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ITEM PF16

PENSION FUND COMMITTEE - 25 FEBRUARY 2005

FACING THE FUTURE – PROPOSITIONS AND PRINCIPLES FOR AN AFFORDABLE AND SUSTAINABLE LOCAL GOVERNMENT PENSION SCHEME

Report by the Head of Finance & Procurement

1. At its November 2004 meeting, this Committee had a report, which set out the key issues in the above titled Green Paper issued by the Office of the Deputy Prime Minister (ODPM). The Green Paper invited comments to be submitted back to ODPM by 31 March 2005. This report sets out the key issues for consideration, and recommends the key points to be included in the response of this Committee, acting as Administering Authority to the Oxfordshire Pension Fund.

Key Issues

2. As the title of the Government’s Green Paper makes clear, the aim of the latest proposals is to deliver an affordable and sustainable LGPS. This requires careful balancing between the interests of the key stakeholders, employees, employers, and the Government and tax payers. Employees are looking for secure benefits commensurate with the contributions they have paid. Employers are looking for a package which helps recruit, retain and motivate staff, with stable, and predictable costs, which in turn offers value for money, and which is simple and efficient to administer. The Government and tax payers are looking for a package which minimises the cost to the State or the Council tax payer. If one of the three key parties believe that they are not getting a fair deal, then the long term sustainability of the LGPS must be questioned. All proposals must be considered in terms of the needs of each stakeholder group.
3. Since the ODPM issued the Green Paper for the LGPS, the Government have issued two further consultation papers, on the pension arrangements for the Civil Service, and for workers within the National Health Service. There is a degree of commonality between the various proposals, but also a number of areas of significant difference. To make the scheme as simple to understand and monitor, there is considerable merit in bringing about a greater degree of standardisation between the various public sector pension schemes. There is increased transfer of staff between elements of the public sector, and many areas of joint working, and standardisation of schemes will assist in managing this, as well as allowing various public sector bodies to compete for staff on a more equal basis.

Key Points for Inclusion in Response

4. Scheme Affordability. In terms of affordability, the Government Actuary has calculated the on-going cost of the proposals at 21% of pensionable pay. This compares to a figure of 20% produced by the Actuary for the Oxfordshire Pension Fund as at 31 March 2004. These latest figures are significantly above those of a few years ago. In 1992, (which was the first valuation after the Government reversed its move to reduce funding levels from 100% to 75%), the on-going cost of the LGPS was calculated at 14%. This increased to 15.5% in 1995, 16% in 1998 and 18% in 2001. The increase in the costs of the pension scheme are typical of increases across the Country, and reflect Government changes to the ACT rules, and national improvements in life expectancy, as well as local decisions by employers, exercising their discretion within the rules of the LGPS, e.g. around early retirements. The Committee need to determine whether maintaining the costs of the LGPS at the current levels represents an affordable and sustainable position.
5. If the Committee is minded to respond in terms that the proposals need to be amended to reduce the overall costs of the scheme, they need to consider the points below, and determine whether the costs to employers should be reduced by a reduction in the benefits payable under the scheme, an increase in the relative contribution of employees, or a combination of the two factors.
6. Employee Contribution. The whole of the variation in the on-going contribution rate detailed above, has fallen to be met by employers. The employee contribution has been fixed at 6%. This means that over time, the ratio between employers and employees has moved significantly from the 60:40 ratio once targeted. The Green Paper is looking to increase the employee contribution to an average of 7%, which would result in a ratio of 67:33. In terms of perceived affordability, and to restore the balance between the stakeholder groups, the Committee is recommended to respond to the Green Paper by requesting the ODPM to seek a position closer to the 60:40 target.
7. The Green Paper seeks views as to whether the employee contribution rate should be fixed, or related to an individual’s pay. The ODPM’s proposals to have a stepped employee rate based on gross salary is based on a question of equality, related to the impact that the current tax regime has on the net contribution made by individuals. The Government are particularly concerned about removing disincentives to low paid staff joining the LGPS.
8. The proposal as presented by the ODPM is not seen as simple, with particular problems if the employee pays a single rate based on their gross salary. The threshold levels and pay bands would need to be closely monitored to ensure that individuals were not financially disadvantaged as a result of a promotion, to a grade attracting a higher contribution rate. The need to collate pay data across employments to determine the contribution rate also adds considerably to the administrative burden of the proposal. The alternative of calculating the employee rate in line with the current tax calculations runs counter to the need for greater simplicity in the system.
9. The proposals could also impact on an employer’s ability to recruit and retain senior managers required to pay at the highest level of contribution.
10. The inequality argument, and the need to make the scheme more attractive to the low paid is acknowledged, but it is felt that this is as much a matter for taxation policy as it is for the LGPS. Any proposed changes to the contribution rate for low paid staff needs to be looked at in conjunction with the impact that LGPS membership will have on a persons entitlement to future State support, and in particular Pension Credit.
11. The Committee is therefore recommended to request that the ODPM look further at the proposals in this area, and in particular to consider more closely the relationship of the proposals with the current national tax and state pension arrangements. The Committee is also recommended to include in their response a request that if the ODPM do determine to introduce variable employee contribution rates, it is done with a view to maximising simplicity and minimising the administrative burden, and impact on employers pay structures.
12. Final Salary v Average Salary. Another area that needs significant consideration is the proposal in the green Paper, to retain the LGPS as a defined benefit scheme, based on final salary. This is clearly of major benefit to employees, and is an important element of the recruitment, retention and motivation work of employers. However the proposal comes at a time when the majority of private sector schemes have moved to a defined contribution basis, and when the Government itself is consulting on defined benefit schemes based on average salaries for the civil service and national health service workers (though the NHS consultation includes a final salary option).
13. The advantage of a final salary scheme in assisting employers recruit and retain experienced individuals in the most senior positions is acknowledged. There could well be upward pressure on senior salaries if the LGPS was to move away from a final salary scheme, both increasing the overall costs to employers, and widening pay differentials and creating employee discontent though the organisation. However, there is an argument that whilst final salary schemes suited the old style typically male dominated career professional workforce, it is not so appropriate for today’s more mixed workforce. The average salary scheme has the advantage that an individual’s pension is directly related to the contribution they have made throughout their working life, rather than their final years, and so provides a fair reward for those looking for a career break, or a step down in responsibilities later in their career. Under the final salary scheme, the majority of the workforce who see little upward movement in their salary over their career, are in fact providing a cross subsidy to those who advance to the senior positions, especially those who do so late in their career.
14. The move from a final salary scheme to an average salary scheme will in isolation lead to a reduction in costs to the Pension Fund. As noted above, the potential pressure on senior salaries may though mean the overall costs to employers may rise. The impact also needs to be considered in conjunction with other scheme changes (see accrual rates below).
15. At this time therefore it is not possible for officers to provide a clear recommendation to this Committee on the issue of final v average salary. Instead it is recommended that the Committee should respond by requesting that the Government gives further consideration to the defined benefit average salary model, including some research on the likely impact on senior pay levels. The Committee is also recommended to request the Government ensure a more standard approach to this issue across the various public sector pension schemes.
16. Scheme Benefits. The principle of looking to standardise pension arrangements across the public sector is also a factor in the recommended response to many other aspects of the Green Paper proposals. The Committee is recommended to support the following changes where they are in line with changes proposed elsewhere, including:

