INVESTMENT COMMITTEE
THURSDAY 14TH SEPTEMBER AT 10 AM / Agenda Item No:
10
UPDATE ON LOCAL GOVERNMENT PENSION SCHEME REGULATIONS
Report of the Finance Director
Author of the report: Nicola Webb (Telephone: 01992 555394)
1.Purpose of the Report
1.1To update the Committee on the changes to the Local Government Pension Scheme.
1.2To outline the proposals for a “New Look” pension scheme from 2008.
2.Summary
2.185 Year Rule
Extensions to the transitional protections for those affected by the removal of the 85 year rule have now been agreed and will be effective from
1st October 2006.
2.2New Look Scheme
The Department for Communities and Local Government (DCLG) published a consultation paper setting out five options for a new look pension scheme from 1st April 2008.
2.3The options are based on a benchmark target total cost which is the cost of the current scheme plus 50% of the savings from the removal of the 85 year rule and the introduction of the option to commute additional pension into lump sum, i.e. funded by both the employer and the employee contributions.
2.4The consultation paper seeks views on what proportion of the costs of the options should be met by employees and whether tiered employee contributions should be introduced, i.e. the balance of employer/employee contributions should change.
3.Conclusion
3.1The options set out in the paper vary in cost terms by a maximum of 1.5% of payroll and £6.3m for the whole fund.. This equates to approximately £3m in the case of the County Council. (This refers to the total cost, i.e. employer and employee contributions.)
4.Background
4.1Draft regulations to change the scheme in respect of the 85 year rule were published in May 2006 and were outlined in a report to the Committee on 20th June 2006. The final regulations were laid before Parliament at the end of July to have effect from 1st October 2006.
4.2On 30th June 2006, the Department for Communities and Local Government (DCLG) published a document titled “Where Next? – Options for a New Look Local Government Pension Scheme in England and Wales.” This follows on from work started in 2001 to review the LGPS and sets out options for interested parties to consider.
5.85 Year Rule
5.1The further amendments to the 85 year rule detailed in the report to the Committee on 20th June 2006will now be implemented from 1st October 2006. In summary they are:
- The date for the removal of the 85 year rule for current members has been extended from 1st October 2006 to 31st March 2008.
- The cut-off date for protection has been extended from 31stMarch 2013 to 31st March 2016.
- A sliding scale of protection has been introduced for those retiring between 2016 and 2020.
5.2As part of the negotiations on the 85 year rule, the Local Government Association and the unions agreed that 50% of the savings from the removal of the 85 year rule will be recycled into the 2008 new look scheme.
5.3Unison feel that the transitional protections offered as a result of the removal of the 85 year rule are not sufficient compared to those offered to other public sector schemes. They are still arguing that the removal of the rule was not required and have called for a judicial review. This is expected to happen in September/October.
6.New Look Scheme Options
6.1The DCLG’s paper on options for a new look scheme start from a target benchmark cost which is the cost of the current scheme plus 50% of the savings from the removal of the 85 year rule and the introduction of the option to commute additional pension into lump sum.
6.2Several benefit improvements have also been included in all the options:
- Increase in the death in service grant from two to three times salary.
- Introduction of partners pensions for cohabitees (subject to the legal developments on this).
- A two tier ill health system providing fully enhanced benefits to those unable to do any kind of work again and unenhanced benefits to those who could undertake some other form of work.
The first two improvements each add 0.3% to the benchmark cost, however the two tier ill health proposal reduces the DCLG’s benchmark cost by 1.1%.
6.3Overall the DCLG’s benchmark cost for the scheme is 21.1% for existing scheme members and 18.3% for new entrants. This is the total cost, i.e. employee and employer contributions. It is based on an average fund and therefore does not reflect particular circumstances. The actuary has been commissioned to carry out an exercise to cost the options specifically for
Hertfordshire. This information will not be available until 11th September, and therefore will be reported to the Committee on the day of the meeting. The other factor to note is that none of the costings take into account the repayment of the deficit.
6.4The options set out in the paper are summarised in Table 1 overleaf and more detailed information can be found in Appendix A. In reviewing the costs of the option, it may be helpful to know that every 0.1% extra cost equates to £200k per annum for the County Council.
7.Employee Contributions
7.1In addition to asking for comments on the various scheme options, the DCLG is looking for views on what share of the cost should be met by employers.
7.2The consultation paper sets out a number of options which show a minimum employer contribution rate of 13%. The coincides with The Local Government Association position that the scheme should cost no more that 13% for employers. The impact of the 13% rate on the options is:
Employer / Employee / TotalOption A / 13% / 6.6% / 19.6%
Option B / 13% / 8.1% / 21.1%
Option C1 / 13% / 7.8% / 20.8%
Option C2 / 13% / 7.7% / 20.7%
The benchmark figures are based on a current employer contribution rate of 14% nationally (this excludes any deficit repayments).
7.3The possibility of tiered employee contribution rates is also considered in the paper. This would mean lower paid staff would pay a reduced employee contribution rate and higher paid staff would compensate by paying a higher rate.
