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Public service pensions - employer contributions

Published Monday, September 10, 2018

Discusses the impact of decisions announced in Budget 2016 and September 2018 to reduce the SCAPE discount rate used in valuations of unfunded public service pension schemes

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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.

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.

Contribution rates for unfunded public service pension schemes are set using the “SCAPE discount rate” - a methodology developed by the Government in the absence of a fund of assets. 

Keeping all other assumptions unchanged, a lower discount rate would result in higher contribution rates at the next scheme valuations. The effect will vary between different schemes due to the different generosity of scheme designs and the different profiles of each workforce.

In Budget 2016, the Government said it had reviewed the discount rate and decided to reduce it, with the result that employer contributions would increase from 2019/20:

Measure description

This measure changes the discount rate used to set employer contribution rates in the unfunded public service pension schemes. The measures changes the discount rate from 3% to 2.8%, to reflect the OBR’s current long-term forecast of GDP growth. The discount rate was last set in 2011, at which point the Government committed to review the rate in 5 years.

The cost base

This measure is expected to increase the employer contributions made to the unfunded public service pension schemes by £2bn per annum from April 2019. This will produce an increase in Public Service Pension Scheme income from 2019-20. Payments to beneficiaries are unchanged by the measure. The overall impact is therefore a reduction in Public Service Pensions Scheme expenditure, the amount paid (or received in the event of a surplus) by the Exchequer to make up any difference between income and expenditure.(HM Treasury, Budget 2016 –policy costings, p70)

The exact level of employer contributions from 2019 would be set following the next round of scheme valuations – showing the position of the schemes as at 2016 - taking account of the new discount rate set in the Budget.

In September 2018, the Government proposed a further reduction in the discount rate, to take effect for valuations purposes from 1 April 2019. In a letter to the TUC, the Chief Secretary to the Treasury said:

You will be aware that a change to the SCAPE discount rate, from 3% to 2.8%, was announced at Budget 2016. Having reviewed recent OBR publications and GDP forecasts; the Treasury is proposing that a further change to the SCAPE rate is appropriate. The proposed change is to reduce the SCAPE rate from 2.8% to 2.4%, but this will be confirmed in due course. The draft directions propose that the lower rate will take effect for valuations purposes from 1 April 2019.

Departments and devolved administrations would need to meet the increase in costs from the 2016 Budget announcement in full. The Government will support them with the increased cost resulting from the more recent 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)

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 SN-06971 public service pensions – employer cost cap.

 

 

 

Commons Briefing papers CBP-7539

Author: Djuna Thurley

Topic: Pensions

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