Select Committee on Defence Third Report

Winners and Losers

50. Inevitably, if there is no additional money going into the scheme but simply a redistribution of existing resources, there will be some who gain from the proposed new arrangements, but equally some who lose out. The Minister told us—

It is right to say that in making some winners there then has to be reductions elsewhere— that is the very nature of the way in which the sum of money is being re-allocated ...[76]

 The Minister's assessment was that inequities in the present scheme were being 'smoothed out'.[77] The overall effect of the proposals is that retirement benefits are being reduced to pay for improvements in survivor and ill health retirement benefits. The rebalancing effect is summarised below.

Table 2

Costs of pension benefits as a percentage of pensionable pay



Existing AFPS

Proposed pension scheme



Lump sum







Preserved benefits


Lump sum







Ill health



Spouse's benefits



Death in service (lump sum)






Source: Ev 52

It should be noted that no serving personnel will actually see their benefits change, unless they choose to join the new scheme, as they will have the option of remaining with the present scheme. They will, however, have to gamble in making the choice between better retirement provision under the old scheme; and higher death in service and other benefits for their dependants under the new scheme. Once the new proposals have been adopted, entrants to the Armed Forces will automatically enter the new pension scheme and will therefore potentially be disadvantaged, compared with their counterparts in the present AFPS.

51. The consultation document provides no examples of how the proposed new scheme will affect individuals and we therefore asked for worked examples, comparing the old scheme with the new.[78]


Retirement benefits

52. Examples of categories of Service personnel who will lose out under the new arrangements include—

  • a lieutenant colonel retiring on a compulsory basis after 18 years' service who will receive about 2,500 less in annual pension and 8,000 less in his lump sum. Calculated as a capital figure, this means a reduction from 356,000 to 302,000.[79]
  • a sergeant retiring after 22 years who will see a small decrease in annual pension (about 500) and about 1,000 reduction in lump sum, giving a reduction in the capital figure of 8,000.[80]

On the other hand:

  • a sergeant retiring after 32 years' service at age 50 would receive an additional 1,000 in lump sum payment, and a 300 a year increase in pension, giving an increase in the capital figure of 6,000.[81]


Death in service benefits

53. Benefits for dependants are significantly enhanced: the death-in-service grant will be increased from one or one-and-a-half times pay to three times pensionable pay; and widow(er)s' pensions will be increased to half of the highest tier ill-health pension which the member would have been entitled to.[82] An example of how improvements in benefits affect individuals is—

  • the spouse of a sergeant, aged 28, who died after 10 years' service, would receive a pension of 4,088 a year, compared to 2,446 now and a lump sum of 73,069 compared to 24,456. Calculated as a capital figure, this is an increase of 61,000.[83]


Ill health benefits

54. A three-tier structure for ill health benefits is envisaged. Tier 1 provides for those whose earning capacity as a civilian is not affected, who would receive an invaliding gratuity based on salary and number of years of service. Tier 2 provides for those whose earning capacity is assessed as significantly reduced, who would receive a pension on discharge based on length of service and enhanced by one-third of remaining service up to normal retirement age. Tier 3, for those unlikely to be fit for any work, would provide a minimum pension guarantee of 20 years' accrued pension, with remaining service enhanced by a half. An example of the effect on individuals is—

  • a colonel retiring on ill health grounds which are not attributable to his service, after 10 years' in the Army, would receive a pension of 16,046 a year (currently 13,811) and a lump sum of 48,137 (currently 41,433). If he died, his spouse would receive a pension of 8,023 (currently 6,906). Calculated as a capital figure, this is an increase to 335,000, from 288,000 under the present scheme.[84]

55. The Forces Pension Society's overall impression is that 'we judge that there are going to be an enormous number of 'losers', possibly the majority'.[85] The Minister told us that 'the inevitability of the logic' of the redistribution of benefits meant that some would lose out.[86] From the range of examples which the MoD has provided, which were presumably selected as being representative of the effects of the new proposals, it certainly appears that there will be many Service personnel who will receive worse pension benefits under the new scheme than are available at present. The net effect of the new arrangements is that those who are not killed or injured during their military service are penalised so that the benefits for those who are can be increased to acceptable levels. We welcome the proposed improvements to dependants' and ill health benefits but regard it as unacceptable that these are achieved by reductions in benefits elsewhere in the pension scheme.


