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ITEM PF14

PENSION FUND COMMITTEE – 25 AUGUST 2006

‘NEW LOOK’ 2008 LOCAL GOVERNMENT PENSION SCHEME (LGPS)

Report by the Director for Resources

1. The issues driving the review of the LGPS have by now been widely rehearsed: - increasing longevity, changes in working patterns, the need for a balance between reasonable expectation and affordable provision and the increasing dependency ratio caused by an ageing population.
2. The Department for Communities and Local Government (DCLG) has now set out, for consultation, four options for a new look Local Government Pension Scheme to be implemented from 1 April 2008. This report considers the context for the consultation proposals, reviews each of the four options together with a number of related issues and considers the key points to be addressed in drawing up a response.
3. The timetable for the introduction of the new-look scheme is as follows:

29 September 2006 Deadline for responses to this consultation paper;

Late Autumn 2006 Consultation on draft regulations for the new-look scheme begins and extends into early 2007;

1 April 2007 Regulations for the new-look scheme to come into force;

1 April 2008 Regulations governing the new-look scheme take full effect.

Background

4. This Committee considered a report in November 2004 on the Government’s consultation document entitled "Facing the future – propositions and principles for an affordable and sustainable Local Government Pension Scheme." The Committee’s March 2005 response is attached as Appendix A (download as .doc file) to this report as a reminder of the context of these proposals. The four options now put forward for consideration build upon the responses to the November 2004 consultation.
5. The DCLG have stressed that there is, at this stage, no preferred option and they are encouraging as wide a response as possible from key stakeholder groups to inform the development of the new-look scheme. Stakeholders are not restricted in their response to the options set out in the consultation paper and are encouraged to offer their own proposals. The consultation paper highlights a number of fundamental concerns that a new-look scheme needs to address and these are described below.

The Changing Local Government Workforce

6. Any new pension scheme must address the needs of a varied local government workforce. The then ODPM commissioned an actuarial study in 2005 which included an analysis of changes in employee membership structure, based upon the experience of six LGPS funds, particularly between the 2001 and 2004 valuations. Key trends identified were:
   
   

1. Part-time working: 72% of the current employee membership is female, with 57% of female workers working part-time. Almost half the employee members work part-time and will therefore be building up benefits in retirement on the basis of a part-time salary;
2. Length of service: the average length of service for members leaving active status in the LGPS has reduced from 8.1 years in 1992-95 to 6.3 years in 2001-04. 75% of pensions in payment in 2004 were less than £5,000 a year:
3. Salary distribution: although average annual full time equivalent pay for women and men at 31 March 2004 was £16,400 and £20,800 respectively, analysis shows that large numbers of women are paid less than the average and small numbers of women are paid significantly more – with a bunching around pay levels between £10,000 and £17,000.
4. Pensioner longevity: for men retiring at 65, based on LGPS mortality, the average period that a pension is expected to be in payment has risen from 12.2 years to 16.0 years since the early 1970’s, an increase of some 31%. For women, the rise is from 16.1 years to 19.0 years, a rise of some 18%.
   
   
7. These issues taken together demonstrate that the membership of the LGPS has changed significantly since the existing benefits structure was introduced in the early 1970’s – particularly since part-timers were allowed to join in 1993 – and this current diversity of the workforce is a strong argument for reviewing arrangements to ensure pension provision meets these needs fairly.
8. The consultation paper also highlights what it terms ‘equality proofing’ in the context of the way in which the final salary basis of the LGPS tends to focus benefits on long-serving staff and particularly those who progress up the earnings scale whilst in employment, noting: "Whilst it is not the role of a pension scheme to redistribute wealth, in order to equality proof the LGPS, a smoothing of these differences, whilst maintaining mutuality across the pension scheme, seems a reasonable objective."
9. Equality proofing informs two of the options for the new-look scheme, which are rehearsed in detail below.

