Teachers Pension Scheme Supplementary Estimate Memorandum to the Education Select Committee

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1 Teachers Pension Scheme Supplementary Estimate Memorandum to the Education Select Committee January 2018

2 Teachers Pension Scheme Supplementary Estimate Table of Contents Page INTRODUCTION... 3 SUMMARY OF SUPPLEMENTARY ESTIMATE... 3 KEY ACTIVITIES SUPPORTED BY THE ESTIMATE... 4 DETAILED EXPLANATION OF THE CHANGES TO THE PROVISIONS... 5 CHANGES TO NET RESOURCES... 6 PROVISIONS AND CONTINGENT LIABILITIES... 8 DEPARTMENTAL ACCOUNTING OFFICER... 8 BUDGETARY LIMITS OUTTURN AND PLANS TO EXPLANATION OF KEY TERMS USED IN THE MEMORANDUM

3 Introduction 1 The purpose of this memorandum is to provide the Select Committee with additional information about the Teachers Pension Scheme (TPS) Supplementary Estimate for It includes information on the changes made in the Estimate and how these relate to the Scheme s budgets and control totals. 2 An explanation of key terms used in the Memorandum is provided in Annex B. Summary of Supplementary Estimate 3 The TPS is an unfunded defined benefit Scheme, in which payments from the Scheme are funded by contributions from current employees and employers in England and Wales, with the difference being financed by the Exchequer. 4 The Scheme consists of largely demand-led expenditure. It is dependent on a number of external factors or decisions made by members of the Scheme, which are outside the control of the Department. These factors include membership numbers; salary levels; mortality rates; the age profile of Scheme members and pension increases. For this reason, the TPS Scheme budgets are not subject to Departmental Expenditure Limit (DEL) control totals. All the budgets are within Annually Managed Expenditure (AME). 5 The budgets are based on cash forecasts of income and expenditure, agreed between the Office of Budget Responsibility and the Scheme s administrator, using contribution rates supplied by the Government Actuary s Department (GAD) and discount rates provided by HM Treasury. The majority of the resource costs in the Estimate are non-cash costs related to the pension liability, rather than the pension benefits paid to retired teachers. The table below sets out the resource and cash control totals. Table 1 Estimate control totals Annually Managed Expenditure Main Estimate million Supplementary Estimate million Change million Net AME Resource 15, , Net Cash Requirement 3, ,515.4 (39.5) 6 The most significant factor driving the million increase in resource costs relates to a one off Past Service Cost charge and is due to HM Treasury s decision to extend the interim solution on Guaranteed Minimum Pension (GMP) indexation and equalisation. Past service costs are a non-cash item; they relate to the provision for future pensions. More information on the non-cash budgets can be found in paragraphs

4 Key Activities Supported by the Estimate 7 The sole activity supported by the Estimate is to service the provision of the pension scheme in accordance with the pension regulations. The TPS is a statutory, unfunded, contributory defined benefit scheme with benefits based on final or career average salary and length of service. It is a voluntary scheme open to all teachers in England and Wales who meet the qualification criteria. The main retirement groups from the TPS are: those members retiring on the basis of reaching normal pensionable age; those members taking actuarially adjusted benefits (where a member accesses a reduced level of pension benefit by retiring earlier than their normal pensionable age); and those accessing their benefits early through agreement with their employer (i.e. premature retirement, where the employer pays a portion of the retirement costs). 8 Retirement and other pension benefits are set out in regulations made under the Superannuation Act (1972) and are paid by public funds provided by Parliament. Pensions are increased annually in line with the Pension Increase Order issued by HM Treasury, which is currently based on the Consumer Price Index. 9 The members contribute to the Scheme on a pay as you go basis. These contributions, along with those made by employers, are credited to the Exchequer under arrangements governed by the above Act. Contributions by employers are set at rates determined by the Secretary of State, taking advice from the Scheme s actuary (GAD). 10 Employer contribution rates and employee tiered contribution rates, in place for the current financial year, were developed in discussion with stakeholders including HM Treasury, in response to the Government s parameters for increasing contributions received. 11 The data used to inform the Supplementary Estimate is based on the latest published actuarial valuation of the Scheme, the report for which was published in September The report is based on Scheme data as at 31 March The next actuarial valuation is due to be completed in 2018, and will be based on Scheme data as at March The forecasts have been updated to reflect recent activity and changes in assumptions regarding the membership demographics, inflation rates, pay bill growth and average contribution rates. 12 The Scheme is administered by Capita Business Services Ltd. The cost of administering the Scheme is included in the net resource requirement within the Scheme Supplementary Estimate. The administration expenditure is offset by contributions received from employers in the form of a levy, currently 0.08% of salary, shown in the net resource requirement. 4