Terminal Grants

56. In the current AFPS, individuals receive a pension and an automatic lump sum (terminal grant) which accrue separately. The drawbacks of a lump sum payment are that, when interest rates are low, the value of having a lump sum to invest can be lower than the value of having a guaranteed index-linked benefit. The Review document says that in principle it would be possible for entitlement to accrue wholly as a pension and then for individuals to have the option of commuting part of this to a lump sum, but that offering a positive choice on retirement, when the vast majority of people would choose commutation in any case, 'could add administrative complexity'. Instead, the proposals offer an automatic lump sum, with the right of 'inverse commutation' which would enable individuals to convert terminal grant back to pension rights, if they choose to do so.[87]

57. We believe the MoD is exaggerating the administrative complexity of offering the option to commute: almost all private sector schemes have commutation, and the new Civil Service scheme is providing it. We note that the MoD is considering the adaptation of an existing commercial pension package for the administration of the new scheme,[88] and any such package will certainly include commutation as a feature. The Director General, Service Personnel Policy, told us he was aware that the Civil Service scheme is offering the commutation option and that this was one of the issues which the MoD was re-examining.[89] We recommend that the MoD follows good practice found elsewhere in pension schemes by offering the option of commutation on retirement, rather than the potentially disadvantageous automatic lump sum.


Immediate Pensions

58. The Armed Forces are unique in the way in which they use the Pension Scheme as a man management tool, as an incentive to trained personnel to remain in the Services. They do this through Immediate Pensions, currently paid to officers who delay leaving the Services until age 38 (or after 16 years' service, whichever is later) and to other ranks at age 40 (or after 22 years' service). In practice, service manning patterns are complex and, of those leaving the Services each year, fewer than 20 per cent of the Armed Forces as a whole do so at their Immediate Pension Point. The Government Actuary's Department works on the assumption that 52 per cent of officers and 13 per cent of other ranks stay in service to the IP point or beyond.[90] The table below sets out departure statistics for each of the three Services for the last three years.

59. Although only a limited number of personnel stay in the Services long enough to enjoy the benefits of the Immediate Pension (IP), all contribute towards it through the abatement which the Armed Forces Pay Review Body includes in its calculations of appropriate levels of Service pay. The IP is an expensive element of the pension scheme, as the Review document acknowledges,[91] accounting for 30 per cent of the total scheme costs.[92] The Government Actuary costs the total benefits of the pension scheme for officers at 33.8 per cent of pensionable pay, but at only 18.1 per cent for others ranks, which is accounted for mainly by the much higher proportion of officers who stay in the Services until they reach the Immediate Pension point.[93]

60. The Review examined the role of the Immediate Pension only in terms of its effectiveness as a retention incentive. It did not consider whether its costs had an adverse impact on scheme benefits. It concluded that it is an effective retention incentive and that to alter it substantially 'would place manpower planning at risk'.[94] It suggested some modification in the arrangements which would allow individuals to decide in their early thirties that they will opt for bonuses instead of an immediate pension at age 40, with pension entitlement then deferred to 55 or 60.[95] No details are given about the amounts which would be payable under this bonus scheme. The MoD indicated in an answer to a written Parliamentary question that it has not undertaken a costing of alternative measures, or a net costing of the early Immediate Pension.[96] We have been told that Immediate Pensions and bonuses are being re-examined but that at present 'there are no detailed descriptions of options, costings or estimates of the different impact on retention'.[97]

61. The Forces Pension Society believed it was 'remarkable' that the MoD had not costed alternative retention incentives as without such an exercise they could not be sure that Immediate Pensions were the most cost-effective method available.[98] The Society's view is that the Immediate Pension is 'a costly manning tool ... financed at the expense of full career pensioners and survivors' and that this is indefensible. The use of pensions as a manning regulator is regarded as 'perverse' because of the effect it has in depressing full-career benefits.[99] Their view is that the MoD should offer a wide range of incentives to retain the Service personnel they require, some of which might be linked to pensions.[100]



