PARTIAL REGULATORY IMPACT ASSESSMENT (RIA)

Title of Proposal

1.             To consider measures for ensuring the ongoing solvency of the Local Government Pension Scheme (LGPS) following the revocation of the Local Government Pension Scheme (Amendment) (No.2) Regulations 2004 and the reinstatement of the 85 year rule in the LGPS.

Purpose and Intended Effect of Measure

Objective

2.             Following the revocation of the Local Government Pension Scheme (Amendment) (No.2) Regulations 2004 the Deputy Prime Minister (DPM) invited representatives of the local government employers' and trades unions, in July 2005, to develop realistic and costed measures by the autumn, to fully meet the identified costs arising from the decision to revoke. The purpose of this Regulatory Impact Assessment is to consider the options for meeting the cost pressures.

Background

3.             The Local Government Pension Scheme (Amendment) (No.2) Regulations were introduced in December 2004 and came into effect on 1 April 2005. They made two changes to the Scheme. The first ensured that the earliest age at which a pension could be paid, other than on grounds of ill-health, was increased from 50-55. The second phased out from the Scheme the rights of eligible members, who joined the Scheme before age 35-40, to receive an unreduced pension if they choose to retire before age 65. The LGPS already has a normal retirement age of 65. Transitional protection applied to Scheme members who were already 50 by 31 March 2005, and also to those who would reach their 60^th birthday by 31 March 2013, with at least 25 years membership.

4.             The Secretary of State, by means of the Local Government Pension Scheme Regulations 1997, requires local authority pension funds to carry out actuarial valuations every three years. The Amendment No.2 Regulations 2004 were introduced to ensure the Scheme complied with the Government's policy for a normal retirement age of 65 in public sector schemes and to positively influence the outcomes for employers of the expected increases in their contributions to arise from the 2004 valuation.

5.             However, following the laying of the Amendment No.2 Regulations in December 2004, significant concerns were expressed by Members of Parliament, trades unions and scheme members. The DPM issued a statement on 18 March 2005 that he was minded to revoke the Local Government Pension Scheme (Amendment) (No.2) Regulations 2004, subject to statutory consultation, and with retrospective effect to 1 April 2005. The statement also announced that the DPM was establishing a Tripartite Committee, with key stakeholders, to consider what measures should be put in place to ensure the Scheme's affordability and sustainability for the longer term

6.             Statutory consultation began on 1 April on draft proposed amending regulations which would have the effect of revoking the Amendment No.2 Regulations 2004, which themselves came into force that day. It was made clear, as part of the consultation material, that no new money from government or local authorities would be made available and that any savings foregone if revocation occurred would need to be found by other means.

7.             The consultation closed on 31 May and the responses received were then considered. On 13 July a statement was made to the Houses of Parliament that the Amendment No.2 Regulations 2004 would be revoked with retrospective effect to 1 April. The Local Government Pension Scheme (Amendment) Regulations 2005 to achieve revocation were laid the same day and came into effect on 3 August 2005.

8.             To fulfil his commitment that the costs of revocation would not fall on the taxpayer, representatives of the local government employers and trades unions were invited to develop realistic and costed measures by the autumn, to fully meet the identified costs arising from the decision to revoke. The framework provided by the LGPS Tripartite Committee would ensure effective and co-ordinated progress of the development of the Scheme.

9.             To assist in that process and as a measure to ensure the continued stability of the Scheme, an amendment was also made by the Local Government Pension Scheme (Amendment) Regulations 2005 to provide each LGPS administering authority with the vires to request an interim valuation of their pension fund, as at 31 March 2005, so as to properly identify cost pressures resulting from the revocation.

10.         Local Authorities are required, by the Local Government Pension Scheme Regulations 1997, to publish and maintain a Funding Strategy Statement. In light of the decision to reinstate the 85 year rule in the Scheme. Appropriate changes could be made to the pension funds' deficit recovery periods which could subsequently be taken into account by actuaries in the relevant actuarial cycle.

Meeting costs and the 85 year rule

11.         The 85 year rule is a special provision within the LGPS which allows Scheme members to retire on a full pension, before the normal scheme retirement age of 65. Scheme members, aged 60 or over, can choose to retire on an unreduced pension where their age plus years of service equals 85 years. Scheme members aged 50 to 60, who also satisfy the rule, can retire with their employers consent.

12.         The Council Directive 2000/78/EC establishes a general framework for equal treatment in employment and occupation. To comply with the Directive, the Department of Trade and Industry consulted on draft Employment Equality (Age) Regulations 2006. The consultation finished on 17 October and the regulations will come into force from 1 October 2006.

