Contact: David Wilson, ext 7407

1 Introduction

1.1 At its meeting in July 2002, the Panel noted the main findings of the Government's stocktaking exercise concluded in May 2002 on the Local Government Pension Scheme (LGPS). The main conclusions were:

· The LGPS continues to meet the needs of full-time local authority career employees, but is too inflexible in its provision as employment patterns change

· The legal framework could be clarified to help understanding of the Scheme

· Elected members should focus more on resourcing and delivery of benefit administration.

1.2 The Government made clear that no major changes to final salary, defined benefit basis of the Scheme were planned. In particular, there is no suggestion that employees should be asked to pay a higher contribution rate for the same benefit package. It promised a series of discussion papers to address these three major issues.

1.3 In September and November 2002, the Office of the Deputy Prime Minister published two discussion papers on:

· Retirement benefit package options - comments were originally required by 14 February 2003 but the deadline has been extended to 17 April 2003 at the request of the Local Government Pensions Committee (LGPC). This will enable authorities to take into account in their comments proposals in the Government's Green Paper on pension reform, and the LGPC's own Circular to be issued in February 2003 on the issues raised in the discussion paper (attached at Appendix 1)

· The scope for further simplification of the LGPS regulatory framework - comments required by 17 March 2003 (attached at Appendix 2).

1.4 This report summarises and comments on the discussion papers. Other fund employers were invited by the Chairman to comment on the retirement benefit options paper at the Annual General Meeting. Subsequently, the County Treasurer invited comments at the Hampshire and Isle of Wight Chief Financial Officers' Association meeting held in September 2002. So far, only one other employer has commented. The comments in this report incorporate the views of that employer.

1 Retirement benefit package options

1.1 The discussion paper's main conclusions were:

· The LGPS is a good scheme for career employees who can receive a pension of up to half their final salary which is index-linked

· It is not so well suited to the needs of part-time staff, career-break employees, the low paid, contract workers or term-time employees.

1.2 The justification for the second of these conclusions is not made clear in the paper. It could be argued that the LGPS does deal with these employees equitably. If employees work less hours then it is reasonable to expect them to be earning lower pension benefits. The real problem here may be that these employees tend to be lower paid, and receive pension benefits accordingly.

1.3 The paper does emphasise that the main scheme is not under challenge, and that current members' rights will not be adversely affected by any changes. However, staffing trends in local government have changed significantly. Local government now employs around two million workers. The majority are women and many are part-time. The LGPS itself has 2.7 million members including pensioners.

1.4 The main factors in influencing any changes are:

· The higher numbers of part-time employees

· More short-term contracts

· Multiple employments

· Greater incidence of flexible working

· Outsourcing of service provision to private contractors.

1.5 The paper suggests that the shortcomings of the LGPS are as follows:

· The benefit package is complex and difficult to understand

· People entering and leaving the Scheme from/to the private sector may suffer reductions in their final pensions - in particular if an employee enters the LGPS from a more generous private sector scheme benefit entitlements can be lost permanently

· Too many new employees are opting out of the Scheme

· A final salary based Scheme does not suit everyone - for example employees might wish to accept downgradings as they approach retirement, although in practice protection is available to staff who decide to do this. For example they can opt for preserved benefits based on their final salary prior to their downgrading

· Its complexity confuses private contractors who may opt to be admitted to the Scheme.

1.6 According to the paper, the LGPS needs to provide benefits which are:

· Adequate and an asset to the local government employment package

· Comprehensive

· Flexible

· Fair to scheme members, employers and council taxpayers

· Efficient and cost-effective

· Fully transferable

· Secure

1.7 A number of options are suggested in the discussion paper to improve the Scheme.

Improved pension package in exchange for higher contributions from employees

1.8 This could be optional or compulsory, and available either to all or selected groups of employees. It might be attractive to those working or intending to work in local government for a relatively short period of time, but would not appeal so much to career employees.

1.9 Employees can already do this to a limited extent by paying additional voluntary contributions or buying extra service.

1.10 Making a more formalised package optional at a higher basic employees' rate would in effect create two schemes. It would clearly have administrative implications. In particular, it would mean deducting employees' contributions at two different rates. This would clearly be feasible - some manual workers who joined the Scheme before April 1998 still pay at 5% of salary instead of the standard 6%. However, it would make the LGPS more complex at a time when the Government itself is implying it is already too complicated.

