In recent years defined benefit (DB) pension schemes in both the public and private sectors have witnessed increased focus on cost and governance. Allan Martin highlights some of the key changes made in public sector DB pensions related to administration, communications and actuarial aspects
Career average schemes
The coalition government of 2010 made a quick start on the pension front. Following Lord Hutton's report and recommendations on public sector pensions, legislation followed in the Public Service Pensions Act 2013. The new career average revalued earnings (CARE) schemes commencing in April 2015, with increased member contributions and later normal retirement ages, have arguably transformed the cost burden on future generations of taxpayers. The changes were introduced with a promise of no further change for 25 years. Separately, other nationwide changes have also been introduced, not least the change from Retail Price Index (RPI) to Consumer Price Index (CPI) indexation.
The table below summarises key elements of the new CARE schemes
The coalition government of 2010 made a quick start on the pension front. Following Lord Hutton's report and recommendations on public sector pensions, legislation followed in the Public Service Pensions Act 2013. The new career average revalued earnings (CARE) schemes commencing in April 2015, with increased member contributions and later normal retirement ages, have arguably transformed the cost burden on future generations of taxpayers. The changes were introduced with a promise of no further change for 25 years. Separately, other nationwide changes have also been introduced, not least the change from Retail Price Index (RPI) to Consumer Price Index (CPI) indexation.
The table below summarises key elements of the new CARE schemes
* Member communications are explicit that this may be negative.
Each year HM Treasury announces the price and earnings increases (or decreases), but CARE benefit reduction (deflation) requires the "affirmative Commons procedure". The potential for benefit reduction is not constrained by any equivalent legislation to that in the private sector (section 67 of the Pensions Act 1995) and this does not appear to be widely appreciated.
Cost cap
As part of the reforms, HM Treasury introduced a 'cost cap' (or strictly speaking a 'cost corridor') on public sector pensions. The 2016 quadrennial actuarial valuations are designed to ensure that costs, expressed as a percentage of earnings, remain within set bounds, for example, 15.8% (+ or - 2%) for the Scottish Firefighters. In practice the valuation experience will mainly pick up salary increases, longevity improvement and ill health. A breach of the cap will require increased employee and/or employer contributions paid, later retirement and/or lower benefits. The mechanism is arguably very sensible long-term planning. It is perhaps unfortunate that its introduction in March 2014 coincided with the other pensions revolution of defined contribution benefit encashment.
A lesser-known fact
Employee and employer contributions for unfunded future service public sector benefits are costed or discounted using the SCAPE discount rate (Superannuation contributions adjusted for past experience). The rate was reduced in 2011 by the coalition government from RPI+3.5% to CPI+3%. The financial impact of the SCAPE reduction manifests itself in increased employee and employer contributions and the value of such arguably eclipses the removal in Advanced Corporation Tax relief for funding pensions in 1997. Although SCAPE is specified by HM Treasury, it will be interesting to see the effect of a change in the discount rate, just in case the growth and/or increase in efficiency to warrant the assumed discounting of future liabilities is not achieved. Effectively a huge inter-generational transfer of liability would be involved.
Recent case law (actuarial equivalence)
The Pensions Ombudsman (PO) recently delivered his decision in a long running case on the topic of commutation factors. Mr Milne, a firefighter from Strathclyde, became a 2006 test case under the 1992 Firefighters' Pension Scheme where the commutation factor was based on 'actuarial equivalence'. The Government Actuary's Department (GAD) was challenged on why the factors hadn't increased from 1998 - as the intervening period saw interest rates plummet with continuing increases in longevity. The end result was the PO directing a correcting scheme payment and the GAD to compensate Mr Milne for interest and tax but not expenses. Thousands of other retiring firefighters and police officers are expected to be affected. The administrative correction, complexities and communication details are currently being addressed.
Pension boards
One of the lesser publicised changes of the Hutton Report was the recommendation: "Every public service pension scheme (and individual LGPS Fund) should have a properly constituted, trained and competent pension board, with member nominees, responsible for meeting good standards of governance including effective and efficient administration. There should also be a pension policy group (advisory board) for each scheme at national level for considering major changes to scheme rules."
The new pension boards have obvious parallels with private sector trusteeship. Both involve responsibility, accountability and reporting requirements. Trust law has built up over centuries, pensions law has built up over many decades, and it would be naïve not to expect public sector pension board responsibilities and duties similarly to evolve.
The new boards fall under the auspices of The Pensions Regulator (TPR) which has a new website area, a specific code of practice, sector specific guides and an extended training toolkit. TPR arguably has other priorities with auto enrolment, private sector scheme deficits and pension scams but if for no other reason, their own employees and officials have a personal interest.
With mainly unfunded benefits, the emphasis is unsurprisingly on administration and communication. The legislation and guidance is peppered with words such as "assisting" (the scheme manager) and the board "considering" matters - rather than the potential more familiar legislative wording of 'must', 'will' and 'should'. With no physical fund of assets, investment will not be the normal trustee burden. Funding will however be on the agenda with 31 March 2016 quadrennial actuarial valuation process and progress to "consider".