13.         The Government has concluded that under this legislation the 85 year rule would be considered age discriminatory and therefore must be removed from the Scheme no later than 1 October 2006. This is because the 85 year rule takes the sum of the member's age and pensionable service to determine eligibility to pension benefit. If a member does not have sufficient age and pensionable service, they are not eligible for the benefit.

14.         The following example may help: The members must be in comparable situations but for their age; one is 61 and the other 63; they both have 22 years service and wish to retire; the 63 year old would have no actuarial reduction in their pension as they satisfied the 85 year rule, whereas the 61 year old would have an actuarial reduction. The reason for the different pension entitlement is on the basis of age; therefore the rule is age discriminatory.

15.         It may be possible to objectively justify the retention of the rule for Scheme members who are close to retirement, as it would not be easily possible for them to make alternative arrangements so close to their retirement.

16.         Confirmation that the 85 year rule must be removed from the Scheme, by no later than 1 October 2006 will assist the Stakeholders in determining what the cost pressures are arising from the revocation, and how they should be met. 

Transitional Protections

17.         Consideration will need to be given to the cost of providing transitional protections for existing Scheme members close to retirement.

18.         Transitional protections were originally provided in the Amendment No.2 Regulations 2004, for all Scheme members who would be aged 60, with 25 years service by 31 March 2013.

19.         Had these protections not been provided then there would have been an additional saving of just over 0.5% of pensionable payroll, or £125 million, per year, for the 8 years - 2005 to 2013.^[1]

20.         So long as the cost of any transitional protections are no more expensive than those under the Amendment No2 Regulations 2004, then there should be no additional cost needing to be taken into account

Rationale for government intervention

21.         The Secretary of State is responsible for the policy development and overall regulatory stewardship of the Scheme in England and Wales and, using the powers under the Superannuation Act 1972, sets the statutory framework within secondary legislation for the management, investment and administration of the Scheme.

22.         It is generally understood, it being the Government's stated policy since July 2003 in respect of the LGPS, that one of the reasons the Scheme was initially amended on 1 April 2005 (by the LGPS (Amendment) (No.2) Regulations 2004) was to assist in reducing employers' cost pressures and to mitigate the anticipated rate of employers' contribution increases as a result of the 2004 valuations. At that time, the "savings" were estimated between £200-400 million per annum.

23.         Following an updated assessment of the LGPS 2004 valuation reports the Government Actuary's Department (GAD) concluded that the costs across all LGPS employers was about £400 million in 2005/06. For local authorities, i.e. those employers with precepting/revenue raising powers, a broad estimate suggests that their costs for 2005/06 fall in the range of £300-350 million.

24.         Revocation of the Amendment No.2 Regulations 2004 means that the cost pressures the changes were intended to relieve remain to be faced. For there to be no additional costs from the revocation falling on government, local authorities or taxpayers, the government must introduce further regulations dealing with these cost pressures to ensure the ongoing solvency of the Scheme and to provide certainty for local authorities' finances generally.

25.         Ministers are committed to providing stable and attractive benefits to current and future Scheme members. It is imperative, therefore, for the Scheme's affordability and sustainability that the effects of revocation are managed prudently, and so help to ensure its ongoing solvency.

26.         Representatives of the local authority employers and trades unions were invited to come forward with proposals to fully meet the cost pressures arising from the decision to revoke, to allow all parties to give further consideration to the issues facing the LGPS.

27.         However, it was made clear that if the employers and the unions were unable to agree a fully costed proposal for the way forward, then a decision would still be required on what amendments were necessary to ensure the Scheme's viability and effect on taxpayers.

Consultation

Within government

28.         Government Actuary's Department
Scottish Public Pensions Agency
HM Treasury

Public consultation

29.         Local Government Association (LGA)
Employers' Organisation and through it other Scheme employers
Local Authorities in England and Wales
Association of Consulting Actuaries (ACA)
UNISON
GMB
Amicus
Transport and General Workers Union (TGWU)
Union of Construction, Allied Trades and Technicians (UCATT)
National Association of Probation Officers (NAPO)
Community and Youth Workers Union (CYWU)

Information to assist in the development of proposals

30.         There were four discrete, but linked events, programmed to assist in meeting the objective of providing properly costed proposals:

            a)         LGPS funds to provide funding updates by 30 September 2005;

            b)         data gathering exercise organised by the Employers' Organisation to                      consider the relationship between the retirement age of members in              the Scheme and satisfying the rule of 85

            c)         commissioning by ODPM of an actuarial longevity study of the LGPS                     in England and Wales; and

            d)         administering authorities agreeing to provide copies of the 2004                              valuation reports to trades unions and their actuarial advisor.

