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The main public service pension schemes (other than the Local Government Pension Scheme) are unfunded and operate on a pay-as-you-go basis – whereby contributions are paid to the sponsoring government department which meets the cost of pensions in payment, netting off contributions received.

The unfunded schemes are subject to actuarial valuation every four years. The purpose is to assess the value of pension rights being built up, so that total contributions (from employers and employees) can be set at a level to reflect this. The valuations must be undertaken in accordance with Treasury directions which, among other things, specify the ‘discount rate’ that should be applied in order to assess the present costs of future benefits. (Public Service Pensions Act 2013, s11)

Discounting is a technique that takes account of time preference by “discounting” (or reducing) the amount of future payments, to express them in today’s terms. In funded schemes, discount rates sometimes reflect the anticipated investment return on a portfolio of assets – so that the discounted value of future payments represents the amount of money that needs to be invested today in order to meet those future payments.  For the unfunded public service pension schemes, the Government has developed the SCAPE discount rate (HM Treasury, Consultation on the discount rate etc, December 2010, ch 2).

The Government announced reductions in the SCAPE discount rate in 2016 and 2018:

  • In Budget 2016 – it announced a reduction from 3% to 2.8%, with effect from April 2019. It estimated that this would cost £1.97 bn in 2019/20 and £2.005 bn in 2020/21;
  • In September 2018 – it proposed a further reduction to 2.4% from April 2019 (HCWS 6 September 2018 c13WS).

Keeping all other assumptions unchanged, a lower discount rate would result in higher contribution rates at the next scheme valuations.

In September, the Government said that departments and devolved administrations would need to meet the increase in costs from the 2016 Budget announcement in full. It would support them with the increased cost resulting from the 2018 announcement in the 2019/20, but not necessarily beyond that:

This is because of proposed changes to the discount rate, which is used to assess the current cost of future payments from the schemes, to reflect the Office for Budget Responsibility’s long-term growth forecasts. Further details will be known later this year. Some increase in costs was anticipated at Budget 2016, which Departments and the devolved administrations will need to meet in full. The Treasury will be supporting Departments with any unforeseen costs for 2019-20. Further discussions will be taken forward as part of the spending review. (HC Deb 6 September 2018 c13WS)

In Budget 2018, the Government confirmed the reduction to 2.4% and that it would fund government departments with the additional costs deriving from the 2018 announcement for 2019/20 but not necessarily beyond that (except in the case of the NHS, where it had made provision until 2023-24):

1.60 The government is supporting departments to ensure that recognition of these costs does not jeopardise the delivery of frontline public services or put undue pressure on public employers. For the NHS, as outlined in the five-year health settlement in England in June 2018, the Treasury has made provision for NHS pension costs until 2023-24. For state schools, the Department of Education are proposing to provide more funding to cover pension costs for the rest of this Spending Review period. To supplement this, the Budget allocates extra DEL to the reserve for 2019-20 to cover an expected £4.7 billion of additional costs. The Spending Review next year will settle the funding for costs beyond 2019-20 arising from the valuations.

Public sector employers have expressed concern about the impact, particularly in relation to the schemes for police and firefighters. The Home Office announced the support it would provide for police authorities in England and Wales for 2019/20 on 13 December 2018.

In response to its consultation on proposals to support education institutions in April 2019, the Department for Education set out the funding it would provide to support state-funded schools and FE colleges with the additional costs in 2019/20. Decisions beyond that would be taken in the Spending Review. It had decided not to provide additional funding for HE institutions or for independent schools but would consider allowing independent schools to leave the Teachers’ Pension Scheme via a phased withdrawal.

Funding for institutions in devolved administrations is a matter for those governments.

The issue of the employer cost cap mechanism which relates to the costs relating to member profiles (e.g. assumptions relating to longevity and earnings growth) is discussed in CBP-6971 Public service pensions – employer cost cap (September 2018).

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