The Starting Point for Comparing the Cost of Different Options

10. The Government Actuary’s Department (GAD) has constructed a benchmark against which the differences in the cost of each of the new-look options can be compared against the current scheme. The benchmark, it should be noted, has been derived from an anonymous sample of six LGPS funds to provide a possibly representative scheme demographic. GAD has strongly advised individual funds to engage their actuaries to produce valuations which are tailored to each fund’s own workforce age and pay profiles, investment and funding strategies and assumptions on, for example, life expectancy. The Oxfordshire Pension Fund actuaries, Hewitts, have been engaged to produce this analysis urgently but, given the scale of the exercise, are unable to guarantee that this will be available in time to enable officers to produce an Oxfordshire-specific analysis for the Committee. In the absence of such data, the Committee should view the figures quoted for each option as being the relative costs between the cost of the current and new scheme rather than as absolute costs. The benchmark is quoted as a percentage of pensionable pay and two figures are provided throughout the GAD analysis - one for existing members of staff and one (in brackets) for new members of staff who join the 2008 scheme directly without having been in the existing LGPS. Over time, as existing members leave, the benchmark cost will move towards the figure in brackets.
11. The construction of the GAD benchmark, is summarised in the table below:

(1)	Scheme as at 31 March 2006 [Cost of present scheme before removal of the 85 year rule and before the change to allow commutation]	22.2% (19.4%)
(2)	Scheme as at 1 October 2006 [Cost of present scheme after removal of the 85 year rule and after the change to allow commutation]	20.0% (17.6%)
	A target benchmark cost for the new-look scheme
(3)	50% of the "savings" from the removal of the 85-year rule and commutation (1) – (2)	1.1% (0.9%)
(4)	Target benchmark cost (2) + (3)	21.1% (18.5%)
(5)	Adjusted benchmark cost – subtracting 0.2% for additional protections and cost of revocation of April 2005 changes	20.9% (18.3%)

12. It should be noted that, at the 2004 valuation, many fund actuaries assumed that all savings from the removal of the 85 year rule would be retained and had not factored in that 50% of the savings would be recycled into the new scheme. All things being equal, the benchmark cost identified in the table above as 21.1% would require an increase of 0.8% (0.6%) over the current employers’ contribution. In Oxfordshire terms, this would suggest an increase of some £1.1m each year from the 2007 revaluation onwards.

The Four Options

13. As part of the review of a new look LGPS, a package of additional benefits is proposed as part of each of the four options. This package provides an increased lump sum death-in-service benefit from two to three times pay, (at a cost of 0.3% (0.2%)) partners’ pensions for cohabitees (at a cost of between 0.2% and 0.3% (0.2%) depending upon the option) and better targeted ill-health provision on a two tier basis (saving between 1.0% and 1.1% (-0.7% and -1.0%) depending upon the option. The net impact of this package on the overall cost of the options is a saving of 0.5% for existing staff and between 0.3% and 0.6% for new staff and these savings are incorporated into the detail of each option set out below.
14. Members have previously supported the proposal to increase death-in-service benefit to three times pay, but have not supported the proposal to introduce partners pensions for co-habitees given the administrative difficulties of establishing entitlement. The Law Commission are currently consulting on this issue (Cohabitation: The Financial Consequences of Relationship Breakdown) and it may be prudent for members to reiterate their concerns pending the eventual outcome of the Law Commission’s work.
15. The rationale for a two-tier ill-health retirement pension arrangement is that it could be better focussed and targeted compare to the present "one size fits all" scheme which may, in some cases, place unfair pressure on medical practitioners and local government employers and managers who are required to make life long decisions at a single point in time. Whilst the rationale behind this proposal is therefore laudable it will be noted that ill-health retirements in England and Wales have fallen dramatically in recent years (around 35,000 in 1995/96 to 9,808 in 2001/02 and 6,784 in 2003/04). The County Council, as employer, in fact has very few ill-health retirements and so this change will deliver little benefit to the Authority. Conversely, the savings assumed for this policy are a significant element in the funding of the various options under consideration – if they prove subsequently to be optimistic, then the cost of whatever option is chosen will invariably increase. Given that central uncertainty and the lack of local benefit anticipated from the proposal, it is suggested that members may wish to oppose this change.
16. The consultation document, in considering each option, has applied the following criteria:

Cost – affordable for employees and employers?

Effect on existing scheme members – how will the future accrual of existing scheme members be affected by the new options?

Attractiveness to employees – does the scheme encourage saving and working later in life?

Design – is the option fit for the modern and future workforce?

Attractiveness to employers – would the option help employers to recruit and retain staff?