62. The Services already use a range of mechanisms to retain particular groups of personnel, particularly where civilian employment offers an attractive alternative. In its Report for 2002, the Armed Forces Pay Review Body recommended financial retention incentives of 30,000 for pilots, navigators and other aircrew at five years before the IP point, in return for five years service; and 50,000 at the IP point for a similar return. This followed a review of aircrew retention by an MoD working group.[101] Retention incentives are also in place for members of the Royal Signals, involving lump sum payments of 10,000 for further commitments of three or five years. A one-off, taxable bonus of 3,000 is available to Royal Navy Warfare Branch Leading Ratings in return for a two and half year extension of service.[102] One of the problems of using bonuses rather than payments from the pension scheme to a greater extent as a retention incentive is that bonuses are taxable but pension terminal grants are not. To reward personnel with the same net amount, therefore, bonuses would have to be paid at a higher level,[103] but the net cost to the public purse would be the same. However, the advantage of bonuses is that the timing and amount of payments can be varied according to circumstances, whereas payments from the pensions scheme are tied to the pension accrual rate and to a common retirement age.

63. The Defence Committee in the last Parliament examined a whole range of factors which affect retention, including financial incentives and commented—

The MoD needs to be flexible but also more strategic in its approach if it is going to use additions to pay as a retention tool, and in particular needs to assess both the negative and positive effects of bonuses.[104]

We agree and believe the MoD needs to look at Immediate Pensions in the broad context of a strategic and flexible approach to financial retention incentives. The MoD needs to justify the cost of the Immediate Pension and demonstrate that it is an appropriate component of a modern pension scheme.


Post-Service employment

64. The Immediate Pension also has another purpose: it is a way of compensating personnel for whom the Services cannot offer a full career for the reduced levels of pay they may receive in subsequent employment.[105] The Review document states that the Armed Forces need to shed a substantial proportion of manpower around the age of 40, and that the current pension points at ages 38 and 40 thus provide natural departure points.[106] For many Service personnel, leaving the Armed Forces at age 40 is not voluntary. Their career prospects may be less good than those of civilians of a similar age, as their Service career may not have prepared them for the types of civilian employment which are available. If they are embarking on a new career, they may be doing so later in their working lives than civilian counterparts, and at a time when they are already likely to have families for whom they need to provide.

65. The Armed Forces Pay Review Body periodically commissions actuaries to assess the relative value of the Armed Forces Pension Scheme against a range of measures. As part of this work, re-employment surveys are conducted to ascertain the level of income from employment which former members of the Armed Forces receive. The results of the 2000 survey found that about 40 per cent of ex-Service personnel found employment at a relatively low level of pay and that, even with the addition of the Immediate Pension payment, there was a shortfall between their civilian income and the Service pay they had received. For about 45 per cent of personnel, civilian pay exceeded Service pay. For the remaining 15 per cent, civilian salary was less than Service pay, but when Armed Force pension was taken into account, total income exceeded Service pay.[107] All personnel also receive a tax-free lump sum equivalent to three times pension on leaving the Services, and this is taken into account in the calculations. The actuaries' assessment is that the proportion of Armed Forces pension which should be treated as compensation for a short career is 50 per cent.[108]


Should the Pension Scheme be used as a manning tool?

66. Our view is that the Immediate Pension remains an important means of recognising the different status of employment in the Armed Forces. We recognise its function in ensuring that the income Service personnel receive once they leave the Services is adequate, and that they are not penalised for choosing a Service career, which cannot be a full career in most cases. We are less convinced of its value as a retention incentive, given that the Government Actuary estimates that only 10-15 per cent of other ranks remain in the Services long enough to qualify for an Immediate Pension.[109] It is a blunt management tool and the MoD needs to find incentives which work more effectively.

67. It could be argued that using the pension scheme to manage the Services' manning requirements is neither appropriate nor wholly effective. Our predecessors in the last Parliament examined the many factors which affect retention in the three Services in their report on the Policy for People.[110] The Committee urged the MoD and the Services themselves to pursue more radical and imaginative ideas to solve retention problems. They also pointed out that the needs of the three Services in terms of retaining personnel are different: in simple terms, the Army, and to a lesser extent the Royal Navy, need large numbers of young, fit people; the RAF in contrast needs to retain a significant number of the people it has expensively trained for as long as possible.[111]

68. One approach the MoD could adopt would be to cost and budget for Immediate Pensions separately, treating this element specifically as an annual compensation payment, charged to the MoD's running costs budget, rather than as part of the pension scheme, and therefore removing it altogether from the abatement calculation. The Government Actuary already excludes some benefits from costing exercises, throughout the public sector, defined as any provision for benefits initiated by the employer (such as redundancy benefits).[112] Immediate Pensions are also already treated differently to normal retirement benefits in that there is no protection from inflation until recipients reach age 55.