5 Detailed explanation of the changes to the Provisions Detailed Breakdown of Expenditure 13 The Resource AME budget is a net budget that mainly consists of non-cash budgets. The key components are: the non-cash movement in the pension provision, i.e. current service cost (the amount we set aside for the expected future payments required to settle the obligation resulting from employee service in the current year); use of provisions; interest on Scheme liabilities; costs of transfers in and cost of enhancements; the non-cash movement on the Premature Retirement Compensation provision. This provision is for the additional costs of early retirements; the cash budget for employers and employees contribution income, which is collected by employers and paid into the Scheme. These contributions buy future year s pension benefits; and the cash budget for other related payments. 14 Table 2 below provides a breakdown of the changes in the Resource AME budgets. Table 2 Detailed changes in resource expenditure and income Main Estimate Supplementary Estimate Variance Outturn Income million million million million Employers Contributions (3,982.3) (3,979.5) 2.8 (3,965.2) Employees Contributions (2,335.4) (2,325.4) 10.0 (2,320.9) Transfers In (23.8) (16.9) 6.9 (21.1) Other Income (0.8) (0.6) 0.2 (0.8) Other Income - Admin Fee (19.4) (19.0) 0.4 (19.3) PRC Contributions (4.6) (3.2) 1.4 (4.0) Total Income (6,366.3) (6,344.6) 21.7 (6,331.3) Expenditure Current service cost 11, , ,873.2 Other costs (1.0) 2.7 Administration Charge (1.9) 18.5 Transfers In (6.9) 21.1 Interest On Scheme Liabilities 9, ,855.0 (28.4) 9,752.4 Increase in premature retirement provision Interest on premature retirement provision (1.8) (1.9) Total Expenditure 21, , , Net AME Resource 15, , ,342.1

6 15 A summary of previous year s outturn and the expenditure plans from to is shown in Annex A. Basis of the forecasts and underlying assumptions 16 The key financial assumptions used to calculate the non-cash costs are: the current service cost is based on a standard contribution rate of 49.1%. This figure is supplied by GAD; and the interest on Scheme liabilities is based on the long term discount rate of 2.80%. This rate comes from HM Treasury in PES Paper (2016) 10, published in December In addition to the financial rates, there are a number of planning assumptions around the Scheme demographics applied by the actuaries. The Department is not the employer of Scheme members, so it has no direct influence over the volume and structure of the teaching workforce. This makes it difficult to predict income and expenditure accurately. Consequently, when forecasting, we can only respond to changes in historic trends in member behaviour, allied to general assumptions about expected changes in the workforce. We have prepared the forecasts on the assumption that increases in the staffing levels in the local authority maintained schools and the academy trust sector will be minimal. However, members working in further and higher education establishments and independent schools collectively account for 30% of the Scheme membership, which could result in a deviation from the standard assumption. 18 Capita maintain a record of active members via an annual return completed each April by employers participating in the Scheme. The annual return is in respect of the financial year to 31 st March. The returns are used to determine the age profile of members and predict the number of retirements, based upon past and/or emerging trends. This is then used to calculate the future pension costs. The remaining population provides information for the following years, adjusted to take account of new starter and mortality rates. Due to the time needed to collect and cleanse the information, the returns used to inform the Supplementary Estimate relate to financial year before last i.e. for the Supplementary Estimate the data used referred to returns in respect of Changes to net resources Income 19 The majority of the Scheme s cash income comes from the contributions made by employers and employees. Employers contribute 16.4% of salary, whilst employees contribution rates are tiered based upon salary bands. The tiers were originally modelled to return an average contribution rate of 9.6%. However, since the rates were set, salary progression has not been as high as that predicted; the average rate received in and used to inform the main estimate for was 9.5%. That trend has continued and we are currently seeing an average rate closer to 9.47%. The reduction in employee contributions of 10 million is due to the use of the revised rate of 9.47%. 6

