The Government Actuary has completed his review of the cost control mechanism used in the public service pension schemes.
HM Treasury asked Martin Clarke, the Government Actuary, to carry out a review of the mechanism. This followed concerns it was not operating in line with its objectives, in particular, the intention that it would only be triggered by ‘extraordinary, unpredictable events’.
The review comprised of an assessment of the current mechanism as well as recommendations on possible changes that could be made to the mechanism.
What is the cost control mechanism?
The cost control mechanism is a form of risk-sharing arrangement that seeks to maintain the level of employer support for the public service pension schemes.
It assesses certain elements of the costs of each scheme. If these costs have changed from their original level by more than the ‘corridor’ of +/- 2% of pensionable pay, then member benefits within that scheme are changed to bring the assessed costs back to the original level. The mechanism is symmetrical so it can both increase and reduce member benefits.
It was established as part of the wider reforms introduced in the Public Service Pensions Act 2013 and impacts more than 5 million public service workers.
Assessment of the current mechanism
Having reviewed the current mechanism in relation to the outcome of the preliminary 2016 valuation results, the main conclusions were that:
- the older Legacy schemes were the driver of the main changes in costs, but benefits can only be amended in the newer Reformed schemes, which would seem to be tending towards intergenerational unfairness
- the main changes in costs in the Legacy schemes were in relation to assumed salary increases and life expectancy; 2 aspects which have largely been mitigated in the Reformed schemes
- costs would be expected to frequently fluctuate by more than 2%, hence regular breaches of the corridor can be expected
- perverse outcomes can occur as benefit improvements can be granted at the same time as employer costs are increasing. Primarily this can occur due to the exclusion of changes to the long-term economic assumptions from the mechanism
Public service pension schemes
Legacy schemes – those public service pension schemes in force prior to the wider reforms introduced in the Public Service Pensions Act 2013. These schemes are typically ‘Final Salary’ schemes which means the level of pension ultimately received is based on a member’s final salary.
Reformed schemes – those public service pension schemes introduced in the Public Service Pensions Act 2013. These schemes are typically ‘Career Average Revalued Earnings’ schemes which means the level of pension ultimately received is based on a member’s average salary over their career.
Recommendations on how to improve the mechanism
Five main recommendations were made as to how the mechanism could be improved, split between changes to the core mechanism and a validation layer to moderate the effects of the core mechanism.
Changes could be made to the core mechanism to:
- only assess costs associated with the newer Reformed schemes (both past and future service)
- or, only assess costs associated with the future service of the newer Reformed schemes
- widen the corridor from its current level of +/- 2% of pensionable pay
The effects of the core mechanism could be moderated by:
- an affordability check whereby a breach of the corridor would only be addressed if it would still have occurred had the long-term economic assumptions been considered within the mechanism
- a qualitative layer of review which allows for reasoned judgement to be used to determine whether to apply the results determined by the core mechanism
The Government Actuary, Martin Clarke, said: “The cost control mechanism is an important process for ensuring the public service pension schemes remain sustainable while also continuing to provide value to the millions of public service workers.
“I am very pleased to have been asked to carry out the review of the mechanism, and to have an opportunity to help improve its operation in the future.”