Cost Management
Background
Over a decade ago, public sector pension schemes were reformed building on the findings of the Independent Public Service Pensions Commission, chaired by Lord Hutton. The Commission conducted a fundamental structural review of public service pension provision.
The Coalition Government accepted the recommendations of the Commission’s final report as the basis for negotiation with the trade unions and legislated in the Public Service Pensions Act 2013 for a framework for new public service pension schemes that were introduced from April 2015.
Key changes for the reformed schemes were moving from a final salary to a career average basis and linking the Normal Pension Age in the scheme to State Pension Age. In the course of negotiations on the reforms, the then Chief Secretary to the Treasury, Danny Alexander, said that the reformed schemes should endure for 25 years.
The need to control future spending
It was also agreed that there should be a mechanism to control future spending on public service pensions, by setting a fixed proportion of pensionable pay that public service employers would contribute to the schemes in the long term. If this cost were exceeded (or fell beyond certain minimum parameters), then the Government should consult on how to bring those costs back within the agreed parameters, with an automatic default to be applied if agreement could not be reached.
To achieve this, the government established cost control mechanisms which calculate the cost of providing scheme benefits. This mechanism is generally applied to those benefits that have been accrued since the career average reforms took effect in April 2014.
The cost control processes
In LGPS there are two processes that run alongside each other to deliver this aim.
The first is a HMT-led process that was originally designed only to control changes in “member costs” (those relating to assumptions about the profile of scheme members) and excluded changes in “employer costs” (those relating to assumptions that are financial or technical in nature). However, following a consultation in 2021, the Government introduced a further check to link this process to changes in the long-term economic outlook. This meant that there would be a higher bar for benefit increases to be awarded if the country’s long-term economic outlook worsened.
The LGPS Regulations 2013 state that the employer cost cap for the Scheme under this process is 14.6% of pensionable earnings (excluding member contributions). Actuarial assumptions to allow the calculation of this are set out in HM Treasury Directions.
One of the Board’s statutory duties, under the 2013 regulations, is to introduce and maintain its own process to examine costs in the scheme alongside the process introduced by HM Treasury. The aim of this process is to provide greater control over employer contribution rates and the actuarial assumptions for this are decided by the SAB. The 2013 Regulations set the agreed target future service rate for the LGPS in England and Wales, at 19.5% of payroll (including member contributions).
Further information
Here are some key documents relating to how the cost control process has been running to date.
The Government Actuary’s Department has now completed the scheme cost assessment required under Regulation 116 of the LGPS Regulations 2013. The SAB cost management process final report was completed using methodology and 10 assumptions determined by the Board, following discussion at the Cost Management, Benefit Design and Administration (CMBDA) Committee. Scheme costs were assessed as being 20.5 percent of pensionable pay, 1 percent above the 19.5 percent target cost. This is within the range where the Board may make recommendations to amend benefits to bring scheme costs back towards the target cost but is not obliged to. Following a discussion, the Board agreed not to recommend any changes in its letter to the Secretary of State about the outcome of the scheme cost assessment.
On 29 February 2024, the Government set out the results of the actuarial valuation of the Local Government Pension Scheme (England & Wales) (the ‘scheme’) as at 31 March 2020. The valuation showed that while the core cost cap cost of the scheme lay outside the 3% cost cap corridor, when the wider economic situation is taken into account through the economic cost cap cost of the scheme, the cost cap corridor was not similarly breached. As a result, there was no requirement for the government to consult on changes to the scheme.
On 11 September 2023, The Public Service Pensions (Valuations and Employer Cost Cap) Directions 2023 were published by HM Treasury. These Directions allowed the Government Actuary’s Department to conclude the 2020 LGPS valuation by setting out how they must carry out the cost control element of those valuations.
At a special meeting in 1st July the Board considered the paused 2016 scheme valuation, HMT cost control mechanism and its own cost management process, in particular the status, and the method for the inclusion, of McCloud costs in that process. The agreement reached by the Board and the subsequent letter to MHCLG (as it was then) were subject to the final publication of HMT Directions not diverging from assumptions used in reaching the outcome. Now that HMT Directions have been published the outcome of the SAB 2016 cost management process can similarly be made public.
As set out in the 18th August 2021 letter to the then minister Luke Hall MP the Board agreed to spread McCloud costs over a 10 year period (rather than the 4 used by HMT) resulting in an outcome of 19.4% against a target cost of 19.5%.
Despite the slight shortfall in cost the Board agreed not to recommend any scheme changes, in particular citing the unwelcome impact of having to backdate any changes to April 2019 would have on already hard pressed administration teams. However the Board has set out its determination to revisit third tier ill health and contributions for the lowest paid members with the view to making recommendations in these areas separately to the cost management process.
Finally the Board expressed its concern around the method used to include McCloud costs in the HMT cost control mechanism.
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