The Treasury needs to change the cost-control mechanism designed to keep check on the affordability of the civil service pension scheme and other public-sector pensions, according to the government’s top pensions adviser
Government actuary Martin Clarke said the present system, introduced in 2015, contained flawed elements that put it on course to deliver a “perverse outcome” of reduced contributions and increased benefits that was out of step with reality for current scheme members.
The mechanism exists to protect the taxpayer from increased costs of delivering public sector pensions, which are unfunded. It uses periodic valuations to decide whether member benefits should be increased or lowered to maintain the level of employer support.
A report from Clarke to the Treasury that was delivered last month but only published this week says a 3.8% anticipated reduction in the cost of delivering schemes identified in 2016 was driven by reductions in assumed future pay increases and also in assumed life expectancy. The valuation process was controversially paused in early 2019 by then chief secretary to the Tresury Liz Truss after a Court of Appeal judgment found an element of the wider 2015 reforms was discriminatory.
The PCS union has said that applying the cost-control mechanism based on the 2016 valuation would have seen scheme members’ contributions reduce by 2% and a range of benefits increase.
In his just-published report, Clarke said 60% of the cost reductions identified in the 2016 valuation related to legacy pension scheme members, while the cost-control mechanism could only be used to change benefits in reformed pension schemes. The new Alpha scheme moved most civil servants from a final salary to a career average pension scheme, although benefits already accrued were protected.
“Considering this outcome against the objectives of the cost-control mechanism, the context of the recent reforms and the wider economic environment this could be considered to be a somewhat perverse outcome,” he said.
“It does not seem possible for the mechanism to be able to protect taxpayers unless it takes into account more of the factors affecting the actual cost of providing a pension.
“In the circumstances, it might be considered generous for members to be immunised against all the long-term financial downside risks whilst being able to benefit from the upside of other risks.
“Whilst comparison with private sector pension schemes is not an objective of the cost-control mechanism, I note that many employer sponsors of such schemes faced with similarly rising costs have felt the need to limit the value of the schemes to members.”
Clarke said the principle of cost control in public-sector pensions was “a good one” and noted that the alternative to a mechanism was a review system “without a firm mathematical prescription that would be open to public interpretation”.
His recommendations to the Treasury suggest ministers could introduce a cost-control mechanism that only covers benefits owed under the reformed pension schemes or which is limited to assessing the projected cost of benefits accrued under future service.
Clarke said that both options would “ensure consistency between the set of benefits that can be adjusted by the mechanism with those that are assessed by the mechanism”.
Another option proposed by the government actuary is widening the “corridor” of affordability that triggers the cost-control mechanism from the current 2% of pensionable pay to 3% or more to “reduce the volatility of the mechanism”.
“The size of the corridor is directly proportional to the likelihood of a breach arising,” Clarke said. “I believe that the mechanism is too volatile and that breaches will continue to happen without an ‘extraordinary, unpredictable event’ occurring.”
Extraordinary, unpredictable events were originally supposed to be the trigger for the cost-control mechanism.
A further option tabled by Clarke would be an "additional layer of qualitative review" that would consider whether any breach of the cost-cap mechanism should result in amendments to contributions and benefits.
Clarke said the additional tier of review could be undertaken by an independent panel or be left entirely to ministers. "This is an acknowledgement that any single mechanistic cost control will not be able to meet all of the objectives and indeed any revised mechanism will still remain imperfect and could result in undesirable outcomes," he said.
McCloud fallout
The current cost-control mechanism had been due to reduce member contributions and increase benefits following 2016’s preliminary valuation of public-sector pension schemes. But Truss said the cost implications of fixing the Court of Appeal’s judgment in the McCloud discrimination case could be £4bn or more a year and would supersede the 2016 valuation. This case found that protecting those within 10 years of their normal pension age by keeping them on the classic final salary pension scheme was discriminatory.
A recent Public Accounts Committee report put the overall bill at £17bn, exclusive of administration costs.
Civil service unions have grown increasingly concerned that the Treasury is planning to load the entire cost of the government's McCloud remedy into a single valuation period for public sector pension schemes. The remedy entitles all scheme members to chose whether they recieve benefits from a legacy scheme or a reformed one between 2015 and 2022.
Last month the unions said the Treasury had been put on notice to expect a High Court challenge to any proposals that involved requiring pension members to pay for botched reforms to their pension schemes.
Responding to the report, a Treasury spokesperson said: "As the review notes, the Treasury requested the Government Actuary to carry out a review of the cost control mechanism and we thank him and his team for this detailed report. We are currently considering its findings and will respond in due course."