Why are these reforms being made?
The intention was for the mechanism to only be triggered by unforeseen and unpredictable events. In 2018, the Government Actuary was asked to review the mechanism after the provisional results at the 2016 valuations suggested the mechanism was too volatile and not operating in line with its objectives. The review commenced in 2020 and his final report was published in June 2021. It contained several recommendations on how to improve the mechanism.
Following a full public consultation process, HM Treasury confirmed in October 2021 that it would take forward three reforms to the mechanism in time for the next scheme valuations. All three reforms are recommendations by the Government Actuary. The reforms are intended to make the mechanism more stable and ensure that it protects both scheme members and taxpayers.
The NI Assembly agreed a legislative consent motion for two of these reforms – the ‘economic check’ and the ‘reformed scheme only’ design - to be applied for devolved pension schemes in NI under the PSPJOA 2022. It is proposed that the third reform – a widening of the cost cap corridor – will be introduced in secondary legislation by the Department of Finance during 2022.
Why is an economic check being introduced?
The Government Actuary’s report, highlighted that the cost control mechanism cannot effectively protect taxpayers unless it considers more of the factors affecting the actual cost of providing a pension.
The introduction of a symmetrical economic check is intended to ensure that any breach of the mechanism would only be implemented if it would still have occurred had any changes in the long-term economic assumptions been considered.
The economic check will operate symmetrically for the benefit of both members and taxpayers. Its main purpose is to ensure greater consistency between benefit changes and changes to the wider economic outlook. It ensures a higher bar for benefit cuts to occur if the long-term economic outlook improves. But it equally applies to benefit increases if the long-term economic outlook worsens.
It is intended to operate in a transparent way and be linked to an objective and independent measure of expected long-term earnings and GDP from the OBR.
Is it right for the CCM to be linked to SCAPE/long-term GDP despite previous statements to the contrary?
All three reforms were recommendations made by the Government Actuary in his independent review of the mechanism. They were also the subject of a full and open consultation process.
It is recognised that when the mechanism was set up, the intention was that changes in expected long-term GDP growth, would be excluded and would not impact on member benefits.
However, the Government Actuary’s review found that the mechanism cannot sufficiently protect the taxpayer without considering more factors that affect the actual cost of providing a pension, and it provides grounds to introduce the impact of changes in expected long-term GDP growth to the mechanism, albeit in a limited way, through the economic check. The effect that changes in long-term economic assumptions can have on the mechanism will be limited because they cannot cause or contribute to a breach, but only prevent or offset one.
The economic check is symmetrical, and so protects both scheme members and taxpayers. The economic check is intended to improve the operation of the mechanism and help make public service pensions schemes more sustainable in the future.
Will the economic check be objective?
The economic check will be linked to the OBR’s independent and objective measure of expected long-term GDP growth and the long-term earnings assumption. It is designed to operate purely mechanically, with no scope for interference from individuals or groups, either from within Government, or outside.
Why is the plan to move to a reformed scheme only design for the cost control mechanism?
By moving to a reformed scheme only design, legacy scheme costs will be excluded from the mechanism, and only costs relating to past and future service in the reformed schemes will be considered.
A reformed scheme only design will ensure consistency between the set of benefits being assessed and the set of benefits potentially being adjusted. It will also increase the stability of the mechanism and reduce intergenerational unfairness. Whilst this transfers the risks associated with legacy scheme costs to the Exchequer, it is expected to reduce intergenerational unfairness and ensure the mechanism is fairer to younger members who did not previously have access, or had access for a shorter time, to the legacy schemes.
Why widen the corridor?
Widening the cost corridor to +/-3% of pensionable pay will ensure a more stable mechanism, meaning it is more likely that breaches occur only in unforeseen and unpredictable circumstances, as was intended when the mechanism was originally established. This should also provide greater certainty to members regarding their projected benefits and future contribution rates.
Will a wider corridor lead to larger benefit changes?
A wider corridor does not mean that different action would need to be taken if a breach beyond 3% were observed. For example, a breach of 4% would still require the same changes in benefits under either a 2% or 3% corridor, because after a breach the aim is to return costs back to target.
However, a 3% corridor will mean that cost changes between 2 and 3% will not trigger a breach and require rectification, which could lead to a larger than otherwise breach occurring at subsequent valuations. Although this risk exists, a wider corridor should ensure a more stable mechanism and limit the frequency of member benefit and contributions changes.
Furthermore, if a scheme shows cost changes between 2-3% at one valuation, then that does not automatically mean costs would either stay at that level or move further in the same direction at subsequent valuations and therefore result in a breach that would be larger than under a smaller corridor. It is perfectly possible that a scheme may see an increase in costs at one valuation, and then a reduction in costs at the next.
Are the changes being made fair on members?
The reforms will make benefit cuts and increases less likely, in line with the mechanism’s original objective of stability and the intention to protect both member benefits and the taxpayer. A more stable mechanism should provide greater certainty to scheme members regarding their future benefits.
Why are the reforms being implemented for the 2020 valuations onwards, and not being applied to 2016 valuations?
The Department of Finance aims to implement these reforms to the cost control mechanism in time for the 2020 valuations. It would not have been possible or appropriate to implement these reforms, including the reformed scheme only design, in time for the 2016 valuations.
These reforms follow the Government Actuary’s review of the mechanism and a full HM Treasury consultation process. The Government Actuary reviewed the mechanism in 2018 following the provisional results of the 2016 valuations, which showed that all schemes might breach the floor. This led to concerns the mechanism was too volatile, and not operating in line with the intention that it should only be triggered by “unpredictable and extraordinary” events.
The 2016 valuation process had already begun before the review was commissioned. The 2016 process was paused due to the uncertainty which arose from the McCloud judgment, and the Government Actuary’s review was also put on hold at this time. Once HM Treasury announced that the 2016 process would resume, it also confirmed that the review would proceed. However, as it was not clear what the outcome of the review would be, it would not have been appropriate to take a decision on whether or how the mechanism should be reformed for the 2016 valuations.