Workers enrolled in public sector defined benefit (DB) schemes could see their benefits change as early as next year, as some of these pension funds appear to have breached the cost cap.
The government published its quadrennial series of documents related to the valuation of public schemes yesterday (6 September), in which it hinted at the breaches.
In a letter to the Trades Union Congress, the chief secretary to the Treasury, Elizabeth Truss, said "the government encountered early indications are that there may be cost cap floor breaches in at least some of the schemes".
Implemented in 2015, the cap was introduced as a cost control mechanism to offer taxpayers and employees protection from unexpected changes in pension costs.
The level of the cap is set as a percentage of pensionable payroll, which varies from scheme to scheme.
However, if the cap is breached, costs may be rebalanced by amending scheme benefits for future accruals to alter the overall cost of the scheme.
This can lead to altering the level of employee contributions so that a higher or lower corresponding level of employer contributions is required.
The scheme valuation reports from the Government Actuary Department (GAD), which are expected later this year once the directions have been finalised, will confirm whether there has been a breach of the cap.
Due to these breaches, the Treasury will be asking the government actuary "to provide his professional opinion as to whether the mechanism has been implemented in a way that delivers the government’s original policy objectives," Ms Truss said.
There are currently more than 5 million active members in the public service pension schemes, which cover the NHS, teachers, the armed forces, the police, firefighters, local government workers, judiciary and civil servants.
Neil Walsh, pensions officer at union Prospect, told FTAdviser that the cost cap floor has been breached "because of public sector pay restraint and lower mortality improvements than expected".
He said: "These are factors that genuinely reduced the expected cost of benefits in these schemes. Under the cost cap mechanism it is likely that benefits in the relevant schemes will be improved in order to maintain the expected cost within the agreed range.
"The cost cap mechanism is there to protect scheme members and taxpayers and it is wrong for Treasury to review it simply because it produced an answer it does not like. Any fundamental change to the cost cap could breach the commitment given that there would be no further reforms of these schemes for at least 25 years."
David Robbins, senior consultant at Willis Towers Watson, explained that government and unions will have to agree on any changes.
He said: "If they can’t agree, the default position is that employees will build up pensions representing a smaller fractional of their pay."
The government is also proposing to change the discount rate used to assess the current cost of future payments from the unfunded schemes, which will increase the bill for public sector employers.
After a cut from 3 to 2.8 per cent in the 2016 Budget, the Treasury is now proposing to reduce it to 2.4 per cent, "to reflect the Office for Budget Responsibility’s long-term growth forecasts", Ms Truss stated.
FTAdviser understands that this change would substantially increase the employer contributions in unfunded schemes to the tune of £4bn.
The Treasury will be supporting departments with any unforeseen costs for 2019/20, Ms Truss noted.
Sir Steve Webb, director of policy at Royal London and former pensions minister, said: "It is ironic that the public sector is reducing discount rates at a time when most other schemes are increasing them.
"The whole funding and accounting for public service schemes remains opaque, and repeated changes, which could include reductions in member benefits, do nothing for stability and understanding."
Mr Robbins said: "With a lower discount rate, more of the money that the Exchequer allocates to government departments will come straight back in the form of employer pension contributions to unfunded schemes.
"When the Prime Minister announced extra NHS spending in the summer, she said that £1.25bn a year would be to cover a specific pensions pressure – this will be what she was talking about."
Beyond 2019/20, the extra money that public sector employers will have to find comes from the budgets to be set in the forthcoming Spending Review.
"So the headline increases in departmental budgets might overstate how much extra buying power they will have after taking account of the money that just gets passed backwards and forwards across government," Mr Robbins added.
This article has been amended post publication to clarify that pension benefits will not be cut as result of the breaches.
maria.espadinha@ft.com
