April Fool’s Day - no joke for public service pension schemes
Steve Simkins, Head of Public Services at Isio
It would’ve been easily spotted as an April Fool if, on the morning of 1 April 2015, public service pension reforms were announced as being delayed by seven years. Little did we know that it would turn out to be the case. With effect from today, around five million people in the UK are reinstated into their old public service pension scheme for seven more years, with a commitment that they will not be worse off if it turns out the new scheme is actually better.
There were some who had their doubts about those within ten years of retirement being protected from change, including Lord Hutton who had made the recommendation to move to new career average schemes for all members. The McCloud age discrimination judgement sealed it and the government was forced to start again seven years later. But this time there are seven messy years to clean up too.
It’s one of several changes taking place today which move the goalposts on the defined benefit schemes of well over six million public service workers, including university staff in the Universities Superannuation Scheme (USS).
Whilst members of the public service schemes (NHS, Teachers, Police etc) are better off because of McCloud, around 200,000 active members of the USS will start to earn lower defined benefits from today. Benefits have been reduced, rather than contributions increased, because members are already leaving due to the challenge of paying a 9.8% contribution and red-brick university employers face affordability issues. This helps members in the short-term given the ever-increasing cost of living, but on the other hand a key part of the benefit changes is a new 2.5% cap on the increase of future benefits in each year, which is tough to swallow in a year when CPI might be 8% or higher.
The changes collide in the Higher Education sector. Whilst USS academics are expecting significant reductions in retirement benefits, academics in new post-92 universities are in the Teachers’ Pension Scheme (TPS). This means that they will benefit from the McCloud seven-year boost and are protected by the government’s 25 year promise not to reform the TPS which still has another 15 years left to run.
The icing on the cake for post-92 academics (and all public service members) is that they continue to receive full CPI protection on all their benefits. In short, 8% CPI this September would mean 8% pension increases next April. This is great for members, but not fully appreciated. And, of course, it comes at a cost which puts the 25-year promise under some pressure.
The USS is a trust-based scheme falling under watch of the Pensions Regulator whose prudent regime is contributing to the funding challenges leading to the benefit reductions. The Local Government Pension Scheme (LGPS) on the other doesn’t have these constraints. And this leads on to the other 1 April 2022 event – the LGPS actuarial valuation.
Whilst nothing actually changes on 1 April 2022, a snapshot of the market is taken which feeds into new contributions for all LGPS employers from 1 April 2023. Unlike the USS, LGPS benefits and member contributions are set in stone and so the only available lever is employer contributions.
Investment markets are still riding high, but challenging future economic conditions create uncertainty for employers. On the face of it high asset values are good news, but the cost of benefits is also much higher because of the inflation protection afforded to members. On balance, we think that prudence will have to be taken out of assumptions to balance the books meaning higher employer contributions or a greater reliance on the future. Employers should engage with their LGPS funds to manage these risks.
There is a lot of change, but public service pensions stubbornly remain defined benefit, perpetuating the two-tier pensions system in the UK. Auto-enrolment has hugely increased pension savings in the private sector, but there is a value gulf between these defined contribution schemes and their public service counterparts.
So, what next for public service pensions? It should be seven years of plenty, but it is not that simple. For example, McCloud is so complicated it will confuse and mislead many members. Also, the value of the very generous inflation protection needs to be clearly communicated to make sure the scheme provides value for money. Finally, the schemes need to be made more flexible to meet the needs of members and employers.
1 April 2022 is a day of change, but many more changes are required to make these very good schemes as effective as possible.