Scheme valuations and the cost control mechanism

The 2016 valuations were the first time the mechanism was tested, and the provisional results suggested there would be breaches across all public sector schemes, mostly due to normal fluctuations in actuarial assumptions. As a result, the Government was concerned this indicated the mechanism was not acting as intended.

This is why the Government commissioned the Government Actuary to carry out a review of the mechanism to assess whether the mechanism was too volatile and was operating in line with its objectives.

The Government Actuary’s final report was published on 15 June 2021. The Government considered the final report and concluded that changes were necessary to ensure the mechanism operates more in line with its objectives, and then put these changes to consultation.

All the Government’s reforms proposed during the consultation and now being implemented are in line with changes recommended by the Government Actuary.

It was right to pause the cost control element of the 2016 valuations, as the uncertainty around member benefits arising from the McCloud and Sargeant court judgments made it impossible to assess the value of the schemes to members with any certainty. If the cost control mechanism had not been paused, the mechanism would probably have required public sector schemes to adjust benefits based on incorrect assumptions about benefit entitlements.

Following the publication of the McCloud consultation, the uncertainty about scheme benefits that arose as a result of the McCloud judgment has reduced. The Government therefore announced in July 2020 that the cost control mechanism would be unpaused and the cost control element of the 2016 valuations was completed December 2021.

No. The Government has announced that any ceiling breaches identified at the 2016 valuations would be waived. It is legislating for this in the Public Service Pensions and Judicial Offices Bill that is currently before Parliament.

When the cost control mechanism was established, it was agreed that it would only consider costs that affect the value of the schemes to members (a ‘member cost’).

Addressing the discrimination identified in the McCloud and Sargeant judgments – giving members a choice of scheme benefits for the remedy period - involves increasing the value of schemes to members; the costs associated with this therefore fall into the ‘member cost’ category.

As a 'member cost', this has been taken into account now that we've completed the cost control element of the 2016 valuations. 

However, the Government has taken the decision to waive any ceiling breaches that may occur, meaning no member will face a benefit reduction as a result of the 2016 valuations process.

McCloud remedy will be captured in full at the 2016 valuations and so will not need to be captured at future valuations. In contrast, the reforms to the cost control mechanism that the Government has announced will only be implemented from the 2020 valuations.

The Government believes it is right to capture the full impact of remedy at the 2016 valuations, given the remedy period will end by the end of the implementation period for this set of valuations.This means that remedy will not need to be allowed for at future valuations.

Capturing remedy over four years also more aligns those who benefit from remedy with those who pay for it. The Government Actuary advised that a four-year spreading period is a reasonable way of achieving intergenerational fairness.

The provisional 2016 valuations results were indicative. They were not finalised prior to the pause of the mechanism.

It was right to pause the mechanism following the McCloud judgment, as the uncertainty around member benefits arising from the court judgments made it impossible to assess the value of the schemes to members with any certainty.

If the cost control mechanism had not been paused, schemes may have adjusted benefits based on incorrect assumptions about benefit entitlements. The Government Actuary agreed that the policy of pausing the mechanism was reasonable.

The Government believes that by creating a more stable mechanism, which limits intergenerational unfairness, these reforms benefit both members and employers.

Whilst the Government’s reforms would make benefit increases less likely, they would also make benefit cuts less likely. This is in line with the mechanism’s original objective of stability and the intention to protect both member benefits and the taxpayer.

The Government does not believe these reforms breach the 25-year guarantee.

The elements protected by the 25-year guarantee are set out in legislation, and the cost control mechanism is not included.

 The Government is making these changes following a thorough and independent review of the mechanism by the Government Actuary. As the Government Actuary’s report makes clear, the volatility seen at the provisional results of the 2016 valuations indicates that the cost control mechanism is not operating as it should and therefore does not sufficiently protect both the taxpayer and members.

Furthermore, the reforms will lead to a more stable mechanism, with both benefit improvements and reductions becoming much less likely, which aligns with the spirit of the 25-year guarantee.

The Government is committed to ensuring public servants are rewarded at the end of their careers and for schemes to be sustainable and affordable in the future.

Through this reform, the cost control mechanism will operate with a reformed scheme only design (for the Civil Service, this is the alpha scheme). This means that costs associated with legacy schemes will be excluded from the mechanism, and only costs relating to past and future service in the reformed schemes will be considered.

Whilst this transfers the risks associated with legacy scheme payments to the employers (and by extension the Exchequer), it ensures consistency between the set of benefits being assessed and the set of benefits potentially being adjusted. It would allow the mechanism to better meet its objectives of stability and reduce intergenerational unfairness.

Widening the cost corridor to +/-3% of pensionable pay will ensure a more stable mechanism, so that it is more likely that breaches only occur in unforeseen and unpredictable circumstances, as was intended when the cost control mechanism was originally established.

The Government recognises that a wider corridor increases the cliff edge nature of the mechanism. This means that larger changes in costs can occur without any remedial action. This was highlighted in the Government Actuary’s report and the Government considered this risk carefully as part of the consultation process.

However, the Government considers that while this risk exists, a wider corridor is necessary to ensure a more stable mechanism so that breaches only occur in unforeseen and unpredictable circumstances.

After considering carefully the balance of risks, the Government believes that an estimated breach frequency of every 10 valuations (every 40 years) provides the right balance between stability (and therefore minimising cliff edge changes) and effective cost control. This can be achieved by widening the corridor to +/-3% of pensionable pay.

In line with the Government Actuary’s view, the Government does not believe that benefits should be improved or reduced when pension costs are moving in the opposite direction.

By introducing an economic check, this will ensure that any breach of the mechanism would only be implemented if it would still have occurred had changes in the long-term economic assumptions been considered.

The economic check will operate symmetrically for the benefit of both members and taxpayers.

It will operate in a transparent way and will be linked to an objective and independent measure of expected long-term GDP from the OBR, so will not be subject to political interference.

The Government recognises the different, funded nature of LGPS schemes to other public service pensions, and that is why it has taken into consideration points raised about the appropriateness of the planned reforms and potential allowances for these schemes.

Moving to a reformed scheme only model means that legacy benefits risks will sit with employers in funded LGPS schemes. However, the Government still believes that a reformed scheme only design is appropriate for LGPS for the same reasons as with other schemes, and will work with LGPS stakeholders to consider the most appropriate way to implement this proposal for LGPS at the 2020 and subsequent valuations, including the treatment of the underpin.

The Government will still introduce an economic check, but because of their different, funded nature, will work with LGPS Scheme Advisory Boards (SAB) to agree a process for an LGPS specific discount rate to be used as part of their own SAB cost management process.

The Government closed its consultation on the discount rate methodology on 19 August. It is now considering the responses received and will set out the methodology to be used to set the discount rate going forward in due course.

The Government’s conclusions regarding the SCAPE discount rate methodology will be based on the separate objectives for the SCAPE discount rate.

The Government’s consultation response on reforms to the cost control mechanism makes clear that the economic check will be based on expected long-term GDP growth, either directly or through the SCAPE discount rate where it remains based on expected long-term GDP growth.