17. Each of the options is reviewed below against these criteria.

OPTION A: An updated current scheme, with additional benefit improvements
This option retains the features of the current LGPS – a final salary scheme with an accrual rate of 1/80th of final salary per year of membership, an automatic tax-free lump sum on retirement of 3/80th of final salary per year of membership.
Secondary benefit improvements, as detailed in paragraph 13 above are also provided.
The benchmark cost of this option is 19.4% (17.3%) of pensionable pay.
Evaluation against criteria:
1.	Lower cost option. The reduction in costs generated by the move to a two-tier ill health pension provision actually means that it costs less than the 20.9% (18.3%) benchmark cost.
2.	A final salary scheme is a valuable recruitment and retention tool for scheme employers, as it tends to focus benefits on long-serving staff, particularly those who progress up the earnings scale – but note following point.
3.	Should this option be implemented, consideration will need to be given to a tiered employee contribution rate, which would encourage short-serving, low progressing staff to join the scheme and would ensure that the scheme catered fairly for the modern workforce. The issue of tiered employee contribution rates is explored in more detail in paragraphs 32 –37 below.
4.	Retaining the current structure will minimise the impact of change on existing scheme members. Introducing a tiered employee contribution rate, however, would affect employees’ take-home pay immediately – as this might be increased or decreased in comparison with the contribution rate they currently pay, depending upon the salary of that person.

Note – if Option A were the preferred option, it might be anticipated that Unions will seek improvements in the package, given that the 19.4% cost compares to the benchmark 20.9%

OPTION B: A new, final salary scheme with an improved accrual rate
This option retains a final salary structure, but moves from a "1/80th: 3/80th" structure to a 1/60th accrual rate, with no automatic tax free lump sum on retirement.
Secondary benefit improvements, as detailed in paragraph 13 above are also provided.
The benchmark cost of this option is 20.9% (18.6%) of pensionable pay.
Evaluation against criteria:
1.	There is some difficulty in comparing the value of the current 1/80th: 3/80th structure to one in which there is no automatic lump sum. The analysis suggests that the proposal represents an improvement in the accrual rate of approximately 0.12%. This option actually costs 0% (0.3%) more than the adjusted target benchmark. In order to ensure the scheme’s affordability to employers it is likely that an increase in the employees’ current contribution rate of 6% would be necessary. As Option B costs more than Options C1, C2 and particularly A, this increase would be likely to be larger.
2.	Same comment as Option A - a final salary scheme is a valuable recruitment and retention tool for scheme employers, as it tends to focus benefits on long-serving staff, particularly those who progress up the earnings scale – but note following point.
3.	Same comment as Option A - should this option be implemented, consideration will need to be given to a tiered employee contribution rate, which would encourage short-serving, low progressing staff to join the scheme and would ensure that the scheme catered fairly for the modern workforce. The issue of tiered employee contribution rates is explored in more detail in paragraphs 32 –37 below.
4.	Same comment as Option A - retaining the current structure will minimise the impact of change on existing scheme members. Introducing a tiered employee contribution rate, however, would affect employees’ take-home pay immediately – as this might be increased or decreased in comparison with the contribution rate they currently pay, depending upon the salary of that person.

 

OPTION C: A new career-average scheme
This option changes from a final salary structure to a career-average structure. Option C1 would have an accrual rate of 1.85% and revaluation on the basis of the Retail Price Index (RPI) and Option C2 would have an accrual rate of 1.65% and revaluation on the basis of the RPI plus 1.5%, this being an estimation of wage indexation.
Secondary benefit improvements, as detailed in paragraph 13 above are also provided.
The benchmark cost of option C1 is 20.6% (17.7%) of pensionable pay – that of option C2 is 20.5% (18.1%).
Evaluation against criteria:
1.	Both of these options move from a final salary scheme to a career average scheme. They cost 0.3% (0.6%) and 0.4% (0.2%) less than the adjusted target benchmark. In order to ensure the scheme’s affordability to employers it is likely that an increase in the employees’ current contribution rate of 6% would be necessary. The increase would be likely to be more than that required for Option A, but less than for Option B.
2.	A career-average LGPS would retain the valuable features of the current scheme and would meet the needs of the modern local government workforce (high level of short service, part-time employees on low salaries) as well as career local government officers. However, it is more complicated to explain to scheme members. The change in the structure of the scheme and its cost to employees may well lead to demands for compensatory increases in pay.
3.	Some employees will be better off and some worse off under C1 and / or C2 because their future pay increases will be lower than or higher than the scheme’s revaluation rate. However, the take home pay of existing members would be affected by any rise in the contribution rate. A tiered employee contribution rate could also be considered for both of these options to encourage staff to join.

