Phase 2 Policy Proposals Discussion Paper

The Department’s letter of 23 July promised a policy discussion paper would be circulated to LGPS interests for their comments as part of the implementation of Phase 2 of the Strategy announcement. Comments received on this paper will be carefully considered and, subject to Ministers’ Agreement, be translated into draft amending regulations for statutory consultation in early 2004 and take effect, in part, from 1 April 2005. Certain provisions will come into effect on 6 April 2005 to be commensurate with changes to overriding legislation.

It is simply not the case that the LGPS can remain as it is. The influence for change which has emerged from the current Stocktake exercise, the Government’s proposals announced in the recent Pensions White Paper, the Inland Revenue’s consultation paper and the ever-changing social and political context of pensions, in both the public and private sectors, makes some change in the LGPS inevitable.

If the LGPS is to retain its status as a funded, final salary public service pension scheme it must –

be able, through all its stakeholders, to positively adapt to ongoing changes in local government and its broader workforce framework;

respond constructively to emerging pension and related policy developments;

remain fully focused on the advantages and responsibilities arising from its statutory basis; and essentially

remain both affordable and sustainable taking account of all its stakeholders: Scheme members, employers and tax payers.

The inevitability of change within the current LGPS statutory framework has been mentioned above. There is a parallel inevitability about the whole pension context in both the public and private sectors and particularly for occupational pension schemes.

The Strategy announcement of July last is a key step to update the existing LGPS framework so that, with effect from 2005, several key steps will have been taken to ensure that Ministers’ intentions for the current Scheme are achieved.

Ministers, given their stewardship responsibilities, have frequently stated their wish to see the LGPS remain a funded, final salary, public service pension scheme. However, to achieve this, the LGPS must be regulated on the basis of fairness and affordability, and be proportionate in terms of the balance between the benefits which are provided for its members and the costs which are incurred by its providers.

The Strategy implementation phases have been designed to ensure that the LGPS will be compliant with recently announced Government policy for occupational pension schemes and strive towards that balance. At the same time, the Strategy provides a regulatory platform to take forward the longer term development of the Scheme towards the latter stages of the current decade.

In 2004, on the completion of the Stocktake’s second stage, Ministers will be well placed to consider how best to bring together all the findings of that exercise. A consultation package later in that year is planned to discuss the Scheme’s future, against the background of the Government’s White Paper proposals to allow schemes the freedom to amend members’ accrued rights, provided that the actuarial equivalent value of those rights is maintained at the point of change. The significance of these proposals is that one opinion might see LGPS accrued rights transferred to an actuarially equivalent new scheme, from a future date.

Subject to Ministers’ wishes, proposals might then be developed, in conjunction with all stakeholders, to provide a new single regime designed to meet the needs of both the current and future local government workforce. Such an approach could facilitate significant simplification of the current Scheme and, at the same time, provide a single benefit regime, free of historical complexity and multiple tiers of complex date-dependent rights.

This discussion paper sets out those changes to the current Scheme which are intended to be included in the second phase amendment package, designed to come into effect, for the most part, in 2005.

The changes currently envisaged include:-

the removal of the ‘85 year rule’ provisions for all new Scheme members;

propositions for the equitable phasing out of the ‘85 year rule’ for existing members;

increasing the earliest age at which LGPS benefits may be paid, other than on the grounds of ill-health, from 50 to 55;

the introduction of flexible retirement and incentivisation methods to encourage Scheme members to remain in employment;

to further streamline LGPS IDRP provisions in line with the amendments likely to emerge from a forthcoming Pensions Bill;

further simplification changes to the Scheme’s regulatory framework; and

a thorough assessment of the merits and demerits of options to increase the present level of employee contributions from pay to the Scheme.

The above list sets out the principal areas of potential change which Ministers, in their 23 July announcement, saw as appropriate and which, subject to the outcome of this exercise and subsequent statutory consultation processes next Spring, would take effect within the current LGPS framework from April 2005. Paragraphs 51-59 outline some other issues on which the views of consultees are also invited.

Each area of change is discussed below against the background, where appropriate, of Government policy and within a LGPS context of change. All references are to regulations in the extant Scheme regulations – the Local Government Pension Scheme Regulations 1997 as amended. Consultees are invited to comment on the questions raised and on the overall thrust of the package of measures which, collectively, are aimed at introducing several immediate, beneficial and cost effective changes to the Scheme, as well as providing a stronger basis for any future, longer term reforms.