69. Uncoupling the IP from the pension scheme in this way would mean that it was no longer necessary to link the size of lump sum or annual payments to pension accrual rates, or the timing of such payments to a common retirement age point. This would give the three Services greater flexibility to vary the timing and structure of payments to allow each Service to tailor its terms and conditions to its needs and to adapt to changing circumstances. Removing an Immediate Pension arrangement from the pension scheme would also allow the Services to target the compensatory element of the IP on the 50 per cent or so of personnel who earn less on leaving the Services, rather than making it a universal benefit. Additional tax implications would be limited to any lump sum payment paid as part of the IP (as pensions are already taxed); this could be avoided by paying the whole IP as an annual pension.

70. We recommend that the MoD continues to examine options for removing Immediate Pensions from the Armed Forces Pension Scheme and operating them as a separate component of Service pay. The more extensive use of targeted bonuses to improve retention in shortage areas throughout the three Services should be pursued with more imagination and urgency. The net effect of these measures would be that, without the distorting effect of Immediate Pensions, greater resources would be available within the Armed Forces Pension Scheme for full career and other benefits.



71. We do not believe the MoD's review of the Armed Forces Pension Scheme has been sufficiently thorough. We welcome the improvements proposed in some areas, particularly dependants' and ill health benefits. However, we reject the MoD's view that these should be funded by reductions elsewhere in the Scheme. We challenge the assumption that the Armed Forces have a generous pension scheme. This has led the MoD to limit its options at an early stage by imposing the constraint of cost neutrality on the review process and we fundamentally disagree with this starting point. It has had the effect of stifling innovation in the whole approach to the pensions review, and what has resulted is therefore what the Minister himself described as 'a reshuffling of the pack'. We believe the Armed Forces deserve better than that.


76   Q 162 Back

77   Q 162 Back

78   Ev 48-51 Back

79   Ev 48 Back

80   Ev 49 Back

81   Ev 49 Back

82   Pension Review document, op cit, paragraph 4.19-4.20 Back

83   Ev 50 Back

84   Ev 51 Back

85   Q 76 Back

86   Q 162 Back

87   Pensions Review document, op cit, paragraph 4.14 Back

88   Ev 113, paragraph 1 Back

89   QQ 176-178 Back

90   Ev 41 and 53, Annex D Back

91   Pensions Review document, op cit, paragraphs 3.4 and 4.6 Back

92   Ev 40 Back

93   Ev 120 Back

94   Pension Review document, op cit, paragraph 4.9 Back

95   ibid, paragraphs 4.7-4.9 Back

96   HC Deb, 28 January 2002, c 16w Back

97   Ev 41 Back

98   Q 84 Back

99   Q 84; Ev 16, paragraph 5d and Ev 18, paragraph 18 Back

100   Q 84 Back

101   Armed Forces Pay Review Body, Thirty-First Report, January 2002, Cm 5361, Session 2001-02, pp 27-30 Back

102   Armed Forces Pay Review Body, Thirtieth Report, February 2001, op cit, p 16 and Thirty-First Report, January 2002, op cit, p 36 Back

103   Q 165 Back

104   HC 29-I, Session 2000-01, op cit, paragraph 88 Back

105   Pensions Review document, op cit, paragraph 4.6 Back

106   Pensions Review document, op cit, paragraphs 3.4 and paragraph 4.7 Back

107   Comparative Valuation of the Armed Forces Pension Scheme, Report to the Armed Forces Pay Review Body by the Actuary, Watson Wyatt Partners, Annex G Back

108   AFPRB, Thirtieth Report, February 2001, op cit, Appendix 4, paragraphs 4.44-4.47  Back

109   Ev 41 and 119 Back

110   Second Report, Session 2000-01, HC 29-I, op cit, paragraphs 56-130 Back

111   ibid, paragraph 161 Back

112   Ev 120 Back

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