Note - Option C1 with a higher accrual rate has greater redistributive effect (and is thus more beneficial) than Option C2 for short service scheme members, if this is seen as an advantage.

Option C2 is more similar to a final salary benefit compared to C1 but the revaluation rate of RPI+1.5% could be expensive compared to a final salary scheme – if salary increases are close to RPI. RPI+1.5% reflects the historic salary trend but this could change.

From the employer’s perspective, compared to a final salary scheme, a career average scheme avoids expensive liabilities being incurred in those cases where a member transfers from one LGPS Fund to another on a significantly higher salary (the costs of which are not met by the amount of the transfer value being received). Furthermore, as discussed in the previous consultation exercise, a CARE scheme would negate the "strain" costs associated with promotions within an authority i.e. if an employee is promoted from a £15,000 post to a £20,000 post, not only does the value of future service benefits in a final salary scheme increase but the value of all the accrued past service benefits increases by a third. With a CARE scheme only the value of future benefits would increase as a result of the promotion.

Conversely, a career average scheme would not be attractive to employees who have a career in local government and who obtain future promotions. They could receive a significantly lower benefit under a CARE scheme than under a comparable final salary scheme, particularly if the promotions were to occur in their later years. The County Council, as employer, will have significant concerns about the impact of this proposed option on their ability to recruit to senior or hard-to-fill specialist / professional posts. This may become a particular issue, given that other public sector employers appear to be confirming pension arrangements based upon final salaries - as noted in paragraph 20 below.

OPTION D: A new hybrid scheme
This option builds upon the previous options C1 and C2 and offers members, in addition, a one-off choice of making extra contributions in addition to those required for the career-average structure, to obtain final salary linked benefits in retirement.
Secondary benefit improvements, as detailed in paragraph 13 above are also provided.
The benchmark scheme cost of this option is as for Options C1 or C2, depending upon which career-average structure is chosen. This final-salary option is projected to cost an additional 3% for those electing to receive these benefits.
Evaluation against criteria:
1.	As Option D is based upon Option C1 or C2, the evaluation for those options also applies here. Additionally, the final salary choice enables members who wish to take this option to do so, whilst retaining the career average scheme for the majority of the workforce.
2.	This flexibility would assist employers to recruit and retain long serving, high progressing staff who benefit most from a final-salary scheme compared to one based upon a career average.
3.	The introduction of choice into a new LGPS under this option may lead to individuals making the wrong choice because their career progression did not proceed as anticipated. There would be a need for very clear information to be provided to scheme members on the options available, which carefully avoided giving advice which might, in the fullness of time, turn out to be unsuitable.
4.	The alternative – of allowing scheme members to switch between career average and final salary schemes is not felt to be desirable – both in terms of the potential additional costs and the administrative complexities involved. The suggestion, with this option, is that scheme members should have one opportunity, possibly at the commencement of their membership, to elect to pay additional contributions.

Preferred Option to Take Forward

18. The consultation document seeks confirmation of the options that stakeholders would support and those that they would not (with reasons). They also request confirmation of the option which is preferred in terms of being taken forward and further developed.
19. The County Council, as employer, will have views as to the impact of each option on managing the council’s workforce and on recruitment and retention issues. In order to assist this Committee determining a response from a fund perspective, it is worth highlighting the response to the November 2004 consultation attached as an appendix to this report. The Committee then requested the ODPM to give further consideration to the defined benefit average salary model and to undertake research on the likely impact of such a model on senior pay levels. Whilst there is passing reference to the potential for requests for compensatory increases in pay to meet additional pension contribution costs, there is little evidence of an impact study of the sort requested by Oxfordshire members.
20. It is also worth recalling that this Committee requested the ODPM to "ensure a more standard approach to the final salary v average salary issue across the various public sector pension schemes." Evidence suggests in fact that teachers, firefighters, police officers, and NHS employees, will be enjoying pension arrangements that are based upon final salary.
21. In determining which option(s) to support, members will also, no doubt, wish to rehearse the cost implications of each option.