Chapter 4 of the White Paper, Simplicity, security and choice; Working and saving for retirement: Action on occupational pensions (Cm 5835), sets out the Government’s intention to raise the normal pension age in public service pension schemes to 65. The Government indicated its intention to proceed with this proposal through reviews of public service pension schemes and in consultation with employers and employer representatives. The White Paper also indicated that by no later than 2006, all new staff in public sector pension schemes will join on the new conditions.

At present the LGPS already has a normal retirement age of 65 for members who joined the Scheme after 31 March 1998. However, certain other members have a normal retirement date between age 60 and 65. Further, regulation 31 provides that members can retire before attaining age 65 with unreduced benefits provided that their age and length of membership satisfy what is commonly known as the "85 year rule".

Therefore, to align the LGPS with the Government’s policy proposals, amendments to the current regulations are required. These could be drafted to provide that no person who, in any relevant employment, becomes an active member of the Scheme after the date of the amendment will be entitled to the payment of unreduced LGPS benefits in relation to that period of membership before age 65. Where benefits are paid early due to retirement on grounds of ill-health or, subject to consultation, redundancy, they will continue to be paid on an unreduced basis.

The Government’s proposals require amendments to public service schemes, such as the LGPS, to apply to all new staff by no later than 2006. However, given the views of several LGPS stakeholders – including the Employers’ Organisation for Local Government in its response to the Retirement Benefit Package Options Discussion Paper (published by the Department on 9 September 2002) – it is currently proposed to introduce this change with effect from 6 April 2005.

In its White Paper, the Government announced plans to rationalise the rules governing the way occupational schemes communicate with members; to streamline the procedure for dealing with disputes between trustees, managers and scheme members or beneficiaries, and to clarify the existing jurisdiction of the Pensions Ombudsman so that cases of maladministration by an occupational or personal pension scheme fall clearly within his remit. It is possible that simplified arrangements for IDRP will feature in a forthcoming Pensions Bill with the expectation that new arrangements could come into force in 2005, or 2006.

Since they were introduced in April 1997, the Internal Dispute Resolution Procedure (IDRP) provisions of the Scheme have been reviewed several times. In 2002, the Department embarked on a series of consultation papers on different aspects of these arrangements but, following the publication of Alan Pickering’s report "A Simpler Way to Better Pensions – An Independent Report" published in July 2002, the decision was taken to suspend action until after the Government had reached a conclusion on the recommendation to simplify the present arrangements.

In the meantime, and in light of the responses to the Department’s own internal review in 2002, it is intended that amending regulations should come into force early in 2004 to streamline the present LGPS arrangements within the confines already laid down by the Pensions Act 1995. On this basis, there is no option other than to retain the existing two stage process in the short-term but there is nothing in the primary or secondary legislation that would prevent local government becoming responsible for both stages. This would place the LGPS in the position already intended by the Pensions Act 1995 with the consideration and determination of both Stage 1 and 2 cases being the responsibility of the sponsoring body itself, with no external referral. The transfer of Stage 2 from the Department to local government would also ease the transition to the simplified, single stage process envisaged by the Government’ Pensions Green Paper.

Detailed proposals for amendments in 2005 will need to be developed to ensure the LGPS is aligned with legislative changes in the forthcoming Pensions Bill. In the meantime, consultees may wish to comment on the matters raised above.

Currently in the LGPS, the employee contribution rate is 6% of pensionable pay, although certain Scheme members pay 5% because of transitional arrangements for manual workers who were members of the Scheme prior to 1997.

As part of the inexorable increase over the past decade, and more, in pension scheme costs, the Employers’ Organisation, individual local authority LGPS employers and professional bodies have identified a case for employees to pay more for their pension benefits and so contribute more towards the costs of their provision. Key drivers in this argument are the recent decline in the value of equities and revised actuarial assumptions for improved longevity, as well as increasingly adverse press coverage when comparisons are made with recent experiences in private sector occupational schemes.

Historical analysis by an independent actuarial practice, specialising in the LGPS, has shown that although most members now contribute at 6% of pay, their share of the cost has fallen to around 30%. They comment that contributions would have to rise to between 7% and 8% of pay to give the same share of the cost as achieved in 1926. Actuarial estimates submitted during the Stocktake process indicate that the average employer contribution for future LGPS provision is some 12% and the 2001 actuarial valuation exercise produced an average figure of 13% in England and Wales.

