Public service pensions: cost control mechanism consultation

Question 1: Do you agree that a reformed scheme only design would achieve the right balance of risk between scheme members and the Exchequer (and by extension the taxpayer), and would create a more stable mechanism?

Yes. By reducing the size of the past service component, this would lead to a more stable mechanism, which could potentially increase confidence in the system for both members and employers. It seems reasonable to ensure that only those benefits that can be adjusted by the mechanism are considered in the assessment of cost.

Question 2: Do you agree with the Government’s intention to widen the corridor? If not, why not?

It is clear that widening the corridor would lead to more infrequent breaches, which would be welcome. However, while more stable outcomes would generally help to maintain confidence among members and employers, continued tinkering with parameters to achieve this will diminish trust.

This is particularly relevant given that the first breach of the cost cap was a downward one that should have delivered benefit improvements or reduced contributions for members. The government’s refusal to honour the provisional outcomes of the 2016 valuations, which would have delivered benefit improvements across all public sector schemes, has already undermined trade unions’ faith in the process.

This intervention in the valuation process has created the impression that the government is motivated by the fact that the clear and objective process put in place delivered the ‘wrong result’ on this occasion, rather than by concerns about the soundness of the process. It is difficult to imagine that the government would have felt the need to review the mechanism if there had been an upwards breach on the first valuation cycle. This would have been presented as the mechanism working as it should, protecting the government from increasing costs.

It is important therefore that the government provides clear assurances that any changes to parameters will last.

Question 3: Do you think that a corridor size of +/-3% of pensionable pay is appropriate? If not, why not?

The Government Actuary’s Department analysis that this would be expected to lead to one breach in every 10 value cycles suggest that this would be an appropriate level.

But the impact on benefits of any breach must be considered, and the wider the corridor, the more significant the benefit adjustments required to bring schemes back into line could be. And from the perspective of members, a sharp reduction in accrual rates or increase in contribution rates would potentially do more to undermine trust or increase opt outs than frequent, smaller changes.

For this reason, it will be necessary to manage the process around breaches carefully, with clear mechanisms for scheme advisory boards to monitor cost pressures and engage with stakeholders ahead of any potential breach. A more flexible approach will also have to be taken to agreeing the level costs should revert to in the event of a breach to minimise the impact of any changes on scheme participation.

Question 4: Do you agree with the proposal to introduce an economic check?

The TUC strongly rejects the proposal to introduce an economic check. We see this proposal as a clear breach of the commitment given by the government in 2011 of no further changes to public sector pensions for 25 years.[1] This agreement reached  then was difficult for many unions and members to accept as it amounted to public servants ‘paying more, working more, and getting less’, but unions engaged in the negotiations in good faith and most supported the resulting deal. The cost control mechanism was a key part of that agreement.

As then-chief secretary to the Treasury Danny Alexander made clear:

“All the agreements include a cap on taxpayer costs at two percentage points above or below the scheme valuation. That cap is symmetrical, so employees will benefit if costs fall.”[2]

The proposed economic check appears to be designed to allow the government to override the results of the cost control mechanism in the event of a downward breach. Although the consultation emphasises the potential for the economic check to be used to override an upward breach if the government considered it affordable, it introduces a large degree of subjectivity and potential for political considerations to influence  what should be a transparent and objective process. This need for objectivity is only increased by the mistrust generated by the government’s response to the initial 2016 valuations.

The TUC also questions the argument made by the government and the government actuary that the 2016 review had a “perverse outcome” because it resulted in a breach of the cost control floor at a time when changes to the SCAPE discount rate resulted in higher employer contributions. A more measured assessment can be found elsewhere in the government actuary’s review, where he observes “the mechanism has worked as it was intended to but that the practical consequences might be considered to be counter-intuitive”.[3]

The consultation acknowledges that “the key drivers of the indicative floor breaches were a reduction in the assumed level of future pay increases and a reduction in assumed life expectancy” in paragraph 3.12. These factors resulted in a reduction in the value of benefits to members, who can expect lower benefit levels and less time in receipt of their pension. The changes to the employer contribution rates were driven by the volatility of the SCAPE discount rate, which has been cut three times since 2011 as a result of revised GDP expectations.

There was no reason to expect these two sets of assumptions to move in lock step, so it is strange that the government seems to have been so surprised by this outcome. If the aim of government policy is to avoid a situation where benefits have to be improved at the same time as employer contribution rates rise, the TUC believes the focus should be on reforming the discount rate (as set out below), rather than allowing the government to override the results of the cost control process.

Question 5: Do you think that the SCAPE discount rate, as it currently stands, is an appropriate economic measure for the cost control mechanism?

No. As outlined above, the TUC believes the government should not introduce an economic measure into the cost control mechanism, but if it were to do so, this would be compounded by the current SCAPE methodology.

The TUC has made the case in its response to the ‘Public Service Pensions: Consultation on the discount rate methodology’ that the Social Time Preference Rate (STPR) is a more suitable basis for a discount rate to apply to public sector pension costs.

One reason for this is that the GDP-based methodology currently used is too volatile. The TUC does not believe that importing another volatile measure into the cost cap process is the best way to respond to concerns over the stability of the mechanism.

Rather, reforming the SCAPE methodology to bring the assessment of pension costs into line with other areas of public sector spending would remove the need for introducing an economic check. By increasing the stability of employer costs, the chances of a situation arising where employer and member contributions would be moving in different directions, as was the result of the provisional 2016 valuations, would be significantly reduced.

Question 6: If the SCAPE methodology changes, and the Government considers that the SCAPE discount rate is therefore not an appropriate measure for the cost control mechanism, then do you think that a measure of expected long-term GDP should be used instead? If not, please set out any alternative measures that may be appropriate in this scenario. Please consider in the context of the separate review of the SCAPE methodology currently being undertaken by HM Treasury.

The TUC does not believe that long-term expected GDP growth is an appropriate measure to include in the cost control mechanism. As we set out in our response to the separate review of SCAPE methodology, the use of expected GDP growth in this context has introduced additional volatility and uncertainty into employer costs over the last 10 years. As we noted in that response, it is difficult to justify why this is an affordability check that should apply to public service pensions but not to other elements of government spending which use a social time preference rate for discounting.