Legislation in place for career-average public-service pension plans

The Public Service Pensions Act 2013 provides for a sea change in pension provision throughout the public-services sector. Career-average schemes will replace existing final-salary arrangements by 2015 to contain costs.

The Public Service Pensions Act 2013, which has received royal assent, will usher in a dramatic change in pension arrangements right across the public services. Its aim is to prevent pension costs continuing to spiral or, as the Government puts it, "to balance the interests of taxpayers, employers and members". The Act is effectively enabling legislation, with very few detailed provisions, but the principal changes it makes possible are replacing final-salary schemes with career-average revalued-earnings (CARE) arrangements, linking scheme pension age to state pension age (in most schemes) and placing a cap on acceptable future costs to employers.

Almost as soon as the coalition Government came into power, it announced that it was establishing the Independent Public Service Pensions Commission, led by Lord Hutton of Furness. He recommended a raft of changes, including the introduction of CARE schemes, higher member contributions and a cost cap, which have been largely adopted.

Two cost-saving changes have been introduced in the past couple of years without the need for primary legislation: the use of the consumer prices index rather than the retail prices index for pension increase purposes and substantially increased member contributions. Those changes, together with the transformation made possible by this Act, are estimated to save £430 billion over the next 50 years. However, the Government points out that it has retained defined-benefit (DB) provision, in sharp contrast to the private sector where most employers now offer defined-contribution (DC) arrangements at least for new hires, and has put in place significant protection for older existing members.

Common framework

The Act puts in place a common framework for pension provision for: the armed forces; the civil service; firefighters; the judiciary; local government; the National Health Service (NHS); the police; and teachers.

It extends to Scotland and Wales, as well as England, even though in some cases executive control may not rest at Westminster. Northern Ireland is largely excluded. For each service, departmental policy documents set out much more detail about the shape of the new provision. We outlined the planned schemes for five of the services, including the four largest (civil servants, local government, the NHS and teachers), in July 2012. Specific rules for each scheme will be contained in regulations, but these cannot circumvent the Act's provisions.

Most regulations will be made at Westminster in the normal way by ministers and will require Treasury approval, but ministers of the Scottish Assembly will make the regulations governing firefighters, local government workers and police in Scotland, and Welsh Assembly ministers will make those governing firefighters in Wales. As now, these Scottish and Welsh regulations will not require Westminster approval.

The Act provides that all the new schemes will commence on 1 April 2015, with the exception of the new local government schemes, which are effective from 1 April 2014.

Scheme design

Although the expectation is that most arrangements will be CARE schemes, the Act permits DB or DC plans to be established, provided they are not final-salary schemes. CARE schemes are defined as those where benefits are based on revalued pensionable pay in each year of service.

Benefits accrued under a CARE scheme for active members (not the benefits of deferred pensioners or pensioners) must be revalued each year in line with prices or national earnings by a Treasury order. Where an individual has a gap in pensionable service of no more than five years, this is ignored and benefits will be revalued during that period as though the individual was an active member. The revaluation method can vary from scheme to scheme and can be negative if prices or earnings fall. Deferred pensions and pensions in payment are governed by the existing Pensions (Increase) Act 1971.

The Act provides for schemes' normal pension age and pension age for deferred pensioners to be the same as state pension age, or 65 if higher (applicable to women until state pension ages for men and women are equalised in November 2018). Pension age is the earliest age at which a pension can be taken without any actuarial deduction. Linking scheme pension age to state pension age ensures that any increase in state pension age is automatically reflected in scheme pension age. In future, any new higher pension age will apply to benefits already accrued at the date of the change as well as to benefits accrued thereafter, but not to benefits accrued before the new schemes are launched.

The schemes for the armed forces, firefighters and the police are exempt from this provision. Normal pension age for these members is to be 60 and there is no mechanism to increase that age automatically.