7.4The Local Government Pensions Committee’s circular on the consultation paper raises a number of concerns about the idea of tiers. The main ones are:
“ encouraging the lower paid to join the Scheme by offering a reduced contribution rate on earnings below a specified level may result in employees joining the Scheme who may not be best served by doing so, due to the impact of the Pension Credit. Until the Sate creates a position whereby there is no disincentive to save towards a pension, is there merit in designing a scheme to attract the lower paid to join?
if, as a result of a lower contribution rate on earnings below a specified level, the overall contribution rate for higher paid staff has to increase (in consequence of more of the present non-joining lower paid staff deciding to join), this could lead to salary drift which would, of course, lead to increased employer costs – not only in terms of additional salary but also in terms of the additional pension and national insurance on-costs on that additional salary. ”
8.What Next?
8.1The Finance Director is working with the Corporate Director (People and Property) to prepare a response which incorporates both the financial and human resource implications of the options.
8.2In considering the financial implications for the fund, the future level of employer contributions is key. Therefore the Committee’s view on the maximum level of employer contributions is sought. This can then be fed into HR’s consideration of the options in the context of knowing what the employee contribution would be. Views on any other aspect of the consultation are also welcomed.
8.3The DCLG plan to issue draft regulations for formal consultation in the late autumn following the results of this consultation. The intention is to lay the final regulations before Parliament in April 2007, providing a year to prepare for implementation in April 2008.
Table 1: Summary of OptionsBenefit
Type / Accrual
Rate / Lump
Sum / Revaluation / Employees
who would benefit / Benchmark
Costs
existing staff
(new entrants)
Option A / Final Salary / 1/80th / 3/80th plus option to commute pension up to 25% of fund value / Accrued pension based on final salary. RPI whilst deferred or in payment / Long serving staff, particularly those who progress up the earnings scale / 19.6%
(17.3%)
Option B / Final Salary / 1/60th / No automatic lump sum; option to commute pension / Accrued pension based on final salary. RPI whilst deferred or in payment / Long serving staff, particularly those who progress up the earnings scale / 21.1%
(18.6%)
Option C1 / Career Average
Revalued Earnings / 1.85%
(=1/54th) / No automatic lump sum; option to commute pension / RPI whilst active, deferred and in payment / Short serving staff and those with low salary growth during their career / 20.8%
(17.7%)
Option C2 / Career Average
Revalued Earnings / 1.65%
(= 1/60th) / No automatic lump sum; option to commute pension / RPI plus 1.5% whilst active; RPI whilst deferred or in payment / Short serving staff and those with low salary growth during their career / 20.7%
(18.1%)
Option D / Hybrid / As per option C1 or C2 / No automatic lump sum; option to commute pension / As per C1 or C2. For those who choose final salary as per B / As per C1/C2. Employees can make a one off choice to have final salary if pay extra 3% in contributions / As per C1/C2
Appendix A
Below is an extract from the DCLG’s consultation paper which describes in more detail the final salary and career average revalued earnings schemes:
“ The four options detail differentcore structures for the new-look LGPS, which have a normal retirement age of 65. Options A and B retain the final salary nature of the Scheme, in which a pension per annum is paid to scheme members from the normal retirement age of 65 as follows:
Pension p.a. = (Accrual rate) x (No. years membership) x (Final salary)
The accrual rate defines the proportion of final salary which the member builds up (or accrues) for each year of their membership of the pension scheme. For the LGPS, the accrual rate is currently 1/80th, i.e. members build up pension rights payable per annum in retirement at a rate of 1/80th of their final salary per year of scheme membership. This pension is then increased in line with inflation (RPI) in retirement.
Option C has a career-average structure, in which scheme members build up entitlement to a pension in retirement based on their salary in each year of membership, not just on their final salary. Pension per annum is paid to scheme members from the normal retirement age of 65 as follows:
Pension p.a. = (Accrual rate) x (Year 1 Salary) x (Re-valuation index)
+ (Accrual rate) x (Year 2 Salary) x (Re-valuation index)
+ … + (Accrual rate) x (Final Year Salary) x (Re-valuation index)
The member’s benefits in retirement are therefore the sum of each year’s accrual indexed according to the chosen revaluation index, which effectively revalues the benefits accrued in each year of service according on a certain basis. Option C1 revalues each year’s benefits in line with price inflation, and Option C2 revalues each year’s benefits in line with a measure of wage inflation. As a greater revaluation index is more expensive (as it gives more value to each year’s benefits), the accrual rate for Option C2 is lower than that for C1.
Option C1 provides each member with an element of pension (1.85%) for the pay received in each year, which is fixed in real terms for each year (by RPI revaluation). Deferred members benefits are increased in line with RPI also – there is therefore no difference in revaluation between active members and deferred members. Option C2 provides members remaining in service with increases to their benefits in line with wage inflation (taken to be RPI + 1.5%). They therefore receive a more favourable revaluation than deferred members.”
Source: “Where Next? – Options for a new-look Local Government pension Scheme in England and Wales.” Department for Communities and Local Government,June 2006.