Producing the best estimates of changing household wealth
Wealth in Great Britain is one of the ONS’s key economic publications, biennially reporting on the level of wealth and how it is held, including the value of homes, how much is owed in debt and the value of pensions. It is derived from results from the Wealth and Assets Survey. Recently the ONS has updated how it estimates the value of pension wealth. Becca Briggs explains how and why the numbers have been updated.
When looking at private pension wealth, there are two main types of saving; defined benefit and defined contribution. Measuring the value of defined contribution schemes is relatively straightforward. Usually, these schemes involve a person accumulating a specific amount of retirement savings through a combination of their own and their employer’s contributions and changes in the market value of the assets acquired. At, or near retirement, this fund can be drawn down or used to buy an annuity that provides an income. As such, at any given time there is a pension ‘pot’, a market-value of accumulated assets that can be counted.
However, the amount held in defined benefit schemes is more complicated to measure as they involve offering people a specified claim at a future date rather than a claim on a pot of assets. The pension accumulated can be a share of a person’s average or final salary over the course of their employment, with the share increasing with length of service. Often the claim is also indexed so that the promised amount keeps pace with changes in prices. Importantly, from a saver’s perspective, they do not have a claim on a specific pot of assets, they only have a promise from a pension fund to pay an accumulated pension in the future. As such, when considering the amount that households have saved through their defined benefit pensions, we have to develop ways to estimate what their accumulated pension is worth today, the ‘present value’ of defined benefit pensions.
There is no single agreed method for calculating the present value of the claims that households have accumulated in defined benefit schemes. The amount that needs to be paid out in the future varies depending on how long people live for, when they choose to retire and, where claims are indexed, the evolution of consumer prices. Pensions funds themselves use a range of approaches to calculate the present value of their obligations to households. We therefore need to make a range of financial and demographic assumptions to estimate the present value of retirement income that has been promised.
A key part of this is choosing a ‘discount rate’ that adjusts the value of a future pensions promise back to its current value, modelling pre- and post-retirement elements separately; £10 received in 10 years’ time is worth less than £10 received today because money held today can be invested to earn a return over the next 10 years. A discount rate accounts for this, but for payments that are far into the future, the present value is very sensitive to the rate used. The choice of discount rate is therefore a very important modelling decision.
The ONS’s methodology and choice of discount rate has evolved over the last two decades. There is a fundamental choice to be made between using market-based discount rates – which are volatile and vary with economic and financial conditions – or an alternative construct that is more stable. That choice has been particularly important over the past two decades given a large fall in long-term interest rates and then a subsequent unwind of that fall in recent years. In making that choice the ONS takes into account the fact that people who have been promised a defined benefit pension payment in the future do not generally have an option to convert that claim into a payment today based on market interest rates. Defined benefit schemes are often designed to make sure people are not exposed to fluctuations in market rates of interest.
Our previous methodology involved a long-term measure of economic growth (Superannuation Contributions Adjusted for Past Experience or SCAPE rate) to adjust for the years until retirement, and then market-based annuity rates to value pension promises after retirement. After some users queried our previous methodology, we asked the Government Actuary’s Department (GAD) to review the method and recommend changes.
GAD published its findings in December 2024, recommending that we change to a discounting methodology that uses a consistent SCAPE-based approach. Put simply, that involves using a long-term measure of economic growth to estimate future pension promises, helping to reduce short-term market volatility and better reflect the stable nature of defined benefit pensions. We accepted its recommendations and implemented them in our 2020-2022 wealth statistics, which were published last year.
Today we have also published the updated data for the 2018-20 period, with the full back series being published by the end of this year.
As stated above, there is no single agreed method for calculating discount rates, and any method involves making assumptions about both current and future behaviour and inflation, but with GAD’s support we are working hard to produce the best estimates of changing household wealth.