Powers to allow an interim actuarial valuation of funds

31.         The issues surrounding the estimates of the cost of revocation are complex and depend upon a range of assumptions being applied to cover a wide variety of individual Scheme member's circumstances, including their retirement decisions, socio-economic factors, and even their health.

32.         The interim actuarial valuation of funds in England and Wales identified the one year cost of revoking the 85 year rule as £435 million for 2005/06.

33.         After making an allowance for the possible beneficial effect of late retirees, the Government Actuary's Department (GAD) and the actuaries advising the LGA and its constituent employers, suggested a reasonable range for the likely total cost of revocation would be between 80-90% of the total £435 million cost. In monetary terms this is around £340-390 million^[2], of which £280-315 is estimated to relate only to local authorities in the Scheme in England and Wales.

34.         If the 85 year rule is not removed until 1 October 2006, then the cost of revocation, for the 18 month period 1 April 2005 to 1 October 2006, based on the same assumptions as above, is in the range of £520-590 million.

35.         A further option is if the 85 year rule is removed for new members from April 2006 and for existing Scheme members as at 31 March 2006, from 1 October 2006. Advice from GAD is that this would reduce liabilities in 2006/07 by £5-10 million. However, savings would be very dependent on turnover and the number/profile of new joiners.

36.         The trades unions believe the total Scheme cost of revocation, for local authorities, falls between £225-275 million.

37.         In light of the government's commitment that the cost of revocation should not fall on central government or the council tax payer, and that regulations to meet the cost pressures would be forthcoming, many local authorities decided not to commission a revised rates and adjustments certificate at this time, and to maintain their existing levels of employer contribution rates.

Data gathering exercise organised by the Employers' Organisation (EO)

38.         The EO gathered information from local authorities on:

a) the average age of retirement of all LGPS pensioners broken down by employer type and gender (male/female)

b) the average retirement age of all LGPS pensioners retiring in the year to 31^st March 2005 broken down by employer type and gender (male/female)

c) the average pension for all LGPS pensioners broken down by employer type, by gender (male/female), and by type of pension

d) the average pension, and the average service and average pay on which the pensions were calculated, for all pensioners retiring in the year to 31^st March 2005 broken down by employer type, by gender (male/female), and by type of pension.

39.         Detailed scheme data was passed from the EO to the unions on 23 September. An updated version was then sent on 29 September.

40.         It was not possible for data to be gathered on the amount of time employees worked past their Earliest Retirement Age^[3] as this date was not calculated and stored by the computer programme software used.

Commissioning of the demographic study of the LGPS in England and Wales

41.         The actuarial firm Hymans Robertson LLP was commissioned to produce an actuarial longevity study of the LGPS in England and Wales. Their report, Local Government Pension Scheme in England and Wales: Review of Demographic Patterns, September 2005, was based on terms of reference and key questions agreed between ODPM, the Employers' Organisation and the trades unions at the second Tripartite Committee on 30 June 2005.

42.         The principal purpose of the report was to provide all the Tripartite Committee Stakeholders with statistical information on the demographics of the scheme membership. This covered three broad areas:

                        a) the profile of employee members and pensions in payment,

                        b) the retirement behaviour of employees, and

                        c) the mortality experience of pensions in payment.

43.         In summary the main findings of the report were as follows:

w That the membership of the LGPS had changed significantly both since the Scheme was originally implemented in 1922, and when the existing benefit structure was introduced in the early 1970's. This had become particularly apparent since all part-timers were allowed to join in 1993.

w 72% of the current employee membership is female, with 57% of female workers working part-time. Almost half the employee members work part-time.

w  75% of pensions in payment are less than £5,000 a year. Women tend to be in receipt of lower pensions than men, primarily due to shorter service and lower pay.

w  For members retiring in the LGPS between 2001 and 2004, almost 90% of men and two-thirds of women would have been able to retire on an unreduced pension at age 60, under the 85 year rule - their Earliest Retirement Age (ERA).

w Women's ERAs are generally later than men's, due to their joining later than average.

w  Around 15% of all retirements are Scheme members who have worked past their ERA. These are known as 'late' retirements. Of these late retirements, men are more likely to continue in employment beyond their ERA than women. The average period of working late was around three years for both men and women. 

w Individuals with larger pensions tend to retire sooner than those with smaller pensions, often on redundancy grounds or in the interests of efficiency. 

w Life expectancy at birth is increasing, but is not directly relevant in the context of pension scheme funding, where the expectation of life from retirement age is most important.

w Statistics confirmed that the UK population generally, and the LGPS population specifically, are showing reductions in mortality rates, implying material increases in the average period that pensions are in payment, compared to when the scheme rules were devised..

w For men retiring at 65, based simply on population mortality, the average period that a pension is expected to be in payment has risen from 12.2 years to 16.0 years since the early 1970's, an increase of some 31%. For women, the rise is from 16.1 years to 19.0 years, a rise of some 18%.

w Pensioners who retire from the LGPS in normal health would be expected, on average, to live around 2 to 4 years longer than pensioners in the population as a whole.