In response to numerous discussions and seminars with interested parties and comments made on the October 2002 Stocktake discussion paper on retirement benefit package options for the future, a range of possible scenarios have been put to the Department. The range also allows for several permutations – in brief, they are:

increase the employee contribution rate for new Scheme members only by 1% of pensionable pay to reflect particularly the increased longevity of this new group of members;

increase the employee contribution rate for all Scheme members by an additional 1% of pensionable pay to reflect the increased longevity of members and the past service costs;

increase the employee contribution rate for all members by 2% to restore the balance of costs, based upon a 40:60 balance between employee and employer, that was extant when the Scheme commenced and to meet other cost-inducing factors normally met by employers;

amend the benefits package to restore the balance of costs between employees and employers or, in changing it by means of specific improvements, to add in much sought after items, for example, pensions for partners or improved death in service terms; and

introduce a more flexible and salary linked contribution tariff so that, for example, full time employees earning a prescribed salary, or above, would pay 6% plus a further amount. Proposals in the Stocktake exercise have involved lower contributions for lower benefits.

There are other aspects to consider at a more local level in taking into account aspects of equity, affordability and fairness. Is there, for example, scope for a more localised approach to pension cost provision with employers in the local authority sector having powers to vary employee contributions, within a tariff framework, given prescribed circumstances?

In these options, and others, there are merits and demerits. Consultees are asked to carefully consider each of the options, as well as the principle of such a step to be set against other policies, already endorsed by the Government, the Employers’ Organisation for Local Government and the TUC, to maximise Scheme take-up as part of an emerging policy to develop the attractiveness of the Scheme, especially among new employees but also to improve membership levels generally.

Consultees, in preparing their responses, will no doubt wish to consider carefully the current context surrounding pension provision in the public sector and to take account of the concerns being expressed, in some quarters, about employers’ present and future affordability of pension provision. It is important, therefore, when weighing up issues of affordability and potential cost transference in the balance of each schemes’ provision, to itemise the specific employer and other costs of each public service pension scheme in order to identify the real impact each has on employers and then tax payers.

The Employers’ Organisation for Local Government have made representations to the Department that, alongside changes to the minimum benefit and normal retirement ages within the LGPS, consideration be given to amending the redundancy provisions of the Scheme. They have requested that consideration be now given to provide that no automatic payment of unreduced LGPS benefits arises where a member who has attained age 55 retires from employment on redundancy grounds. Rather, they consider that benefits payable on redundancy grounds prior to age 65 should be payable at the employee’s choice and subject to actuarial reduction, with the option for the employer to waive or reduce the actuarial reduction. Amendments could require that the cost of waiving any reduction would be met by a capital payment to the fund by the relevant employer.

Regulation 26 currently provides that where a member who is aged 50, or more, retires from a local government employment and his employing authority certify that the reason for his retirement was his redundancy, unreduced LGPS benefits are payable immediately. Government policy is that future public service pension benefits should not normally become payable before age 65, unless they are actuarially reduced.

Consultees are invited to comment on the proposition that the Scheme should now be amended to provide that LGPS benefits arising from future membership of the Scheme will not be automatically paid unreduced where employment ceases on grounds of redundancy and prior to the member attaining age 65, unless the relevant employer determines that the reduction be waived.

Consultees may also wish to consider whether a locally determined approach to policy on the waiving of actuarial reductions is preferred. The regulations could, for example, introduce a requirement for each employer to produce a policy statement concerning their exercise of any discretion to waive an actuarial reduction where benefits become payable on redundancy grounds. Alternatively, guidelines could be produced, either by the Department or other authoritative body, which employers would be required to have regard to in considering whether to waive an actuarial reduction.

In this context views are also invited on the scope of any desired changes to the Local Government (Early Termination of Employment)(Discretionary Compensation) Regulations 2000.

The scope of the Stocktake exercise did not include any specific examination of the provisions contained in the Local Government (Early Termination of Employment)(Discretionary Compensation) Regulations 2000. In due course it will be necessary to ensure that any changes to the LGPS which impact on these provisions are taken into account. A number of issues discussed above and other external influences now highlight the need for interested parties to comment further, as necessary, on any desired changes to the 1996 Regulations. Interested parties views would be welcomed.