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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
Introduction
- 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.
- 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.
- 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
- 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.
- 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
- 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:
- 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;
- 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:
- 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.
- 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%.
- 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.
- 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."
- 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
- 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.
- 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%)
|
- 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
- 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.
- 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.
- 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.
- 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?
- 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
- 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.
- 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.
- 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.
- 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
- 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
|
- 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
- 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].
- 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.
- 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:
- around 6.6%
in order to maintain the employer contribution rates set in 2004;
- around 7.1%
in order to achieve a reduction of 0.5% in the employers’ contributions
in relation to those set in 2004;
- around 7.6%
in order to achieve a reduction of 1.0% in the employers’ contributions
in relation to those set in 2004;
- around 8.1%
in order to achieve a reduction of 1.5% in the employers’ contributions
in relation to those set in 2004;
- 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.
- 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.
|
- 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.
- 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.
- 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
- 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.
- 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).
- 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.
- 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
|
- 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.
- 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
- 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.
- 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
- 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.
- 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
- The Local Government
Pension Scheme (Amendment) Regulations 2006 have already introduced
provisions to support flexible retirement in the current scheme, allowing
members to:
- retire from
60, or from 50 with employer consent – those without 85 year rule
entitlement having their pension actuarially reduced to reflect
early payment;
- 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;
- 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.
- A number of further
improvements could be considered in developing the new look scheme:
- allow scheme
members to make extra contribution to offset any reduction in their
pension in the case that they wish to retire early;
- extend flexible
retirement from age 60 to the scheme’s minimum retirement age (currently
50 but rising to 55 by 2010);
- remove the requirement
for employees to obtain employer consent for flexible retirement;
- remove the requirement
for employees to take a reduction in hours or grade in order to take
flexible retirement;
- 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
- 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.
- 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:
- 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
- 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
- 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.
- 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.
- 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
- 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.
- 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
- 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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