Summary of Costs of Options A-D Against the Benchmark

22. A quick comparison of the costs of the four options against the GAD benchmark is shown in the table below:

	Existing	New
Target benchmark cost for the new-look scheme	20.9%	18.3%
A: an updated current scheme	19.4%	17.3%
B: a new final salary scheme with an improved accrual rate	20.9%	18.6%
C1: a new career average scheme (1.85% accrual rate and RPI revaluation)	20.6%	17.7%
C2: a new career average scheme (1.65% accrual rate and RPI + 1.5% revaluation)	20.5%	18.1%
D: a new hybrid arrangement	As C, plus an additional 3% for those who join the final salary arrangement

23. Whilst, all of the options suggest – at least for existing staff - levels of cost which are below or at the benchmark, it should be reiterated that the benchmark itself implies – all other things being equal - an increase in the employers’ contribution rate of 0.8% (0.6%) per year. Given this perspective, it would seem appropriate to review employee contribution rates and this issue is discussed below.

Employee and Employer Contribution Rates

24. As noted above, the benchmark pension cost of 21.1%, compared to the 20.3% assumed by most pension funds in the 2004 valuation, implies an increase of 0.8% in contributions. (For the purpose of clarity, it should be appreciated that the GAD figures are focussing on the costs of the various options going forward and therefore deliberately ignore past service deficits. What this means is that the 20.3% 2004 benchmark equates to employee contributions of some 5.8% - see below - and employer contributions of 14.5%. In addition, employers will be making past service deficit payments to restore their funding level to 100%. [Oxfordshire’s perspective is a member’s contribution rate of 6% and an employer’s contribution rate of 14.3% for current service plus 4% for past service deficit - giving a total current employers’ contribution level of 18.3%. A potential increase of 0.8% would imply a new rate of 19.1% for the Council].
25. Given the requirement to ensure that contribution rates remain affordable for employers – and given the recycling of 50% of the "savings" into the target benchmark, it may be reasonable to consider an increase in the employee contribution rate.
26. The consultation starts this issue with an average employee contribution rate of 5.8% - based upon the fact that the majority of members pay 6% of salary but some have protected rights and pay 5%. On this basis, possible contribution rates for existing employees (new entrants will need to pay the same rates) are suggested as follows:
    
    

1. around 6.6% in order to maintain the employer contribution rates set in 2004;
2. around 7.1% in order to achieve a reduction of 0.5% in the employers’ contributions in relation to those set in 2004;
3. around 7.6% in order to achieve a reduction of 1.0% in the employers’ contributions in relation to those set in 2004;
4. around 8.1% in order to achieve a reduction of 1.5% in the employers’ contributions in relation to those set in 2004;
   
   
27. How these suggested rates might apply to each of the options is explained below:

Option A has a benchmark total cost (excluding additional transitional protections) of 19.4% for existing members – some 1.5% less than the target benchmark scheme cost (adjusted for the cost of the additional transitional protections). Accordingly, the illustrative employee contribution rates shown above could be reduced by 1.5% in order to achieve the same stabilisation / reduction of employer contribution rates as set out in paragraph 26;

Option B has a benchmark total cost (excluding additional transitional protections) of 20.9% for existing members – equal to the target benchmark scheme cost (adjusted for the cost of the additional transitional protections). Accordingly, the illustrative employee contribution rates shown above would achieve the same stabilisation / reduction of employer contribution rates as set out in paragraph 26 without further adjustment;

Option C1 has a benchmark total cost (excluding additional transitional protections) of 20.6% for existing members – some 0.3% less than the target benchmark scheme cost (adjusted for the cost of the additional transitional protections). Accordingly, the illustrative employee contribution rates shown above could be reduced by 0.3% in order to achieve the same stabilisation / reduction of employer contribution rates as set out in paragraph 26;

Option C2 has a benchmark total cost (excluding additional transitional protections) of 20.5% for existing members – some 0.4% less than the target benchmark scheme cost (adjusted for the cost of the additional transitional protections). Accordingly, the illustrative employee contribution rates shown above could be reduced by 0.4% in order to achieve the same stabilisation / reduction of employer contribution rates as set out in paragraph 26;

Costings for Option D are as for Options C1 or C2, depending upon which career average scheme is chosen. The employee would pay an additional fixed contribution rate of approximately 3% and no additional cost would fall on the employer.

28. The possible flexibility explored above is summarised in the table below, with the starting point of an average employee contribution rate of 5.8%:

Option	Benchmark Cost	Employee Contributions	Benchmark Employer Contributions (future service only)	% change with respect to the 2004 valuations
A	19.4% + 0.2%	5.1% 5.6% 6.1% 6.6%	14.5% 14% 13.5% 13%	0% -0.5% -1.0% -1.5%
B	20.9% + 0.2%	6.6% 7.1% 7.6% 8.1%	14.5% 14% 13.5% 13%	0% -0.5% -1.0% -1.5%
C1	20.6% + 0.2%	6.3% 6.8% 7.3% 7.8%	14.5% 14% 13.5% 13%	0% -0.5% -1.0% -1.5%
C2	20.5% + 0.2%	6.2% 6.7% 7.2% 7.7%	14.5% 14% 13.5% 13%	0% -0.5% -1.0% -1.5%
D	Employees who elect for final salary linked benefits pay an additional 3% - otherwise, costings are as for Option C1 or C2.

