The government is proposing a series of changes to the Local Government Pension Scheme cost-control mechanism, aligning it with other public sector plans while giving more discretion to the Scheme Advisory Board.
The cost-control mechanism was introduced after the Lord Hutton review recommended a structure to share the risks and costs of public service pensions fairly between employees and the government.
It includes a cost cap, which is set as a percentage of pensionable pay and 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.
The cost-control mechanism had to be paused following the McCloud judgment in 2019 due to uncertainty about scheme costs, which affected public sector schemes’ 2016 valuations.
Currently, the regulations are fairly prescriptive about what actions the SAB should take in certain outcomes
Rob Bilton, Hymans Robertson
The Treasury announced the resumption of the mechanism in July 2020, as progress in determining benefits increases were more certain, and published amending directions in October 2021, allowing the 2016 valuations to conclude.
A consultation on changes to the cost-control mechanism was launched in June 2021, taking forward three reforms that were first suggested by the government actuary, after a review of the mechanism found it had produced costly, unintended outcomes.
The changes – which also confirmed that the McCloud remedy costs will be imposed on the schemes and are the base of a judicial review filed by trade unions, currently ongoing in the High Court – were introduced in legislation in March 2022.
The cost-control mechanism was redesigned “to ensure it only considers past and future service benefits built up in the reformed schemes with all legacy scheme costs excluded”, while the cost-cap corridor was widened from 2 per cent to 3 per cent of pensionable pay, “thereby reducing the regularity of breaches”, the government said.
The Treasury also introduced an economic check, so that a breach of the mechanism will only be implemented if “it would still have occurred had the impact of any change in long-term economic assumptions been considered”.
Now, the Department for Levelling Up, Housing and Communities is proposing to introduce some of these changes to the LGPS, launching a consultation to this effect on January 30.
The LGPS also operates an additional mechanism – the cost management process – which is managed by its Scheme Advisory Board to help reflect the scheme’s funded nature.
Changes to the LGPS mechanism
The government is looking to amend the scheme’s regulations to implement the changes brought by the Treasury in relation to the cost-control mechanism.
The consultation is also proposing “technical changes to the SAB mechanism to reflect those that are being made to the HMT mechanism, particularly in relation to the newly introduced ‘economic check’,” Hymans Robertson partner Rob Bilton told Pensions Expert.
Technical details of the economic check will be introduced by the government via public sector scheme valuation directions. In the case of the LGPS, the DLUHC stated that it may be necessary to amend the regulations, but if this is the case it will consult with the SAB to “ensure any change is technically accurate” before it is implemented.
The draft rules are also proposing to move the SAB mechanism from a three-yearly cycle – aligned to the LGPS funds’ valuation cycle – to a four-year interval, as it occurs with the Treasury’s cost-control mechanism.
Finally, the DLUHC is planning to remove a requirement that any benefit changes – as a result of the SAB cost-sharing mechanism – must bring the scheme back to the target cost of 19.5 per cent of pay.
Bilton explained that this measure is “seeking to provide greater flexibility to the SAB mechanism and the actions that are taken once an outcome is known”.
Government to impose McCloud costs despite significant opposition
The government has confirmed it will impose the costs of the McCloud remedy on public sector schemes’ 2016 valuations, despite its consultation garnering significant opposition from members and trade unions.
He said: “Currently, the regulations are fairly prescriptive about what actions the SAB should take in certain outcomes.
“The amendment is seeking to give more discretion to the board, to reflect that the operation of a cost-sharing mechanism requires an element of discretion due to the uncertain nature associated with defined benefit pension funding.”
Bilton concluded that the overall aim of the proposals – providing “greater alignment and flexibility – are welcome to help ensure that the SAB mechanism allows cost sharing to adequately recognise the unique nature of the LGPS in the world of public sector pension schemes and avoid, or at least limit, the impact of perverse outcomes”.
This consultation will last for eight weeks until March 24 2023.