7 20 Transfers In have been lower than forecast. We consider that this is due to changes in the like for like benefits when transferring between Public Sector Pension Schemes. This year we are estimating a reduction of 6.9 million when compared to the Main Estimate. Changes are recognised in both Resource income and expenditure; the net effect of this change on the Resource requirement is therefore nil. Expenditure on pension costs 21 The main expenditure budgets within pension costs are the service costs and the interest on the Scheme liability. The key changes are: 7 HM Treasury recently decided to extend the interim solution on Guaranteed Minimum Pension (GMP) Indexation and Equalisation for all Public Sector Schemes. This has resulted in a one off Past Service Cost charge of 250 million in this year. the Interest on Scheme Liabilities has reduced by 28.4 million since the Main Estimate. The majority of this change is derived from the actual final liability being less than the forecast used for the Main Estimate. Net Cash Requirement 22 The net cash requirement has reduced by 39.5 million. This is the net result of a number of factors: Contributions: 12.2 million increase in cash requirement, as we have seen lower than forecast contributions receipts from both employers and employees. o Employees contribution rates are tiered based upon salary bands. In recognition that salary progression was not as high as that predicted, the average rate received in and used to inform the estimates for was 9.5%. That trend has continued and we are currently seeing an average rate closer to 9.47%. This has led to a reduction in the cash required of 9.4 million. o Employers contribute 16.4% of salary and contributions are also affected by the lack of salary progression. This has led to an increase in cash required of 2.8 million. Benefit payments: 22.4 million decrease in net cash requirement. Benefit payments include lump sum payments, of which the majority are paid either the end of the academic year or Christmas for retiring teachers. This year there were fewer than anticipated retirements, which has led to a reduction in the cash required. We are monitoring retirement behaviour, as we expect to see a trend where members retire later. This is due to a reducing population whose benefits in the pre-2007 scheme include eligibility to retire at 60. Contributions debtor: 18.0 million decrease in net cash requirement. Lower than forecast contributions have also led to a reduction in the contributions debtors. Transfers Out: 10.3 million decrease in net cash requirement. This year there have been fewer transfers into and out of the Scheme. The balance of 1.0 million comprises a number of minor changes including creditors, premature retirement compensation, Transfers In and administration costs.

8 Provisions and Contingent Liabilities Provisions 23 The Scheme has two provisions for future liabilities: the main pension liability, which GAD estimated at billion at 31 March 2017; and premature retirement compensation provision, which was estimated at million at 31 March This provision is to meet the cost of on-going compensation payments for people retiring before their normal retirement age. The payments are paid as part of the monthly pension payment, which the Scheme will pay on receipt of an actuarially calculated invoice. 24 Further details of the pension scheme s liabilities are published in the Teachers Pension Scheme for England and Wales Annual Report and Accounts (HC 122). Contingent liabilities 25 In the unlikely event of a default by the approved Additional Voluntary Contributions provider, the Scheme will guarantee pension payments. The potential liability as at 31 March 2017 was estimated at 47.1 million per annum. This guarantee does not apply to members who make payments to other institutions offering Free Standing AVCs. Departmental Accounting Officer 26 This Memorandum has been prepared with reference to the guidance in the Estimate Manual provided by HM Treasury and available on the House of Commons and Scrutiny Unit website. The Departmental Accounting Officer (DAO) has personal responsibility for the content in the memorandum; formal approval of the memorandum has therefore been obtained prior to submission to the Select Committee. 8

9 Annex A Budgetary Limits Outturn and Plans to Outturn Plans million AME Resource Programme 1 11,710 10,542 10,649 13,287 12,125 11,342 15,766 15,851 Net Cash Requirement 3,079 3,302 3,361 3,592 3,549 3,306 3,515 3,746 ¹ Pensions income and expenditure outturn and plans are classified as programme, including the fee for administering the Scheme. 9

10 Annex B Explanation of key terms used in the Memorandum Annually Managed Expenditure The Estimate for a Pension Scheme only includes Annually Managed Expenditure (AME). AME is primarily demand led and is generally less predictable and controllable. Scheme Liability This is calculated in the previous year s accounts and represents the starting position for the latest year. Interest on Scheme Liabilities The pension scheme liabilities calculated in the previous year are now one year closer to being realised, therefore an Interest charge is used to calculate this increase in the value of the liability. Current Service Cost This is the value of future pensions accrued by employees who have worked and contributed to their pension in the year. Past Service Cost These result from any back dated changes to pension entitlements. Enhancements These arise from the award of extra years service which are not usually worked by employees, normally on early retirement or the purchase of added years. Transfers in / out These come from members who have transferred their pension benefits either to or from another pension arrangement. 10

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