29. The consultation seeks views on what an average employee contribution rate should be – and what an affordable employer contribution rate should be for future costs (i.e. ignoring past service deficits). The table above provides a framework for addressing these points for each of the options. Members have previously commented that a 60:40 split between employer and employee contributions was an appropriate target with an upper limit on employee contributions of 7%. A 60:40 split applied to the benchmark costs above would produce employee contribution rates of 7.8% (Option A), 8.3% (Options C1 and C2) and 8.4% (Option B) all in excess of the 7% ceiling - it is therefore difficult to see how the 60:40 split could be advanced further given these figures. On the other hand, focusing on a 7% employee contribution rate would, for options B, C1 and C2 produce a reduction to the employer contribution rate of between 0.5% and 1.0%. Option A is, as already noted, a lower cost option compared to the benchmark and an employee contribution rate rising from an average of 5.8% to 7% to fund a lower cost package (reducing the employer’s contribution by 1.5%+) may be politically difficult to progress. Nevertheless, in terms of rebalancing the contributions from employer and employee, members may wish to promote a 7% employee contribution rate.
30. As to what an affordable employer’s rate is, Oxfordshire is currently paying 14.3% for current and future service pension obligations and an additional 4% for the past deficit on the fund – a combined rate of 18.3% which has applied since 2005/06. Prior to that, the combined rate was 15% and obviously, the higher the requirement to fund employer’s contributions the higher the impact upon the taxpayer and/or the greater the budgetary squeeze on front-line service provision. Members may wish to reflect on the balance between scheme benefits and scheme affordability in reviewing whether the current employers’ contribution rate is acceptable.
31. Reference has already been made to the aim of ensuring that the scheme remains affordable for employees, particularly part-time and lower paid members. Within the framework of possible average employee contribution rates set out above, the Consultation document looks further into the principle of a tiered contribution rate for scheme members.

Tiered Contribution Rates

32. Tiered contribution rates were flagged in the analysis of Options A and B as a way of equality-proofing a final-salary scheme and for Options C and D, as a way of protecting affordability for the lower paid if employee contribution rates were to increase. It is suggested that, under this regime, employees would pay a reduced rate of contributions on pensionable pay up to a certain point and then an increased rate above this point.
33. One option trailed in the consultation paper is to fix the cut-off point to the point at which earnings are taxed at the basic rate of 22% rather than the starting rate of 10%. For 2006/07 this was set at £7,185 (the sum of the personal allowance of £5,035 and the starting rate income tax band of £1-£2,150).
34. The second option flagged has a cut off point related to a salary level aimed at attracting the lower paid - £12,000 is suggested, rising with inflation each year.
35. The table below show a number of combinations of contribution rate for each of the two suggested structures – designed to produce a range of average employee contribution rates from 5% to 8% to cover all of the scenarios set out in the table above. (Note that these are purely illustrative, based upon full time equivalent data from a sample of funds, for employees who currently pay 6% contributions).

Possible Two-Tier Structures with a Cut-Off Point of £7,185

Lower band %	Upper band %	Weighted rate %
4.0	5.5	4.9
3.5	6.0	5.1
4.5	6.0	5.4
3.0	7.0	5.5
5.0	6.5	5.9
3.5	7.5	6.0
4.0	8.0	6.5
5.0	7.5	6.6
6.0	7.5	6.9
5.5	8.0	7.1
6.5	8.0	7.4
6.0	8.5	7.6
7.0	8.5	7.9
6.5	9.0	8.1

Possible Two-Tier Structures with a Cut-Off Point of £12,000

Lower band %	Upper band %	Weighted rate %
3.0	8.0	4.9
4.0	6.5	5.0
4.0	8.0	5.6
5.0	6.5	5.6
5.0	7.5	6.0
5.5	7.0	6.1
6.0	7.0	6.4
5.5	8.0	6.5
6.5	7.5	6.9
6.0	8.5	7.0
7.0	8.0	7.4
7.0	8.5	7.6
7.5	8.5	7.9
7.5	9.0	8.1

