Public Service Pensions Bill

Memorandum submitted by Mercer    (PSP 23)

Introduction

1. Mercer  is a subsidiary company of Marsh & McLennan Companies, a global professional services firm providing advice and solutions in risk, strategy and human capital. Within Mercer UK we have a dedicated and experienced Public Sector Advisory Services Team with over 250 years’ combined experience, and are one of the leading actuarial and investment advisers on the Local Government Pension Scheme (LGPS).
2. We set out below our evidence to the Bill Committee. This evidence is provided by our Public Sector Advisory Services Team. We recognise that much of the Bill is concerned with the Government’s social and financial policy, and in particular the need to contain public sector pensions costs going forward and to have provisions which properly reflect the increasing longevity of the membership. Our particular expertise, and therefore the comments below, relate primarily to the operational and funding aspects of the new schemes. In general we welcome the overall direction of the new Public Service Pension arrangements, particularly the new requirements for governance and the improved provisions for regulatory oversight. We are of the view, however, that the effectiveness of the new provisions will depend to a large extent on the detailed arrangements which are put in place, and we comment on this further below.
Governance
3. Sections 4-7 of the Bill cover the governance arrangements for the new Public Service Schemes, which contain requirements over and above those which currently apply. In particular they contain a requirement for the appointment of pensions boards with specific responsibilities under the Act. We welcome these new provisions, particularly the associated requirements for a member of the board to have adequate knowledge and understanding of the scheme concerned.
4. In relation to the LGPS, the majority of individual Funds already have a pensions committee in place, the members of which are normally councillors who are subject to re-election on a regular basis. We have experience of a large number of well-run and well-governed Funds. In our view, the distinguishing features of such funds are that they devote the appropriate amount of resource to their management and governance, they have a pensions committee of an appropriate size, ensure that the committee is sufficiently well-versed in its responsibilities, and devote time to training where appropriate. We would welcome a greater consistency of approach, to ensure that the experience and standards of the best-run Funds are shared more widely. We would hope that any new requirements should not be detrimental to this objective, and that any regime should concentrate on the establishment and monitoring of arrangements against agreed principles, rather than a prescriptive "tick-box" type approach.
Revaluation of Benefits
5. Section 8 of the Bill covers revaluation of benefits. It affords the Treasury very wide powers in setting the rate of revaluation to be applied to members’ benefits. As such, we believe that the arrangements for determining the rate of revaluation are not sufficiently transparent, and we believe it would be preferable to see the rate more closely defined either in the Act or in the supporting Regulations. We would wish to see the choice of an appropriate revaluation index which properly reflects changes in costs of living, recognising that different indices may be appropriate for different purposes. However, we are aware that the majority of the Schemes already have "Heads of Agreements" which allow for revaluation of "CPI plus a fixed margin" as the revaluation index, so we are unclear about whether or not the proposal is to unwind these Heads of Agreements in this particular respect. This is an area which we believe should be clarified.
Normal Pension Age
6. Section 9 deals with the link between Normal Pension Age (NPA) under the Public Service Pension Schemes and State Pension Age (SPA). In terms of managing life expectancy change, linking NPA to SPA a very blunt tool, and may not reflect the specifics of each Scheme concerned. SPA is affected by politics as much as financial equity, so is unlikely to be a good reflection of the effect of unanticipated changes in life expectancy within the Public Service Pension Schemes. It is possible that the overall cost control arrangements (as covered under Section 11 of the Bill) may be able to deal with any effects of unanticipated changes in longevity, to the extent that they are not already covered by changes in SPA. However, trying to include both longevity changes and changes in NPA/SPA within the cost control arrangements is likely to involve even greater effects being covered than might otherwise be envisaged. Therefore how any changes through the cost control mechanism link with changes to SPA needs to be clarified.
Cost Control Mechanism
7. Section 11 deals with the employer cost cap and the associated cost control arrangements. In principle, we welcome the introduction of these arrangements to support the sustainability of the Schemes. However, in terms of the mechanism overall, the arrangements could have unintended consequences if costs are measured over a wide spread of liabilities (pensioners, deferreds and actives), but then the effects concentrated into a much smaller group (e.g. just actives). In particular, the effects on this smaller group could be both disproportionately large and volatile. This applies particularly if past service liabilities from any of the existing public service schemes are to be covered within the cost control mechanism (and in this context the letter from the Chief Secretary to the Treasury to the Trades Union Congress on 10 October confirmed that the cost control arrangements will include pre 2014/15 past service liabilities for those who become active members under the post 2014/15 arrangements). Overall, this may not give the desired outcome for both taxpayers and scheme members.
8. In the current LGPS (and likely the other schemes), less than 50% of the liabilities relates to members who are currently active, so the proposed cost control mechanism leaves well over half of the existing liabilities outside its coverage and the tends from those liabilities will still affect employer contribution rates in individual LGPS Funds (it seems to us that there is a window of opportunity to address this at the present time). This needs to be understood and considered when dealing with the treatment of the "old" and "new" LGPS.
9. For the LGPS, the control mechanism needs to be fit for purpose and recognise its different funded and demographic nature. In particular, we support the concept, as agreed by the "LGPS Project Board" earlier this year, that remedial action should be considered whenever the variation from the employer cost cap exceeds a narrower margin (for example 1% of pay). However, the frequency of any changes needs to be monitored as regular changes in benefits or contributions will affect members’ confidence in the scheme, as well as make it impractical to administer and communicate. Any lead-in time for changes to benefits or contributions will need to be managed, so that members’ expectations for their arrangements are maintained and that they can retain confidence in the scheme going forwards.
Actuarial Valuations
10. Section 10 of the Bill refers to actuarial valuations. The wording of the Bill seems to apply this to all actuarial valuations, including the actuarial valuations of the individual LGPS Funds for the purpose of setting employer contribution rates. Whilst we have seen correspondence from the Treasury indicating that Section 10 will not be applied to such individual LGPS Fund valuations, we believe that this intent should be clarified in the wording of the Bill.
11. Section 12 of the Bill appears to include within its scrutiny coverage the actuarial valuations for the purpose of setting contribution rates under the LGPS. Whilst we would like greater clarity over the interpretation of "solvency", and "long-term cost-efficiency" our main point concerns the potential subsection 12(4), dealing with reviews of actuarial valuations. We would hope that any review process will be able to recognise the different local characteristics of each of the LGPS Funds, in particular their different maturities, investment strategies and demographic characteristics, but the form and extent of such reviews is not clear from the Bill itself.
Closure of Existing Schemes
12. Section 16 sets out provisions in relation to the closure of existing arrangements. This could be interpreted to mean that the existing arrangements will be kept separate in some way from the new schemes. Whilst we suspect that this is not the intention, we believe that the wording of the Bill should be reviewed carefully to ensure that there are no unintended consequences which arise from the wording used. For example separating the old scheme liabilities would be in effect closing that scheme with knock-on implications for investment strategy and therefore long-term costs.
Non-Scheme Benefits
13. The potential effect of Section 23 seems very wide, in that it appears to allow Public Service Employers to establish pension arrangements outside the proposed new Schemes. We would suspect that this is not the intention, but are nevertheless of the view that the purpose of this Section should be clarified as part of the ongoing discussions.

November 2012

Prepared 22nd November 2012