The wider Government policy is to encourage adequate saving for retirement and thus an outcome of this review could be to quantify an adequate retirement income and the inter-relationship with the State pension and means tested benefits.  The quantification of adequate savings and benefits in the public sector can set a benchmark for the private sector. The interaction with means tested benefits and support for care costs are important long term inter-relationships. The GMPF Management Panel does not believe pensions should be levelled down to the lowest common scheme, that would give short term savings but potential long term costs for the State.

Affordability in the context of pensions is not an easy concept because of the uncertainty of cost in defined benefit schemes and the uncertainty of benefits in defined contribution schemes.

The GMPF Management Panel continue to be supporters of defined benefit pensions because of the likelihood of delivering better pensions at lower cost v defined contribution options.

The advantages of defined benefit schemes in the long term are:

1. lower costs re administration and investment management (the administration and investment costs of running GMPF are currently around 0.1% p.a. of Fund value);
   
   
2. the scope for an investment strategy to deliver better returns on a defined benefit basis (where the employer covenant is strong) compared to defined contribution schemes where the decisions tend to be more cautious.

The table below was produced by our actuary (Hymans Robertson) to demonstrate the sensitivity of cost to the real discount rate (or projected investment returns) for a typical LGPS fund.

Table 5 – Sensitivity of Scheme Cost to Investment Returns/Discount Rate

Notes:

1. The total contribution rate comprises both employee and employer contribution rates to meet the costs of future service.  It does not include any provision for deficit recovery.
   
   
2. There is no allowance for expenses.
   
   
3. Pay is assumed to increase by 1.5% more than inflation.

Thus there is a 2%-3% reduction in cost for each 0.5% increase in the net discount rate.

The above illustrates the impact on affordability to the employer of the change in calculating inflation from RPI to CPI. The impact is to reduce the future service rate by around 2.5% as illustrated above and improve funding positions.

At the higher rates of investment return, the cost of the Scheme is likely to be perceived to be affordable. However there are no assets that guarantee such levels of return and thus the concerns arise if returns are materially lower, costs increase and deficits grow.

There are a number of other factors that can also lead to volatility of costs.  These include:

1. increased life expectancy/spending longer on pension;
   
   
2. pay increases in particularly with final salary.

Our actuary has also undertaken some calculations analysing the cost of the LGPS and the impact of making changes to the benefit structure. These analyses are of course very sensitive to the underlying assumptions, but highlight the significance of core benefits.

Table 5 – LGPS Current Contribution Rate Structure (assuming 2.8% real return)

Note:

1. The proportion of the split above would remain relatively unchanged under a Career Average Revalued Earnings basis.
   
   
2. The bulk of the costs relate to the build up of core benefits arising at retirement from active or deferred status.

The Actuary then looked at the implication of changing some elements of the benefit structure.  The outcomes are summarised below in Table 6.  Again the underlying assumptions are very important but they provide a good indication of the scale of impact.

Table 6 – Impact of changes in benefit structure

Notes:

1. This is very sensitive to the assumptions on the types of ill health retirement, the saving above is likely to be at the lower end of expected savings.
   
   
2. Increasing retirement age by 1 year would be expected to reduce liabilities by about 5% and give significant cost savings.  However the potential benefits to contribution rate are offset by higher ill-health costs and potentially less commutation savings under the current structure.

The conclusions from the costing analysis are:

1. it is important that the benefits provided are valued by employees and employers. What needs should public sector pensions meet in terms of their level and flexibility?
   
   
2. the bulk of benefits (and costs) are determined by the rate of accrual of benefits;
   
   
3. the cost of the benefit package can be changed by altering the rate of accrual, changing the retirement age, changing the cost to employees;
   
   
4. in the current environment, the consequences of increasing employee contributions needs to be carefully assessed and in particular the likely impact on Scheme membership of any such change.

You can also view each chapter using the links to the left of this page

Next Page

Back