It is also important to note that there are parallel pension advisory boards where employers and employees/their representatives discuss potential benefit improvements and costs. The negotiation of the new 2015 scheme benefits was undertaken via these boards, with iterative calculations between different pension fractions, revaluation rates and transition arrangements - albeit legal action continues in respect of at least one scheme's benefits.
As you would expect with public sector appointments, there are issues of disclosure, strict attention to conflicts of interest, media protocols and entertainment disclosures. Board remuneration is limited and closer to pro bono than to normal commercial rates. This arguably does little to encourage board applications from all ages, ethnic backgrounds and both sexes. Procurement is also strictly controlled. Many other issues and problems are however very similar to the private sector - tax allowances, GMP reconciliation and occasional case law.
Each year HM Treasury announces the price and earnings increases (or decreases), but CARE benefit reduction (deflation) requires the "affirmative Commons procedure". The potential for benefit reduction is not constrained by any equivalent legislation to that in the private sector (section 67 of the Pensions Act 1995) and this does not appear to be widely appreciated.
Cost cap
As part of the reforms, HM Treasury introduced a 'cost cap' (or strictly speaking a 'cost corridor') on public sector pensions. The 2016 quadrennial actuarial valuations are designed to ensure that costs, expressed as a percentage of earnings, remain within set bounds, for example, 15.8% (+ or - 2%) for the Scottish Firefighters. In practice the valuation experience will mainly pick up salary increases, longevity improvement and ill health. A breach of the cap will require increased employee and/or employer contributions paid, later retirement and/or lower benefits. The mechanism is arguably very sensible long-term planning. It is perhaps unfortunate that its introduction in March 2014 coincided with the other pensions revolution of defined contribution benefit encashment.
A lesser-known fact
Employee and employer contributions for unfunded future service public sector benefits are costed or discounted using the SCAPE discount rate (Superannuation contributions adjusted for past experience). The rate was reduced in 2011 by the coalition government from RPI+3.5% to CPI+3%. The financial impact of the SCAPE reduction manifests itself in increased employee and employer contributions and the value of such arguably eclipses the removal in Advanced Corporation Tax relief for funding pensions in 1997. Although SCAPE is specified by HM Treasury, it will be interesting to see the effect of a change in the discount rate, just in case the growth and/or increase in efficiency to warrant the assumed discounting of future liabilities is not achieved. Effectively a huge inter-generational transfer of liability would be involved.
Recent case law (actuarial equivalence)
The Pensions Ombudsman (PO) recently delivered his decision in a long running case on the topic of commutation factors. Mr Milne, a firefighter from Strathclyde, became a 2006 test case under the 1992 Firefighters' Pension Scheme where the commutation factor was based on 'actuarial equivalence'. The Government Actuary's Department (GAD) was challenged on why the factors hadn't increased from 1998 - as the intervening period saw interest rates plummet with continuing increases in longevity. The end result was the PO directing a correcting scheme payment and the GAD to compensate Mr Milne for interest and tax but not expenses. Thousands of other retiring firefighters and police officers are expected to be affected. The administrative correction, complexities and communication details are currently being addressed.
Pension boards
One of the lesser publicised changes of the Hutton Report was the recommendation: "Every public service pension scheme (and individual LGPS Fund) should have a properly constituted, trained and competent pension board, with member nominees, responsible for meeting good standards of governance including effective and efficient administration. There should also be a pension policy group (advisory board) for each scheme at national level for considering major changes to scheme rules."
The new pension boards have obvious parallels with private sector trusteeship. Both involve responsibility, accountability and reporting requirements. Trust law has built up over centuries, pensions law has built up over many decades, and it would be naïve not to expect public sector pension board responsibilities and duties similarly to evolve.
The new boards fall under the auspices of The Pensions Regulator (TPR) which has a new website area, a specific code of practice, sector specific guides and an extended training toolkit. TPR arguably has other priorities with auto enrolment, private sector scheme deficits and pension scams but if for no other reason, their own employees and officials have a personal interest.
With mainly unfunded benefits, the emphasis is unsurprisingly on administration and communication. The legislation and guidance is peppered with words such as "assisting" (the scheme manager) and the board "considering" matters - rather than the potential more familiar legislative wording of 'must', 'will' and 'should'. With no physical fund of assets, investment will not be the normal trustee burden. Funding will however be on the agenda with 31 March 2016 quadrennial actuarial valuation process and progress to "consider".
It is also important to note that there are parallel pension advisory boards where employers and employees/their representatives discuss potential benefit improvements and costs. The negotiation of the new 2015 scheme benefits was undertaken via these boards, with iterative calculations between different pension fractions, revaluation rates and transition arrangements - albeit legal action continues in respect of at least one scheme's benefits.
As you would expect with public sector appointments, there are issues of disclosure, strict attention to conflicts of interest, media protocols and entertainment disclosures. Board remuneration is limited and closer to pro bono than to normal commercial rates. This arguably does little to encourage board applications from all ages, ethnic backgrounds and both sexes. Procurement is also strictly controlled. Many other issues and problems are however very similar to the private sector - tax allowances, GMP reconciliation and occasional case law.
Allan Martin is an independent pensions actuary and pension scheme trustee, ACMCA