• A normal retirement age of 65
• A tax free lump sum at retirement, available by giving up up to 25% of accrued pension
• Changes to dependents pensions (where civilly registered), and early and ill health retirements. It is recommended to reject extending benefits to co-habitees due to the administrative difficulties associated with establishing entitlement.
• Death in service payments of 3 times salary
• Flexible retirement schemes
• Changes resulting from Inland Revenue changes

17. Pension Accrual Rate. The principle of looking to standardise pension arrangements across the public sector means that at this point it is not possible to support the 1.6% accrual rate (i.e. a pension benefit of 1/62.5 of salary for each year of pensionable service) proposed within the Green Paper. In particular, the revised accrual rate of 1.6% of salary per year of service is not consistent with the proposals for the Civil Service and NHS workers. The Civil Service proposals are based on an accrual rate of 2% p.a. with the average salary increased each year in line with price inflation. The options for the NHS are a 1.67% accrual rate for the final salary option, 2.05% for a career average model where the average salary is increased in line with price inflation, and 1.8% for a career average model where the average salary is increased in line with national average earnings.
18. There is of course a need to assess how the various aspects of the proposals fit together. The move towards an average salary scheme is seen by some as a means to address issues of affordability. However the Government have specifically linked the increase in accrual rate in the Civil Service proposals with the move to average salaries to argue that their proposals are cost neutral in total, although re-distributive in nature. The Committee is recommended to request that the ODPM look at a more standard approach to the accrual rate across public sector pension schemes, with the actual rate linked to a view on affordability.
19. Defined Benefit v Defined Contribution. As stated above, the Green Paper proposes to retain the LGPS (and the other public sector pension schemes) as a defined benefit scheme despite the widespread moves to a defined contribution scheme in the private sector. As a recruitment and retention issue this is widely supported. The Committee is therefore recommended to respond against the Green Paper proposal to develop a defined contribution scheme to sit alongside the current defined benefit arrangements. The proposals are a step in the wrong direction, are not seen to be adding anything significant to the current arrangements, but will introduce much greater problems in terms of scheme administration. The proposals run counter to the target of increasing scheme simplicity for current and potential scheme members.
20. Scheme Administration. The final issue in the proposals to bring to the attention of this Committee is the proposal to introduce new regulatory powers, enabling the administering authority to differential charge scheme employers, based on the quality of their information returns. As covered elsewhere on the agenda, the quality of returns from the various employers is mixed, and does have a significant impact on the workload of the Administration team. The introduction of a financial incentive to drive improvements in employer returns is therefore to be welcomed, and the Committee is recommended to endorse the support of this proposal in their reply.
21. Government Communication and Transitional Arrangements. As well as the specific proposals in the Green Paper, the Committee is recommended to include in their response, a request to the Government for clear and early communication in respect of their more specific proposals following this consultation exercise, and in respect of the transitional arrangements that will apply. Elsewhere on this agenda, reference is made to the real concerns being expressed as to how the transitional arrangements included with the latest Regulations which abolish the 85 year rule, which are set to cover the period to 2013, will be amended if at all, by the implementation of the new look LGPS in 2008. It is vital that there is clear information to all to prevent a sudden and unmanaged rush of retirements before 2008, as people seek to retire with certainty of their entitlements, rather than await clarification of future rights.

RECOMMENDATION

22. The Committee is RECOMMENDED to consider the report, and authorise the Head of Finance & Procurement to send a response to the ODPM by 31 March 2005, in accordance with the recommendations as set out in the report, as amended during the course of debate on this report. The Head of Finance & Procurement is asked to consult with the Chairman, Deputy Chair and group spokesperson for this Committee in finalising this response.

SUE SCANE
Head of Finance & Procurement

Background Papers: Facing the Future – Propositions and Principles for an Affordable and Sustainable Local Government Pension Scheme – ODPM

Contact Officer: Sean Collins, Assistant Head of Finance. (01865) 815411

February 2005

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