44.         In conclusion Hymans summarised that there appeared to be a strong case for the benefit structure evolving, just as the population that it is designed to cater for is evolving. Increased longevity and a substantially increasing pensioner population (compared to working population) means retaining older workers in employment would become increasingly important.

45.         Hymans report also provided further justification for the removal of the 85 year rule on discrimination grounds, as it showed that the rule is indirectly discriminatory towards women. This is because although they make up the majority of the workforce, on average, they have less service in local government than men, as a result of joining later if life, and therefore are less likely to be in a position to benefit from the rule.

Administering authorities provide copies of 2004 actuarial valuation reports

46.         A first batch of these reports was passed to the trades unions, by the EO, in July 2005. A further batch, making a complete set, was handed over by the EO in September for analysis.

47.         In addition to this the trades unions requested information direct from Local Authorities under the Freedom of Information Act 2000.

Options

48.         Three options have been identified:

A)     Do nothing

B)     Increase tax-free lump sum

C)    Increase employee contributions

Option A - Do nothing

49.         It was made clear, as part of the consultation material on regulations to revoke the Amendment No.2 Regulations 2004, that any savings foregone through revocation would need to be found by other means. No new money from government or local authorities would be made available.

50.         As the Amendment Regulations 2005 allowed for the taking place of interim valuations, it could be the case that the revised certificate will show that due to investments performing better than expected, the suspected cost of revocation has been mitigated.

51.         However, relying on the increased performance of investments would not be prudent, as investments can go down as well as up and any improvements in investments could easily be offset by a reduction in bond yields, or vice versa.

52.         Furthermore, the Government made a clear commitment to Parliament that further regulations will be introduced to ensure the cost pressures arising from the revocation are met. Relying on increased performance of investments would not ensure the costs have been met in the long term, and therefore would not meet the Government's commitment to Parliament.

Option B - Increase tax-free lump sum

53.         Scheme members currently receive 3 times the amount of their final pension as a tax-free lump sum when they retire.

54.         From 6 April 2006, HM Revenue and Customs (HMRC) tax simplification will permit Scheme members to take up to 25% of the capital value of the pension as a tax-free lump sum, when they retire.^[4]

55.         Where Scheme members chose to take more, any increase, above the three times amount currently provided for, would be paid for by the Scheme member commuting part of their final pension, e.g. swapping pension for tax-free cash at a commutation rate of 12:1. This means for every £1 of pension foregone they would receive £12 tax-free cash.

56.         This could be popular with members and at the same time reduce employers' liabilities. The attached spouse's pension would be unaffected as only part of the member's pension would be surrendered.

Option C - Increase employee contributions

57.         Scheme members, post 1998, currently pay a 6% contribution towards their pension fund. A small number of manual workers who were members of the Scheme prior to 1988 pay 5%.

58.         One option for meeting the cost pressures arising from the Scheme is to increase all Scheme member contributions by 1%.

59.         This could have a knock-on effect of increased pay demands from local government workers, possibly discourage Scheme membership take-up (particularly the part-time) and possibly lead to existing members opting out.

Alternative options considered

Binding pay deals

60.         This would prevent high pay increases which place pressure on the pension fund. A variation of this would be the option to control or reduce the amount of pay which is pensionable. Pay rises could also be negotiated separately from pensionable pay rises, so that, for example, pensionable pay might rise each year by 1% less than actual pay.

61.         The impact of introducing binding pay restraints, or a variation thereof, would depend on when this was introduced and for how long. It is almost inevitable that there would be catch-up in the future and so any saving would be unlikely to be realised in the long term, although future catch-up could not be backdated.

62.         This option was rejected as the potential long term benefits could not be guaranteed.

Move to Career Average Re-valued Earnings (CARE) Scheme

63.         A CARE scheme could help control future cost volatility and can be designed to deliver broadly the same expected employer cost as a final salary scheme, but with a lower member contribution rate. The saving arises from the difference in the expected rate or revaluation of each year's benefits. This could be more attractive than final salary designs to those with modest pay growth expectations.

