NHS Pension Scheme Governance Group

Transcription

1 NHS Pension Scheme Governance Group Response to Her Majesty's Treasury s ( HMT ) consultation on a second draft of the valuation and employer cost cap directions and draft regulations on the employer cost cap as attached to the cover note to various parties dated 7 October 2013 Submitted by the Governance Group of the NHS Pension Scheme This response is submitted by the Governance Group of the NHS Pension Scheme. The Governance Group is a partnership group between national recognised NHS trade unions, employers and representatives from the Department of Health. The Group falls under the auspices of the NHS Staff Council and its Executive. The Governance Group welcome this opportunity to respond to the consultation outlined in the cover note from HMT dated 7 October 2013 on: The Public Service Pensions (Valuations and Employer Cost Cap) Directions 2013 ( the Directions ); and Public Service Pensions (Employer Cost Cap) Regulations 2013 ( the Regulations ). In short the Governance Group acknowledge and understand the fundamental changes to the cost cap mechanism set out in this second draft and believe this will be a more transparent and robust system. However, we do not feel that these Directions have resolved the potentially significant and unjustified deficit created by inconsistencies between the valuations of the liabilities and the notional assets. This negative impact on scheme funding will, all other things equal, inflate the employer contribution rate and may have undesirable effects on service delivery and patient care. As requested in the cover note, our response will relate to whether the Directions meet the Government s overriding objectives and principles. 1. Impact of the Directions on the past service valuation Overview of the preliminary valuation as at 31 March 2012 (the 2012 valuation ) The 2012 valuation will determine the employer contribution rate for implementation on 1 April This will be the first re-assessment of the contribution rate for employers within the NHS (currently 14.0%) since the last formally completed valuation which had an effective date of 31 March 2004 (the 2004 valuation ). With such a long period between valuations, scheme experience is likely to have diverged significantly from the assumptions adopted as at 31 March The three items which will inform the new employer contribution rate are: 1. Scheme experience differing from valuation assumptions; 2. Valuation data, methodology and assumptions adopted for the 2012 valuation; and 3. Yield from member contributions. Version 1 7 November

2 Clearly no action can be taken retrospectively to change actual scheme experience over the 8 years inter-valuation period and member contributions are required to meet a certain yield, meaning that these two items are fixed. This makes the choice of valuation approach and assumptions a critical part of the valuation process. Slight differences between the assumptions for the 2012 valuation and those adopted for the 2004 valuation may have a significant impact on the new employer contribution rate. As part of the 2012 valuation the total contribution rate required from 1 April 2015 (Direction 36) will be the sum of the contributions required to: 1. meet the accrual of benefits between April 2015 and April 2019; 2. service the notional past service deficit (or surplus) revealed from the valuation by spreading this deficit (or surplus) over a period of 15 years (Direction 18); and 3. meet the difference between the contributions expected to be paid and the cost of benefits accruing over the period between April 2012 and April The impact of the Directions on the notional assets The notional asset value of the NHS Pension Scheme was rebased on 31 March 2003 using the value of scheme liabilities at that time, calculated using the 2004 valuation assumptions. The notional asset value at 31 March 2004 was bn as reiterated in schedule 2 of the Directions. We have identified three changes to assumptions and methodology which will affect the notional asset value: (1) SCAPE discount rate One of the key assumptions in the rebasing of the notional asset value was the SCAPE discount rate which at that time which was 3.5% per year above price inflation. Under the Directions the notional asset value as at 31 March 2004 will be rolled forward (Direction 32), with net income, to 31 March 2012 using notional investment returns of 3.5% per year above price inflation until 31 March 2011, and 3.0% per year above price inflation until 31 March 2012 (and beyond for subsequent valuations). However, under the Directions, scheme liabilities will be valued as at 31 March 2012 using the SCAPE discount rate of 3% per year above price inflation (Direction 25(a)). This causes a mismatch in long-term discount rates used in valuing the notional assets and the scheme liabilities. This mismatch will create a significant negative experience item in the 2012 valuation. (2) Long term general earnings growth In addition to the SCAPE discount rate, a general earnings growth assumption was also used to calculate the initial notional asset value. The assumption used to rebase the notional asset value on 31 March 2003 was 1.5% per year above (RPI) price inflation. Under the Directions the general earnings growth assumption is based on forecasts from the Office for Budget Responsibility ( OBR ) both in the short- and long-term. The long-term assumption is 4.75% per year (Direction 24(f)), or 2.75% per year above (CPI) price inflation Version 1 7 November

