Pensions - Articles - Budget change will increase public sector pension costs

Aon has said that the announcement in Monday’s Budget of a further reduction in the discount rate used for valuing benefits and setting employer contribution rates in the public sector, will increase costs while there are potentially also increases to benefits for employees.

 Public sector contractors with New Fair Deal contracts will be directly affected unless they had negotiated risk-sharing at the bidding stage. How much of a problem this is depends on whether many TUPE staff are still members of those schemes, the length of contracts, and whether possible future increases to the employer contribution rate had been priced into contracts.
 Some existing contracts will be still under the old Fair Deal (in which staff are in broadly comparable schemes), so this announcement is likely to have an impact when it is time to re-bid.
 Madalena Cain, principal consultant at Aon, said: “The Budget announced the government’s intention to further reduce the SCAPE discount rate – used for valuing benefits and setting employer contribution rates for the public sector for the next four years. This will be factored into the current valuation cycle for the unfunded public service pension schemes, such as the Civil Service Pension Scheme, the National Health Service Pension Scheme, and the Teacher's Pension Scheme. While employers would have been aware of an increase to their costs next year from the 2016 Spring Budget announcement that the discount rate would be reducing from CPI+3% to CPI+2.8%, this further reduction to CPI+2.4% will lead to significant cost increases for all employers. This could be an increase of 5% to 7% of salaries on top of the current employer contribution rates and the 3% increase that had already been expected.
 “While it’s the government’s intention to cushion the blow of these unexpected contribution rises for government departments via additional funding for a transitionary period, contractors who participate in these schemes will have little option but to absorb the full costs immediately.”
 Madalena Cain continued: “Increases to this extent - if not factored into their original pricing for the contract - could adversely impact the delivery of those services. It could also lead to more cautious pricing by contractors in the future, meaning that the public sector picks up higher than expected risk adjusted costs.”
 Benefit improvements
 The cost cap mechanism was introduced in 2015 and assesses whether future pension benefits should be improved or scaled back as a result of costs rising, or falling, by more than 2% of the baseline employer contribution rate.
 Madalena Cain continued: “Early indications are that there may be a cost cap floor breach in at least some of these schemes.
 Changes to the actuarial mortality tables show members are expected to live less long than originally expected, a key reason for reducing the cost of benefits - and so the cost cap floor improves benefits.
 “What is unusual in this situation is that we would not expect to see significant increases in the cost of pension benefits being accompanied by an improvement to pension benefits. Ironically, changes to the discount rate are excluded from the cost cap analysis for benefits, so we are seeing both at once. These benefit improvements, if implemented, could potentially lead to further employer cost increases, leading to a double whammy for contractors.”

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