36. The DCLG has requested stakeholders to confirm whether tiering is supported under a new-look scheme. When tiering was raised in the previous consultation exercise this Committee took the view that a more appropriate solution might lie in changes to the tax regime and a review of state support arrangements and how they militate against pension take up by the lower paid.
37. At one of the DCLG presentations on the new-look scheme, in fact, this specific question was raised - but no evidence was advanced to suggest that work is being undertaken to address these concerns. Under the present system, depending on the level of their earnings and career path/working pattern, an employee could under the current pensions system, due to the combination of the employee contribution rate (6%) and the level (if any) of any tax relief and reduced national insurance contributions, be better off not joining the local government pension scheme. The employee could rely instead on the State Second Pension and the Pension Credit. If the earners in a household have always had a low lifetime income, retirement saving may simply be an inappropriate activity for them because current consumption needs will be a very high proportion of their current income leaving little, if any, money to commit to savings. Under the current system, means-tested benefits will, for such people, replace a large proportion of earned income when the earner retires and the Institute of Fiscal Studies comments that, in this situation, a reliance on government-provided retirement income may well be a rational decision.

Future Cost Sharing Between Employers and Employees

38. The LGPS trades unions and local government employers have considered the principle of introducing a mechanism to ensure that variations in the ratio of employer to employee contributions are limited. At the moment the funding ‘risk’ falls entirely on the employer although in theory, the employer also benefits from any reduction in contribution rates in the future. One option suggested is to complete a review of demographic assumptions at every second or third triennial revaluation post-2007. If the assumptions had increased or decreased to a substantial degree since the last revaluation, a review of the fixed employee contribution rate to the prevalent employer contribution rate would take place – leading potentially to an adjustment to the employee contribution rate to re-establish the defined ratio or an adjustment to the scheme’s benefit package to achieve the same effect.
39. A major issue with this proposal is that any future cost-sharing would need to be managed at a national level – given that the LGPS is a national scheme – and change to employee rates determined nationally may well have different impacts upon different LGPS schemes – given the differences between schemes in terms of demography, investment performance, etc.

Reviewing the Take-Up of Additional Commutation in the Context of a Future Cost Sharing Agreement

40. There has been some discussion about the merits of keeping the assumptions about commutation savings under review. This would mean that consideration could be given to recycling any additional savings arising from higher-than- anticipated levels of commutation – or – conversely, if take up was lower than anticipated, what adjustments could be made to the benefits package or employee contribution rate to ensure continued affordability. The DCLG is not proposing that such a review mechanism is to be built into the scheme at this stage – but is inviting comments on this issue.
41. Members have previously expressed concerns around the savings assumed from the enhanced commutation arrangements – the assumption being that 50% of retiring members will elect for the maximum 25% commutation on the 12:1 basis. If that assumption proves optimistic then funding pressures will be identified in subsequent revaluations and it is therefore suggested that members seek a guarantee that the review mechanism outlined above becomes an integral element of the new-look scheme.

Flexible and Early Retirement

42. The Local Government Pension Scheme (Amendment) Regulations 2006 have already introduced provisions to support flexible retirement in the current scheme, allowing members to:
    
    

1. retire from 60, or from 50 with employer consent – those without 85 year rule entitlement having their pension actuarially reduced to reflect early payment;
2. take flexible retirement from 60, where the employer gives their consent and where the employee takes a reduction in hours or grade. This will mean that the employee takes a reduced pension before 65 while remaining in employment;
3. continue to accrue service in the LGPS beyond age 65, pre-age 65 benefits not taken at or before age 65 being actuarially increased to reflect late payment.
   
   
43. A number of further improvements could be considered in developing the new look scheme:
    
    

1. allow scheme members to make extra contribution to offset any reduction in their pension in the case that they wish to retire early;
2. extend flexible retirement from age 60 to the scheme’s minimum retirement age (currently 50 but rising to 55 by 2010);
3. remove the requirement for employees to obtain employer consent for flexible retirement;
4. remove the requirement for employees to take a reduction in hours or grade in order to take flexible retirement;
5. benefits accrued after age 65 also to be increased by cost-neutral uplift factors when a member elects to take them after age 65.
   