3 and is a significant strengthening of this particular assumption. This increase of 1.25% per year above the relevant measure of price inflation will, all other things equal, serve to increase the value of past service liabilities for all active members. We would again suggest that comparing the notional asset value calculated using one assumption with a liability calculated using a different assumption introduces an inconsistency into the valuation. (3) Actuarial methodology The projected unit method (Direction 16) to be used in the 2012 valuation is a change from the 2004 valuation where the entry age method was used. This change of methodology will affect the actuarial liability for active scheme members. Both of these actuarial methods calculate liabilities associated with pensionable service before the valuation date. However, the entry age method also allows for pensionable service after the valuation date offset against the contributions expected to be paid using the entry age standard contribution rate. This too will have an impact on the value of scheme liabilities with no adjustment made to the notional asset value. However the impact of this change is difficult to determine easily. Assessing the Directions against the stated objectives and principles We understand from work previously done by independent actuarial advisors to the Governance Group that the notional deficit created by the inconsistencies introduced by the Directions into the valuation of the assets and liabilities as outlined above could be in the region of 16bn and could require an additional employer contribution of around 4% per year. We appreciate, as outlined in the Department of Health s response to questions from the Technical Advisory Group to the NHS Pension Scheme dated 5 November 2013, that valuations are a set of enormously complex actuarial calculations involving hundreds of assumptions and that there are many other offsetting and compounding effects but this issue in isolation would appear to be a material upward pressure on costs. In the cover note to the consultation the principle of completeness (principle a.) states that costs should include any past service effects that have arisen since previous valuations. Past service effects are usually understood to reflect the difference in the values of assets and liabilities at the new valuation date which arise due to scheme experience differing from valuation assumptions. We feel that the three changes in assumptions and method highlighted above (discount rate, earnings growth and actuarial methodology) are outside of past service effects as these changes affect the value of both liabilities and the notional assets due to the fundamental principle of actuarial consistency. Principle c. concerns the discount rate and how the revised rate following the consultation in 2011 will apply until it is next reviewed in 2016 (subject to any significant change in circumstances ). The impact of a change in the discount rate was raised in the HMT Consultation on the discount rate used to set unfunded public service pension contributions. This document Version 1 7 November

4 dated December 2010 stated that a change in discount rate would also affect the value placed on the pension benefits accrued relating to past service. The Government has decided that it is not appropriate for this to be reflected in future contribution rates as a result of any change in the discount rate following this review. This appears to directly contradict the Directions. This consultation document also includes a section specifically covering the impact of a change in the SCAPE discount rate on employers. This section states that the Government s intention is that departmental budgets set in the Spending Review will not come under additional pressure due to a change in the discount rate. Again, the intention here appears to be a form of protection for employers against increasing pension costs arising from a reduction in the SCAPE discount rate. Principle h. labelled technical immunity involves the employer cost cap and how it should exclude effects caused by changes to the discount rate, the long term earnings assumption or changes in the actuarial methodology used in the valuations. This principle picks up the three key issues we have highlighted as affecting the past service funding position but only relates them to the employer cost cap. We believe this acknowledgement that the employer cost cap should be technically immune to these changes should naturally be extended to the valuation as a whole. A possible solution Rebase the notional asset value The potential additional notional deficit is caused by a technical disconnect. Recalculating liabilities on a lower discount rate but not rebasing the notional asset value offends against the accepted actuarial requirement for consistency in the valuation of assets and liabilities. If this were a private sector pension scheme, the reduction in discount rate is likely to have been associated with a reduction in bond yields which would be accompanied by a rise in the value of bond invested assets. It might be argued that the Directions do allow for a revaluation of notional assets depending on the reading of Direction 32. This refers to element D as the notional investment returns on the notional assets of the scheme. If this notional return includes an element of capital growth arising from the fall in discount rates this could resolve the issue. If there is to be no allowance for capital growth then we believe that Directions will create a significant negative experience item in the 2012 valuation. Due to the additional cost pressure that will fall on employers we feel that there is enough evidence to support a rebasing of the notional assets as at 31 March This rebalancing would offset the effects of the adjusted SCAPE discount rate, long-term general earnings growth and change in actuarial methodology. Version 1 7 November

