Defined BenefitJan 23 2018

Public sector pension inflation protection costs £5bn

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Public sector pension inflation protection costs £5bn

The government will be spending £5bn to guarantee that public sector scheme members will be protected against inflation.

In a consultation outcome published yesterday (22 January), HM Treasury said that it will extend an interim solution to pay the Guaranteed Minimum Pension (GMP) to civil servants who will be reaching the state pension age.

Between 1978 and 1997, employers sponsoring defined benefit (DB) pension schemes could contract their employees out of the additional state pension, as long as the scheme paid a comparable GMP.

The benefit of contracting out was that both employer and worker had a reduction in their National Insurance contribution.

With the introduction of the new flat rate state pension in 2016, contracting out ceased in April that year.

Nevertheless, according to existing legislation, the government needs to continue to meet its obligations to index (price protect) and equalise (make equal payments to men and women) these pension entitlements.

The Treasury had previously announced that public sector pension schemes would pay the increases on GMPs for people reaching state pension age from April 2016 to 5 December 2018.

Yesterday’s announcement extends that provision for individuals reaching the state pension age until 6 April 2021.

According to estimates from the Government Actuary’s Department, this will cost public schemes around £5bn.

However, there was other solution considered in the consultation that would only cost £1.5bn, which is a case-by-case approach.

This method compares the total income that would be received by the pensioner each year from public and state pension provision, under the old and new systems. This method does not provide full indexation to all members.

Where the member’s total income from these sources that year is lower than it would have been under the old system, the member would be compensated that year. This compensation would only be up to the value of the loss of GMP indexation.

Nevertheless, the government dismissed this option, since it would be “a very complex solution for schemes to implement, and differs significantly from the interim solution currently in place”.

“Running a case-by-case solution would require ongoing work, for many years, in order to calculate whether a member would be better off under the old or new system,” the Treasury said.

Another option would be to convert the GMP benefit into normal scheme benefit, which was strongly supported in the consultation.

“Conversion may be less burdensome administratively in the long-term than the full indexation (extending the current interim solution permanently).

“If implemented correctly, it should make the system more transparent and make it easier for members to see how their benefits have been derived,” the government said.

However, this solution would require an agreed methodology, and would need “to be underpinned by suitable legislation,” it added.

Due to this, the government will use the time of the extension to consider the adoption of conversion, which has a similar cost to expanding the interim solution.

Trade union Prospect has welcomed the news about the outcome of this consultation.

Neil Walsh, pension officer, said: “The proposed removal of inflation increases for GMPs would have had an insidious effect on their incomes in retirement.

“The members covered by the extension of current policy should benefit to the tune of thousands of pounds over the course of their retirement.

“Prospect will continue to push for the protection of these payments for all members.”

Prospect's 141,000 members are engineers, scientists, managers and specialists in areas such as agriculture, broadcasting, defence, education and children's services, energy, environment, heritage, shipbuilding, telecoms and transport.

maria.espadinha@ft.com