Public service pensions – the cost control mechanism

Following the reports of the Independent Public Service Pensions Commission, chaired by Lord Hutton of Furness, the Government legislated in the Public Service Pensions Act 2013 for a framework for new public service pension schemes, to be introduced from April 2015 (2014 for local government). The new structure of public service pension schemes is designed to manage some of the costs and risks to the Exchequer of providing public service pensions. For example, basing benefits on career average earnings rather than final salary, removes from the Exchequer much of the ‘salary risk’ and linking the normal pension age to the State Pension age (except for the ‘uniformed services, where it is 60) removes much of the longevity risk.

As an added safety valve, the Commission recommended that the Government should set a “fixed cost ceiling: the proportion of pensionable pay that they will contribute, on average, to employees’ pensions over the long-term. If this was exceeded then there should be a consultation process to bring costs back within the ceiling, with an automatic default change if agreement cannot be reached”(Interim report, recommendation 12).

The Government legislated in section 12 of the Public Service Pensions Act 2013 for a  ‘cost control mechanism’, which would operate symmetrically, so that if valuations showed that costs had risen or fallen outside of a target rate, steps would have to be taken to bring them back to target. It applies to ‘member costs’, such as increases in life expectancy or salaries.

2016 valuations

In September 2018, the Government said initial results of the 2016 valuations indicated that members should get “improved pension benefits for employment over the period April 2019 to March 2023.” There would be consultation on what this would mean for each scheme and changes would be implemented from April 2019. It also asked the Government Actuary (GA) to “undertake a review of the mechanism to check whether it is working as intended and delivering the Government’s objective to protect taxpayers and workers from unforeseen changes in pension costs” (HC Deb 6 September 2018 c13WS).

The operation of the cost control mechanism in relation to the 2016 valuations was paused on 30 January 2019 due to uncertainty about scheme costs following the Court of Appeal judgement in McCloud v Ministry of Justice. This had held that the ‘transitional protection’ offered to some members as part of the 2013 Act reforms amounted to unlawful discrimination.  The Government said that if it was successful in court, it would implement the changes to employee benefits as planned. If it was defeated, employees would be “compensated in a way that satisfies the judgment.”

Trade unions representing public servants objected to the pause. The TUC said the government should “stick to its own rules and deliver what it pledged.” The 2016 valuation had showed public sector pensions to be cheaper than expected. Under the agreed rules, this “should mean lower contributions or improved pensions for members.”

On 16 July 2020, the Government lifted the pause, as progress in determining the McCloud remedy meant costs were now more certain. The cost of the remedy would count as a ‘member cost’ in the completion of the 2016 valuations.

In February 2021, the Government said that the inclusion of the cost of the McCloud remedy in the 2016 valuation would lead to higher costs than had been expected and in some schemes breaching the ceiling. While a cost ceiling breach would generally result in action having to be taken to return costs to target, the Government had decided that this would not be appropriate for the 2016 valuations, particularly given its concern that the mechanism that might not be working as had been intended. However, in the case of costs falling below target, member benefits would be increased to bring costs back to target.

On 7 October 2021, the Government published amending directions for completion of the 2016 valuations. A letter from the GA confirmed that the amending directions reflected the Government’s policy intention that the entire impact of the McCloud remedy should be taken into account at this set of valuations.

Clause 86 of the Public Service Pensions and Judicial Offices [HL] Bill would allow ceiling breaches in the 2016 valuations not to be rectified by means of benefit reductions.

In the Lords, Opposition Peers raised concerns about the scope for parliamentary scrutiny over the decision to class the remedy as a member cost. In debate on 29 November 2021, the Minister said the Government had “received pre-action protocol letters on behalf of some trade unions which have indicated that they may issue judicial review proceedings.” He was “not able to comment on the specifics of live or threatened litigation” (HC Deb 29 November 2021 c1179 and 85).

On 15 December, six trade unions – the Fire Brigades Union (FBU), GMB, PCS, Prison Officers Association, the Royal College of Nursing and Unite – applied to the High Court for judicial review. The FBU said the case related to younger scheme members who would not benefit from the remedy, but would bear its costs.

Changes to the cost control mechanism for future valuations

Cost control policy will change for valuations from 2020 following a review of the mechanism conducted by the Government Actuary (GA), at the Government’s request.

In a report published in June 2021, the Government Actuary said:

• The older legacy schemes were the driver of the main changes in costs, but under the cost control mechanism, benefits could only be amended in the newer reformed schemes, which would seem to be tending towards intergenerational unfairness. Furthermore, the main changes in costs in the legacy schemes were in relation to assumed salary increases and life expectancy, two aspects which had largely been mitigated in the design of the reformed schemes.
• Costs could be expected to frequently fluctuate by more than two per cent, hence regular breaches of the corridor could be expected.
• Perverse outcomes could occur as benefit improvements could be granted at the same time as employer costs are increasing. Primarily this could occur due to the exclusion of changes to the long-term economic assumptions from the cost control mechanism.

The GA made recommended potential changes to improve the operation of the mechanism, assessed against the policy objectives the Government had set.  He said that in his view it was not possible to create a single mechanism which could meet all the objectives fully. The possibility for undesirable outcomes would remain.

On 24 June 2021, the Government launched a consultation on three proposals, all of which were “recommendations by the GA”:

• Designing the cost control mechanism so that it considers only benefits built in the reformed schemes. This would ensure consistency between the benefits being assessed and those potentially adjusted;
• Widening the corridor from 2% to 3% of pensionable pay, thereby reducing the regularity of breaches; and
• Introducing an economic check, so that a breach of the mechanism would only be implemented if it would still have occurred had long-term economic assumptions been considered.

In response to this consultation on 4 October 2021, the Government said it had decided to proceed as proposed, although it would consult further with LGPS stakeholders on the application of an economic check in that context.

The majority of respondents to the consultation had supported the proposals to move to a ‘reformed scheme only’ design and to widen the corridor (with a slight majority agreeing it should be set at 3%).

However, in the case of the economic check, there was a division in opinion. Those supporting it said it would avoid the ‘perverse outcome’ where benefits improved at the same time as employer costs were increasing. Others – including trade unions – were opposed on grounds that it may be a breach of the 25-year guarantee and previous government commitments regarding the types of cost the mechanism was intended to control.

The Government has tabled amendments to the Public Service Pensions and Judicial Offices [HL] Bill 2020-21 in advance of its Commons Committee stage on 27 January that would introduce the ‘reformed scheme only’ design and the ‘economic check.’ The widening of the cost corridor is to be implemented by means of secondary legislation.

Comment

In March 2021, the National Audit Office reported that “employee representatives told us that reviewing the mechanism because of what happened at the first valuation undermines trust between employees and the government.” Analysis by GAD in 2012 had suggested the mechanism could easily be triggered:

HM Treasury’s original intention was for the cost control mechanism to be activated only ‘if extraordinary, unpredictable events’ occur. HM Treasury told us it is concerned that the current design exposes taxpayers and members to short-term changes in assumptions rather than responding to long-term trends. GAD’s analysis, performed in 2012, suggested the mechanism could easily be triggered if multiple factors were to move at the same time.

In June 2021, the Public Accounts Committee said recommended that HM Treasury should “prioritise work to quickly resolve the challenges presented by the McCloud judgment and cost control mechanism, in order to give certainty to scheme members and employers, and rebuild the trust lost through these issues.”(Public Service Pensions, June 2021, para 5).

For more on the reforms, see Public service pensions – the 2015 reforms Commons Library Briefing Paper, CBP 5768.