   

Existing Scheme Members in the New-Look Scheme

44. All scheme members would accrue membership from 1 April 2008 under the new look scheme and their retirement benefits would be determined under the terms of that scheme. The issue of how the accrued benefits of existing members at 1 April 2008 are to be calculated when they retire is a somewhat technical issue which will impact upon the scheme’s administration arrangements and has yet to be decided. Possible approaches - considered in terms of cost and impact on the new-look scheme, impact on existing scheme members, implementation of transitional protections from the current scheme and administrative ease, are as follows:

A: give all existing scheme members at 31 March 2008 an actuarially equivalent period of service in the new-look scheme according to a formula to be provided by GAD.

Given the vagaries of future career progression and dates of retirement, some individuals might benefit more than others from this transfer. Ensuring that no one ‘lost out’ implies underpinning, which means that the funds available for a new-look scheme would be reduced.

B: give existing scheme members at 31 March 2008 more credit in the new-look scheme than they would receive under method A.

This would provide additional benefits to existing members and smooth transition, but the additional cost would further reduce the amount available for a new-look scheme. Additionally, the protections here would interact with the protections from the removal of the 85 year rule extending beyond 1 April 2008 and add to the administrative complexity.

C: treat all accrued service of existing scheme members as at 31 March 2008 as a benefit to be payable on retirement, under the terms of the current scheme, based on final salary at retirement.

This has the virtue of clarity since this approach would not change the expectations of existing members in respect of their accrued service at 1 April 2008. This approach would, however, add to administrative complexity in assessing benefits for existing members post 1 April 2008, as they will effectively have two sets of entitlements.

45. Method C might also provide an approach to implement transitional protections. As pre-1 April 2008 service is to provide benefits at retirement based on the current scheme, direct account can be taken of accrued 85 year rule rights at 1 April 2008. It is not so straightforward, however, to account for post 1 April 2008 85 year rule rights for a scheme member who is eligible for transitional protections between 1 April 2008 and 1 April 2020, as these rights will have been accrued in the new-look scheme. The following alternative approaches are suggested:
    
    

1. a member who is eligible for protections between 1 April 2008 and 31 March 2013 could receive unreduced pre-1 April 2008 benefits under the terms of the current scheme, and unreduced post -1 April 2008 benefits under the terms of the new-look scheme; or
2. a member who is eligible for protections between 1 April 2008 and 31 March 2013 could receive unreduced benefits under the terms of the current scheme for all pre 1 April 2020 service; or
3. a member who is eligible for protections between 1 April 2008 and 31 March 2013 could receive unreduced pre-1 April 2008 benefits under the terms of the current scheme, and unreduced post-1 April benefits under the terms of the new-look scheme, but on an actuarially equivalent basis to the benefits he would have received in post -1 April service, had the current scheme been in place.
   
   
46. All of these proposals, other than ii would have a cost impact upon the new-look scheme because, as with A and B, ensuring that no scheme member loses out would lead to additional costs and reduced funding for the new-look scheme.
47. The most straightforward and therefore most attractive, administratively speaking, is option A which gives all existing scheme members at 31 March 2008 an actuarially equivalent period of service in the new look scheme. The Government Actuaries (GAD) would provide the formula for calculation. A noted above, this option would not be cost neutral as it ensures via ‘underpinning’ that no scheme members ‘lose out’ in the transfer of their benefits. Preserved beneficiaries would receive payment of their benefit in accordance with pre April 2008 regulations.

Scope of Scheme Employers’ Discretions

48. A number of LGPS administering authorities have suggested that specific optional scope could be provided in the new-look scheme to enable employers to provide specific additional benefits over and above the national benefit package. Consultees’ views are invited on whether such discretion should be available in the new-look scheme.
49. It is recommended that this proposal is not supported as it represents a move away from a national scheme with national conditions of service.

RECOMMENDATIONS

50. The Committee is RECOMMENDED to consider the report and to authorise the Director for Resources to send a response to the DCLG by 29 September 2006 which incorporates the views of the Committee on the issues raised in this report as articulated in their discussion of this agenda item, subject to the Director for Resources consulting with the Chairman, Deputy Chairman and Opposition Group Spokesman in finalising this response.

JOHN JACKSON
Director for Resources

Background Papers: Reports to 26 November 2004 and 25 February 2005 Pension Fund Committees: "Facing the future – propositions and principles for an affordable and sustainable local government pension scheme"

Contact Officer: Ken Bell, Interim Assistant Head of Finance. Tel (01865) 815411

August 2006

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