NHS PENSION SCHEME REVIEW INTRODUCTION OF AN EARNINGS-DYNAMISED CAREER AVERAGE SCHEME WITH AN ACCRUAL RATE OF 1.8%

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1 NHS PENSION SCHEME REVIEW INTRODUCTION OF AN EARNINGS-DYNAMISED CAREER AVERAGE SCHEME WITH AN ACCRUAL RATE OF 1.8% NOTE ON HOW THE AVERAGE DISTRIBUTION OF OUTCOMES WOULD HAVE VARIED WITH AGE AND VALUATION GROUP BEFORE PAY REFORM INCLUDING AGENDA FOR CHANGE Date: 11 March 2006

2 1. This paper has been produced by the Government Actuary s Department at the request of the NHS Pension Scheme Review Team in order to inform discussions at the Review Technical Advisory Group (TAG). 2. The main points to note are: The cost-neutral earnings dynamised CARE accrual rate has been assessed at (a rounded) 1.8%. In arriving at this figure no allowance has been made for potential future cost pressures arising from Agenda for Change (AfC). The assessment was based on assumptions derived from the Scheme experience, and on 31 March 2003 membership data, all of which pre-dated the implementation of AfC. A cost-neutral switch from final salary to CARE will lead to a redistribution of benefit values between sub-groups of member resulting in some sub-groups having, on average, a higher expectation of benefits under CARE than other groups. However, it is important to note that a comparison of averages does not mean that all members in a particular sub-group will better/worse off under CARE. Individual experience can be vary greatly within each grouping. In addition to re-distributing benefit values between the main valuation groups (see Annex B for a description of these), also likely to be re-distributed within the groups, with older joiners, on average, having a higher probability of gaining than younger joiners. Although, on the valuation assumptions, a unique entry age can be identified for each valuation group below which the average member loses and above which the average member gains, this is not to say that individuals joining the scheme below this age might not in practice turn out to be winners, and vice versa. A number of valuation groups are particularly heterogeneous, in terms of the wide range of individual occupational sub-groups that they include and/or the differences between the characteristics of the sub-groups included (notably, Groups 1, 5, 11 and 15). For such valuation groups, the average outcomes tabulated at Annex A are likely to conceal a wide range of potentially different outcomes for individual members. 3. Following an analysis of the NHSPS experience data, the NHSPS 1999 assumptions have been updated to reflect a set of parameters closer to those which might be adopted at the forthcoming 2004 actuarial valuation. This paper reworks the results of the previous TAG13 paper based on these revised assumptions, and then goes on to examine the distribution of outcomes on moving to an earnings-dynamised career average revalued earnings (CARE) scheme for various subgroups of the NHSPS membership as a whole. The paper should be read in conjunction with the earlier TAG13 paper, and important background notes to all TAG papers are set out in TAG In TAG13, the rounded cost neutral CARE accrual rate in an NPA65 scheme with lump sum by commutation at the rate of 12 per 1 pa, and including pensions for unmarried (and unregistered) partners, was assessed as 1.8% (to the nearest 0.05%). Cost neutrality in this context has been assessed in relation to the expected future service cost of providing final salary benefits to future new entrants in an NPA 65 scheme, before allowing for future cost pressures arising, for example, from the 1