5 2. Impact of the Directions on the standard contribution rate The same key changes highlighted above will also affect the standard contribution rate ( SCR ). The SCR is the total rate of contributions required to meet the cost of future benefit accrual. We accept that the reduction in the discount rate has been the subject of earlier consultation and will not comment further on this here. Also we accept that a switch to a projected unit method of valuation is a more transparent approach. We are concerned that the long term assumption on the rate of earnings increases is being imposed at 4.75% per year. This is 0.5% per year above the rate used when the cost ceilings were set and the rationale behind the change has not been explained. We believe that an increase of 0.5% per year in the general earnings growth assumption could increase the SCR for the existing final salary scheme by around 1.4% with a negligible increase in the SCR for the 2015 scheme. The Directions include hard-coded short term general earnings growth assumptions year-onyear from 2013/14 to 2017/18 (2.2%, 2.5%, 3%, 3% and 3% respectively). These are based on OBR forecasts covering the UK economy as a whole. These forecasts are higher than the already agreed increases to pay within the NHS which will be 1% in 2013/14 and up to 1% in 2014/15 and 2015/16. It should be noted that the higher earnings increases cannot be justified on the basis of incremental pay increases as these are applied in addition to the general pay increase figures. The Directions specify that future improvements of mortality be based on the most recent population projections published by the Office for National Statistics (Direction 25(b)). It will be important to know when these projections are due to be published and where they are likely to fall during each valuation cycle, particularly for the 2012 valuation as all long-term assumptions should be incorporated within the initial employer cost cap. It would be helpful if ONS population projections were timed for publication just before the commencement of each valuation cycle although we accept this may not be possible. 3. Input into valuation assumptions Direction 19 specifies that assumptions outside of those hard-coded in the Directions will be set by the responsible authority having obtained advice from the scheme actuary. This direction does not indicate that wider stakeholder consultation will be called upon which is contrary to the paper issued by HMT in November 2012 titled Actuarial valuations of public service pension schemes. This document contains the following passage on page 9: Where it is appropriate for different schemes to use different data, methodology and/or assumptions when carrying out valuations, directions will set out the process by which these will be agreed between scheme actuaries, the Treasury and other stakeholders, such as trades unions. These stakeholders will be involved via normal scheme governance arrangements. We would expect a specific direction to be included based on this guidance. Version 1 7 November

6 4. The employer cost cap The cost cap mechanism has changed materially from the previous draft of the directions. The ambiguity around setting the employer cost cap in the long term has been replaced with a more transparent approach. We consider this to be a more robust system and welcome the change in approach. The Directions do not explicitly set out the costs which will be treated as employer costs within the valuation process. It would be helpful to see these listed for completeness. 5. Financial impact and concluding remarks During the previous consultation period, NHS Employers issued a response which recorded the potential financial impact of an increase in the contribution rate payable by employers. This response can be found by following this Link. This analysis remains just as relevant for this consultation. As is noted the additional cost pressure that may result from the Directions will be on top of recent changes to pension legislation which have already placed additional burdens on employers budgets (such as the additional costs associated with automatic enrolment and the end of contracting-out). As stated in the response by NHS Employers: To put any increases in pension contributions into context, any 1% increase in employer contributions represents an increase in the entire NHS pay bill of around 400m. Based on the draft valuation directions we roughly estimate that contributions to remove the past service deficit alone could be worth around 1.7bn, 4% of the pensionable payroll. This assessment reveals the severity of a potential increase to contribution rates required by employers from 1 April 2015 and the impact the Directions may have on the running of the National Health Service. Version 1 7 November