Local Government Pension Scheme: Government presses pause on employer cost cap process following unlawful discrimination ruling

On 8 February 2019, in a written circular addressed to all LGPS administering authorities and local pension boards, the LGPS Scheme Advisory Board confirmed that it has no option but to pause the LGPS cost control mechanism.

The circular follows the Government's decision to pause the cost control mechanism for unfunded public sector pension schemes in light of the McCloud case, and its subsequent confirmation that the pause also applies to the LGPS.

What is the pension costs control mechanism?

• The bulk of the Coalition Government's reforms to public service pensions were introduced from 2015. As part of the reforms, the government accepted the recommendation of Lord Hutton's Independent Public Service Pensions Commission that there be a ceiling (or cap) on costs to the employer. The "employer costs cap" was introduced by the Public Service Pensions Act 2013. Its aim is to target and control future spending on public service pensions.
• The employer costs cap also includes a "cost floor".
• The employer costs cap is reviewed at each scheme valuation: every 4 years for the unfunded schemes (for example, the Civil Service, NHS and Teachers' pension schemes); and every 3 years for the LGPS.
• As a funded public service scheme, the LGPS in England and Wales is subject to a second cost control mechanism, managed by the LGPS Scheme Advisory Board.
• The idea of the costs control mechanism is to keep costs between the target floor and ceiling. If the ceiling or floor are breached, there is a consultation to allow the scheme manager, employers and members to agree the steps needed to bring costs back within target. These steps might include changes to future benefit accrual, or to employee contributions.

What decisions have been taken and what do they mean for public sector pension schemes?

In September 2018, the government reported that early indications from the latest scheme valuations of the unfunded schemes were that the cost floor had been breached in some cases. It said that, to correct this and return scheme values to the levels targeted in 2015, public sector workers would be given improved pension benefits for the period April 2019 to 2023.

This report came at a time when the Treasury was proposing to increase employer contributions to the unfunded public service schemes by reducing the Superannuation Contributions Adjusted for Past Experience (SCAPE) discount rate from 2.8% to 2.4% to "reflect the Office for Budget Responsibility's long-term growth forecasts". (The SCAPE discount rate is a measure of the present cost of future payments from pension schemes. It is an assumption which falls outside of the cost cap.)

However, on 30 January 2019, the government confirmed that it was pausing the employer cost cap process for the unfunded schemes. This was due to uncertainty following the Court of Appeal's judgment in the McCloud case. (In December 2018, the Court of Appeal ruled that the transitional protections which were put into place for some members in connection with changes to the Judicial and Firefighters' pension schemes made as part of the Hutton reforms, constitute unlawful direct age discrimination.)

The government's decision to pause the employer costs cap process for the unfunded schemes means that the anticipated benefit improvements for the members of those schemes will not go ahead in April 2019. However, the planned increases to employer contributions will go ahead.

The government has since confirmed that the pause in the employer cost cap process also applies to the LGPS. This is what has prompted the LGPS Scheme Advisory Board to confirm that it has paused the cost control arrangements which it is responsible for managing, at scheme level, in the LGPS. The effect is that no benefit improvements or employee contribution changes due to the employer costs cap are planned for the LGPS from April 2019. However, the Board is committed to honouring the cost management process pending the outcome of McCloud and will review the position when the case is resolved.

Osborne Clarke comment

The long term impact of the McCloud case on public service schemes, including the LGPS, is not yet clear. We wait to see whether the Supreme Court will grant the Government leave to appeal. If the Court of Appeal's judgment stands, the Treasury has provisionally estimated the potential cost impact to be around £4 billion a year. In the light of this, it is not surprising that the Government has called a halt to the current cycle of the public service pension scheme cost control mechanism.

What may be surprising to some is that the cost control mechanism was pointing towards a package of benefit improvements for public service pension scheme members, in spite of the tenor of the 2015 reforms and at a time when changes to the SCAPE discount rate mean that employer contributions are going up. This has led the government to ask the Government Actuary's Department (GAD) to check whether the costs cap mechanism is working as intended and delivering Government’s objective to protect taxpayers and workers from unforeseen changes in pension costs.