64.         One possible variation on this option is that CARE could be offered as the default options for certain groups of staff e.g. part-timers or those whose earnings were below a certain level. All members could be allowed to opt into the other design (i.e. from CARE to final salary and vice versa) at the start of their career and possibly at points in the future (for subsequent benefit accrual).

65.         A CARE scheme would reduce the risk of future cost volatility due to pay settlements and is potentially cheaper to administer in the long term. It could provide better pension for low paid/part-time workers and more accurately reflect the needs of the local government workforce (as identified in the Review of Demographic Patterns report, by Hymans Robertson). It is not known what accrual and revaluation rates would be acceptable to trades unions. It could also exacerbate work place tensions as it would require a cultural shift from the perceived "gold standard" of the final salary pension Scheme.

66.         This option was rejected as it would require a major change to the Scheme which would not be possible by the autumn. It is likely to be considered further in discussions on the long term reform of the Scheme.

Change to ill-health/early retirement packages

67.         Current practice permits local authorities to enhance a Scheme member's pension, up to a maximum 40 years, where they retire early or under ill-health grounds. Savings could be achieved by amending the amount local authorities can enhance by, or criteria by which they set their standard. This could result in better pension provision for those permanently retired on ill-health grounds

68.         For ill-health retirements, a two tier system could be introduced for Scheme members who are able to work again but not necessarily in their previous local government post. This could reduce instances of Scheme members retiring on ill-health grounds and then returning to work in another area (not local government) whilst still receiving a full occupational pension from local government. It would also reduce the long term liabilities facing the Scheme by reducing the number of fully enhanced ill-health/early retirement cases.

69.         This option was rejected as it would require a major change to the Scheme which would not be possible by the autumn. It is likely to be considered further in discussions on the long term reform of the Scheme.

Incentives to remain in employment

70.         The later members delay their retirement beyond the earliest age from which they can take their benefits unreduced (and as of right), the greater the cost saving to the Scheme. Care would be needed in designing the benefits being offered to members to delay their retirement, so they do not fall under the preservation requirements or fall foul of age discrimination.

71.         The wider picture also needs to be taken into account. Encouraging scheme members to remain in employment will become increasingly important as the ratio of working age population to pensioner population decreases in the coming years (as identified in the Review of Demographic Patterns report, by Hymans Robertson).

72.         This option was rejected as it would require a major change to the Scheme which would not be possible by the autumn. It is likely to be considered further in discussions on the long term reform of the Scheme.

Costs and Benefits

Sectors and groups affected

73.         There are currently 1.5 million active Scheme members who could be affected by any amendments to the LGPS benefit structure.

Race equality assessment

74.         There are no race equality issues concerning our proposals

Health impact assessment

75.         The Normal Retirement Age for the LGPS is 65. However, the 85 year rule enables Scheme members satisfying the rule to retire on an unreduced pension from age 60, or from age 50 with employer's consent. The trades unions and some actuaries have expressed concern that there may be more instances of ill-health retirement if the 85 year rule is removed from the Scheme and local employees have to work longer. No evidence has been supplied, at this stage, to support this opinion. If the 85 year rule is removed from the Scheme any increase in ill-health retirements will become apparent at the tri-annual actuarial valuations of the funds.

76.         It is intended that flexible retirement provisions, as introduced by Finance Act 2004, which will be permissible from 6 April 2006 may mitigate this risk. Flexible retirement, will allow Scheme members to continue working at reduced hours/grade, and accruing pension benefit whilst starting to draw part of their pension. This will remove the current cliff edge where a Scheme member retires from work overnight.

Rural considerations

77.         In their report, Review of Demographic Patterns (as referred to in paragraphs 41 to 45), Hymans Robertson looked at longevity figures in the LGPS and analysed the mortality experience for their England and Wales LGPS client funds over the three years from 2001-2004. A subset of the pensioner data they considered, for officers retiring other than through ill-health, related to regional variation.

78.         The results of this analysis showed that the North-South^[5] gap in mortality figures was slightly less pronounced than Urban-Rural^[6] differences. The gap between London and the rest of the South was the most significant. Overall these figures showed that those in Rural areas were living, on average, 1.5 years longer than those in Urban areas.  This means that increased longevity will have a greater impact on cost pressures facing the LGPS Rural funds than it will for Urban funds.  

Breakdown of costs and benefits

79.         For all stakeholders it was imperative there was an evidential base for the costs and benefits of the proposals. Various initiatives to determine the evidential base were undertaken by the stakeholders (as referred to in paragraphs 30 to 47). The following costings have been agreed by GAD.

Option A - Do nothing

Economic

80.         Benefits - None