3 anticipated impact of Agenda for Change on turnover or salary scales. Using the new 2003 assumptions has no effect on rounded cost-neutral accrual arte which remains at 1.8%. The cost neutral CARE accrual rate has been determined as that applicable to new officers entering the scheme, so that the calculations have excluded the already closed NPA55 groups. Practitioners, who already accrue benefits on a different CARE basis, have also been excluded from this calculation. 5. Based on an accrual rate of 1.8%, an analysis has been undertaken (on the latest set of assumptions) of the various subgroups of the open officer membership as a whole experience increases and decreases in average benefit values in a CARE scheme as described above. Furthermore, the accrual rate has been determined as cost neutral in relation to the future accrual of benefits. Should existing members be given an option to switch into a new CARE scheme, close consideration should be given to the terms (for both future and past service) on which the switch might take, because of the potential opportunity for financial selection against the scheme. 6. The subgroups experiencing increases and decreases in average benefit values under an overall cost-neutral switch from final salary to CARE will depend on the demographic characteristics of each valuation group of members. Where the CARE scheme incorporates earnings (rather than prices) dynamisation of each year s accrual of benefits, the outcome is likely to be particularly sensitive to each group s expected future career pay progression over and above general increases in pay. If all other elements of the demographic assumptions are assumed to be held fixed for each valuation group, there will be a unique entry age within each such group above which (on the valuation assumptions), the average member entering at that age will gain in terms of expected benefit values under the CARE approach, and below which the average member will lose in those terms (because the younger members will tend to lose more, on average, in terms of the future career pay progression which would otherwise have led to higher value final salary benefits). 7. Based on the new entrant methodology adopted for the NHSPS funding valuations, the scheme-wide neutral CARE accrual rate will therefore give rise to a different pivotal age for each valuation group, and these pivotal ages, together with other relevant statistics for each valuation group, are set out in Annex A. 8. It should be emphasised that, although each group identified in Annex A is expected collectively (on the global assumptions adopted) to experience either an increase or a decrease in average benefit values, individual members of each such group might in practice, after a switch to a CARE scheme, have a significantly different experience. 9. Annex A shows (for example), that within Valuation Group 15, there is an average loss of 0.5% of the value of benefits on moving to a CARE scheme with an accrual rate of 1.8%. On average, new entrants to this group below age 31 at entry would (on the assumptions adopted) be losers, and 47% of the payroll of new entrants in this group is assumed to relate to those joining below this age. The average loss to this group would be 5.0% of the value of their final salary benefits, whilst the average gain to the remaining 53% of new entrants payroll assumed to attach to those joining above age 31 would be 3.5% of the value of their final salary benefits. However, to place these statistics in context, in practice, those joining below age 31 would have a wide range of career pay progression prospects (depending partially but not entirely on their specific occupational group), and would be likely to include significant 2

4 numbers of winners in practice, even though when taken as a whole the group is lose, on average. Government Actuary s Department 11 March

5 Annex A: changes in the distribution of benefit values on moving to an NAE-dynamised CARE scheme with an accrual rate of 1.8% Valuation Group % increase or decrease in average benefit values in CARE NAE scheme neutral relative to 60ths FS scheme* Approximate entry age at which benefit broadly neutral % of payroll relating to those whose benefit increase on average % of payroll relating to those whose benefit decrease on average Average % gain for those whose increase Average % loss for those whose decrease 1-4.5% 39 32% 68% 5.5% 9.0% 3 1.5% 32 64% 36% 5.0% 5.5% 5-6.0% 38 34% 66% 2.0% 9.5% % 33 86% 14% 5.5% 9.0% Men -4.5% 39% 61% 3.5% 9.0% % 31 60% 40% 4.0% 5.0% % 26 81% 19% 6.0% 4.0% % 31 53% 47% 3.5% 5.0% % 29 85% 15% 5.5% 3.5% Women 0.5% 60% 40% 4.0% 5.0% * Note that the unrounded cost-neutral accrual rate is in fact just over 1.81% (or, more accurately, closer to 1/55ths). Therefore the slight rounding down of the rate to 1.8% tends to depress these figures. 4

6 Annex B: description of valuation groups Description of Employment Group Group Number Non-manuals administrative, executive and clerical officers Mental health officers Manual staff Hospital medical staff, part-time specialists and nurses without special class status Men 1 Women 11 Men 2 Women 12 Men 3 Women 13 Men 5 Women 15 Medical practitioners Dental practitioners Nurses and physiotherapists with special class status GP practice staff Men 7 Women 17 Men 8 Women 18 Men 9 Women 19 Men 10 Women 20 5