The Institute for Fiscal Studies indicated in giving evidence to parliament on the Bill that higher earners and those whose earnings increase rapidly are losing "quite substantially". On the other hand, it says lower earners are actually gaining "quite substantially" from these changes. Analysis from the Pensions Policy Institute suggests that the proposed changes to the NHS, local government, teachers and civil service pension schemes will reduce the average value of the benefit offered across all schemes by more than a third.

Protections put in place

No further benefits can be accrued under existing DB schemes after the closing date for each scheme, except as a means of protecting those closest to retirement. These protection arrangements vary from scheme to scheme.

Regulations can allow exceptions for those who were members (or were eligible for membership) at any time before 1 April 2012. In practice, this means that those within 10 years of pension age will be given full protection, while those up to a further four years away from retirement may receive more limited protection.

An important protection for all members is that benefits accrued under existing final-salary schemes will be calculated using a member's final salary at the date of leaving pensionable service under the new scheme, possibly at actual retirement. Benefits will not be calculated using final salary at the date the existing scheme is closed.

The new schemes are intended to last until 2040. The Act tries to make it difficult to make any changes to protected benefits or to accrued rights prior to 2040.

Controlling costs

Regular actuarial valuations of the new DB schemes are required by the Act, but the Treasury is to specify the detail, after taking advice from the Government Actuary. The Treasury will be able to specify how the valuation is conducted, when it is undertaken, what it covers and, importantly, when any increase in the employer contribution rate will be effective.

Central to the new arrangements is the provision for a cap on employers' costs in relation to DB schemes. Regulations will set scheme-specific caps, based on Treasury directions on calculating the cap and assessing costs. Treasury regulations will also set margins either side of the cap so that if costs move outside that range action must be taken to get them back on track. They will also stipulate how agreement is to be reached on changes made to return costs to within the acceptable band and may specify a default if there is no agreement. Steps taken may include increasing or reducing member contributions or benefits. Indicative cost caps have been published, but these have still to be finalised.

The Act requires a separate valuation of funded DB schemes, which will apply to the two local government schemes, for England and Wales, and for Scotland. Each of 89 funds in England Wales and the 11 funds in Scotland will have a separate valuation.

Governance and administration

Each scheme must have a manager who is responsible for administering the scheme. This could be the relevant minister. Managers have certain specific responsibilities, such as to provide annual benefit statements (for DB schemes) and keep specified records, but will be able to delegate.

Several managers are permitted for a scheme. For example, the secretary of state for communities and local government is responsible for the scheme for local government workers in England and Wales, but the managers of the 89 separate funds will be the local administering authorities, as now.

Each scheme must also have a pension board to assist the manager, and a separate advisory board. The pension board's role is to assist the manager in ensuring "the effective and efficient governance and administration of the scheme". Pension boards must be made up of equal numbers of employer and member representatives (added during debate on the Bill in response to opposition concern), but can have other members too, such as representatives of the government department or independent members. The advisory board (a body added after opposition pressure) is to advise the relevant minister on the desirability of changes to the scheme.

The Act gives the Pensions Regulator greater powers of oversight over the schemes.

Other changes

The Act ends the special pension arrangements for the Prime Minister, the Lord Chancellor and the Speaker. In fact, the current Prime Minister waived his entitlement to such a pension when he took office, the current Lord Chancellor is making arrangements to do likewise, as did his predecessor, and the Speaker announced on the day the Bill was published that he would retain his pension, but would take it only when he reached the age of 65 rather than drawing it as soon as he left office. There are also provisions to ensure that, if future legislative changes are made linking pension age for MPs and MEPs to the state pension age, accrued benefits can only be taken at the revised pension age.

Finally, the Fair Deal policy, which governs the pensions of public service workers who are transferred to a private-sector contractor when work is outsourced, is due to be amended so that transferred staff can remain in the public-service scheme to which they previously belonged. It was not possible for such staff to remain in the civil service scheme, so the Act makes that possible.