented careers and squeezed pay, this is proving difficult. In our book All of Our Futures, we found that an average British worker now retires with something like 11 different pension pots spread over nine different pension providers. The risk of pensioner poverty – or even destitution if your savings run out before you die – is very real.

Pertinent to this story though is the change in investor culture as a result of that shift. The thing about defined benefit pensions is that they demand long term planning and stability – which means aiming for long term investments. These can be in things like rentable property and assets (there’s a reason that the Canadian pension sector pension fund owns Aberdeen, Glasgow and Southhampton airports) but they also invest in government bonds – especially the very long payback bonds like 30 and 50 year bonds. They tend to have to invest with solidarity in mind and thus look to benefit all of their members in the long run.

Defined contribution schemes, however, are much more focused on an individualistic “Me First” push for a quick gain – particularly in the earlier years of a saver’s scheme (many DC schemes do tend to move into safer investments towards the end of a saver’s career as a safeguard against being wiped out with no time to recover before retirement). What this does though is pull demand away from long, “safe”, investments and push it towards higher risk, higher (potential) reward investments. This, in turn, pushes the price of longer dated investments up as they try to compete.

So we end up with an extremely volatile situation of people’s livelihoods being dependent on risky investments and the safeguard of long dated government bonds becoming so much more expensive that the Government starts cutting public services – including those that retired people rely on.

It doesn’t even make us any richer! Pensioner poverty rates have been static for the past 20 years and the rest of us face a future of having neither enough savings nor even enough capital wealth from inflated house prices to sustain ourselves. The only people who got rich from this shift in pension cultures are the folk who took commissions from the defined contribution schemes (until very recently, the UK had some of the most expensive pension fund management fees in the developed world and still has issues with things like high cost and complexity of moving your savings for ethical or financial reasons).

A better way would be to be a bit more Canadian. To bring Scottish workplace pensions into public hands and have them invest in Scottish infrastructure(either directly – though that Canadian scheme is apparently not the best landlord when it comes to the homes it directly owns – or through vehicles like the Scottish National Investment Bank).

The economy needs to be rebalanced towards patience and long-term security rather than grabbing a quick buck and trying to not drop it. An economy that puts “Me First” apparently works for almost no-one. An economy that puts “All of Us First” is one that will work for everyone.