Steve Bee wrote here recently about the Pensions disaster around the corner (Originally on Citiwire.co.uk) contrasting the poverty of private pension schemes compared with largesse paid out to pensioners in the state sector.

His article provoked a huge debate on the Money Blog about public sector pensions, with taxpayer outrage on one side and spirited defence on the other, usually on the grounds that lower-paid public sector workers deserved such benefits.  

Steve highlighted the changing shape of pension provision in the UK that may be all too familiar to you - namely that whereas in the past final salary pension provision was the norm for all large and many smaller employers, that is no longer the case.

Now,  he says, there are fewer than half a million employees in the private sector in open pension schemes of this type against 5 million public sector employees.

Why the difference?

The glib reason is always cost. Pensions are getting more expensive. We are on average living longer, meaning we receive our pensions for longer. However there has been the double whammy of lower investment returns, meaning that our savings during our working life time grow less, and the annuity cost of our pensions is more.

A decent index-linked pension at normal retirement age now costs around £25 for each £1 of annual pension. So if you want to retire on an income of £25,000 you will need a pension pot of £625,000.

For the private sector, the rising cost of such pension promises is a big problem. However it would be manageable except for two compounding issues: value and risk.

Value first. Despite the recent strike over pension scheme changes at the Grangemouth oil refinery, it is generally true that employees do not place the same value on £1 in their salary compared with £1 in their pension scheme. The employer gets less ‘bang for his buck’ funding his pension scheme.

The second issue is the risk that a final salary pension scheme puts on an employer. Since new legislation in 2003,  a company has to make good the funding of all those promises, whatever health improvements or investment conditions throw at it. Many finance directors think that they already have enough risks in their business.

So how can the state buck the trend by continuing to offer such gold plated pension schemes?

First off, because it – or rather you and me as taxpayers - can take almost unlimited risk. And the decision makers at the top really do value their final salary benefits because they will be amongst the biggest beneficiaries.

So it comes back to cost. And here the state has a huge advantage. Most public sector pension schemes are unfunded, with the Government paying out pensions from income rather than putting money aside from employer and employee contributions as happens (or did happen) in the private sector.

It does at least calculate the size of the promises its building up in the national accounts. Currently it shows that cost to be about £700 billion.

That is a huge number by anybody’s standards. However most observers believe that even that staggering figure is too low.

How do we know that? Oddly enough, we get a glimpse of the true figure when married couples split up.

At Bradshaw Dixon Moore we value pensions on divorce, including those of public sector employees. We value them on a consistent basis and time in, time out, we produce results much higher than the state-provided valuations.

For example we recently valued a local authority worker’s pension at £140,000 instead of the government’s assessment of £84,000. In another case involving a pension in payment, the lump sum was valued at £608,000 instead of £380,000.

Uniformed services are especially tricky. A police case with a government valuation of £114,000 we valued at £181,000 assuming they left the force immediately. Allowing for their generous early retirement terms, we worked it out at a whopping £360,000.

No wonder some observers such as the Institute of Economic Affairs puts the true cost of the public sector scheme pension debt at more than £1 trillion, or £1,000 billion if that’s an easier figure to understand.

Remember, one way or another, taxpayers are funding this burden. Can the state really afford to buck the trend forever?

Nigel Bradshaw is chairman and actuary at Bradshaw Dixon Moore