The government is to introduce new legislation on public sector pension schemes following a court ruling that its 2015 reforms breached equality obligations.
In 2015, the coalition government made changes to the pension schemes for various public workers that based retirement benefits on average career earnings instead of final salary. But, argues pension consultant John Ralfe, under strong pressure from trade unions, the government watered down what were originally intended to be radical reforms that would have significantly cut the cost of public sector pensions.
The government agreed to exclude from the reformed schemes those closest to retirement age (as they had least time to prepare for their impact). In late 2018, a court ruled that by allowing older members to remain in the previous retirement scheme, the government had unlawfully discriminated, in particular against younger members (see box below).
The 2015 reforms had been intended to achieve savings of £400bn over 50 years, largely by putting the pension age up. While one result of the changes was that many workers had their retirement delayed, their pensions when they did retire were often more generous. As a result, according to Ralfe, the changes have cranked up annual public sector pension costs from £36bn to £60bn.
Further reforms
The government is now consulting on further reforms to public sector pensions and, separately and specifically, on the local government pension scheme, with both consultations completing this month. The aim is to eradicate the discrimination introduced in the earlier reforms.
Richard Warden, partner at pensions consultancy Hymans Robertson, argues that the proposed reforms will create an administrative burden. ‘Schemes will need significant resource to identify the eligible members, contact multiple employers for historic data, and update records and calculation process,’ he explains.
‘Benefits that have already crystallised, such as retirements, may need to be revisited, and changes will be needed to software systems. Employer cost will vary by scheme and by employer in local government funds. This puts upwards pressure on employer contribution rates.’
‘Employers need to ensure they ask the right questions of their actuary to ensure the disclosures provided in future meet their needs and minimise the risk of challenge from auditors’
McCloud and Goodwin
The coalition government’s 2015 pension reforms were challenged in the courts. Issued in December 2018, the judgment in the McCloud case – brought by a judge – was that by protecting the benefits of older members the legislation unfairly discriminated against younger workers.
In the Goodwin case, where judgment was issued in June 2020, the teachers’ pension scheme was held to be unlawful in providing less generous survivors’ benefits to widowers or other male partners than to widows.
Taken together, the two rulings provided a serious challenge to the administration of public sector pensions, leading to the need to introduce further reforms.
Warden adds that most employers and auditors are treating the remedy as a past-service cost in the P&L account. ‘Restrictions to the eligibility criteria that were announced in the consultation may have led some employers that had already reported a cost in a prior year to claw some of this back via a past service gain in the P&L this year.’
He warns that, for local authorities, the Goodwin judgment, alongside the McCloud ruling, increases the administrative pain. ‘For employers, the impact is likely to be a small increase in their liabilities with little impact on contribution rates. For pension accounting purposes, it tends to be treated in the same way as McCloud, ie as a past-service cost, although some employers are ignoring it on materiality grounds.’
More costly
Joel Duckham, senior consultant and public sector accounting lead at public sector pension adviser Aon, says the accounting impact for employers will vary and is dependent on the membership and assumptions made for future pay increases. ‘Arguably it is the cost management outcome that could prove to be more expensive in terms of contribution increases based on the Government Actuary Department’s initial calculations.
‘Even if there is limited impact on balance sheets, given the level of interest auditors have been showing in relation to the Goodwin case – which is typically immaterial in relation to employer balance sheets – we expect auditors will be keeping a keen eye on progress with the now unpaused cost-management processes. So employers need to ensure they ask the right questions of their actuary to ensure the disclosures provided in future meet their needs and minimise the risk of challenge from auditors.’
Duckham says many public sector bodies made an allowance in their accounts for the additional liabilities expected to arise from the McCloud judgment in 2019, based on the Government Actuary Department’s worst case calculations. ‘However, Aon took a more realistic approach for the 2019 actuarial valuations, which set contributions for local authorities in England, Wales and Northern Ireland, and our calculations suggest that the effect on contributions is not material.’
Unsustainable
Ralfe warns that further reform cannot be avoided. ‘Without being too apocalyptic, the gulf between the public sector and private sector pensions has widened over the last few years. There are virtually no private-sector defined benefit schemes left still open, even for existing members. I think that is just unsustainable.
‘My view is that you should have some sort of gentle reforms today rather than continuing to ignore it, which then leads to an explosion, and then it is done in a rushed and an unhelpful way.’