1.11 A number of issues would need to be resolved before making such a change compulsory. Would it be made compulsory for both current and new members? Many current members may be happy with the Scheme as it is and may not wish to change, particularly if they are approaching retirement. It might be better to make the improved Scheme compulsory for new Scheme members but an option only for current members.

1.12 It is certainly worth exploring further as an option.

1.13 It might be advisable to carry out a survey of current Scheme members' views on the balance of advantage between higher employees' contributions and benefits. This could be done by the Office of the Deputy Prime Minister.

Amended benefit package to assist in managing ill-health and early retirements

1.14 In particular the paper suggests a review of the use of enhancement, augmentation and review procedures.

1.15 Any review in this area should be welcomed. Procedures for approving ill-health retirements have been tightened since July 1999. Earlier and easier access to some benefits with review periods to protect the Scheme from non-genuine cases might be helpful.

1.16 Employers make up-front contributions to cover the cost of early retirements at rates determined by the actuary. Early retirements from the Hampshire Fund remain well below the national average for LGPS funds. Other local government funds should note the Hampshire Fund's good practice in managing early retirements.

The work/retirement balance

1.17 The paper suggests that ways should be found to allow employees more options for those wishing to retire early or after retirement age. The Hampshire practice of asking employers for up-front contributions if their employees retire early should be retained. Otherwise employers would ignore the strain on the Fund created by granting early retirement and cross-subsidisation between employers would occur.

1.18 Augmentation of service can be used to provide scope for early retirements. Extending the retirement age would encourage employees to work and contribute longer, and draw pensions for shorter periods than now. It might be better to remove the compulsory retirement age of 65 so that benefits could accrue longer and those retiring late could receive higher pensions. Alternatively employers could grant extensions of service as in the police and fire schemes.

1.19 The County Personnel and Training Officer has commented that more flexibility for older employees would be especially helpful. This should focus on stepping-down options and allowing employees to work on without pension reduction.

A lower employees' contribution over the first five years

1.20 This would assist new employees in the short term, many of whom are on lower salaries and may have large expenditure commitments. Benefits for employees paying such a lower rate could be reduced to compensate, and/or be offset later in their careers by paying a rate above the standard to secure the full package of benefits.

1.21 Such a step might make the LGPS more attractive to new and younger employees, who may be less focussed on providing for their retirement than older employees. It might not be so attractive to older first-time entrants. Again, it is flexibility that is important - it should be an option, not a requirement. It might be advisable for the Office of the Deputy Prime Minister to canvass the views of new LGPS members and those who have opted out of the Scheme on this suggestion.

1.22 A low-cost start-up facility would probably need to be run as a separate scheme.

More employer-based discretionary benefits

1.23 The principle of extending employers' discretion is a good one. Increased discretion would make it easier for individual employers to tackle their own particular employment problems.

1.24 However, care would need to be taken to ensure that employers exercising more discretions met the costs, so that cross-subsidisation between employers could be avoided or minimised. This would mean introducing more up-front contributions from employers wishing to exercise discretions. These would have to be determined by the actuary.

A "stepped" pension plan

1.25 The paper suggests that a stepped pension plan would be linked more closely with career, salary progression and length of service. For example, employees could be given the opportunity to pay higher proportional contributions as their salaries increase, say every five years, and earn improved benefits in return.

1.26 It is unclear how a "stepped" plan would do anything significant to cater for current employment trends. It would have all the perceived drawbacks of the current Scheme, and would mean segmenting the LGPS into sub-schemes. This would involve more administrative effort, cost and complexity.

A hybrid scheme

1.27 It is suggested that the Scheme could start as a defined contribution scheme for new employees, where the risk of poor performance falls on the employee, but that, after a minimum period of service, it should become a defined benefit scheme as now.

1.28 It is difficult to see how the introduction of a hybrid scheme would achieve the objectives of the review. It would be seen by employees as a money-saving measure and an infringement of their terms of employment. It would do little to address current employment trends, and would mean more administrative costs.

Salary averaging

1.29 Basing pensions on, say, average salary over the last five years would appear to be primarily a means of reducing the Scheme's liabilities and hence improving funding levels.

1.30 As with a hybrid scheme, such a change would be interpreted as a money-saving measure which would be damaging to the overall employment package. Again, it is difficult to see how this would create the flexibility needed to cater for current employment trends. It would mean more administrative costs.

Flexible employee contribution rates for individuals and employee groups

1.31 The paper introduces the possibility of a "cafeteria" system where individuals or groups of employees could opt to pay different contribution rates to suit their particular circumstances. For example, an employee could pay a higher contribution rate to finance retirement at an earlier age, or to buy a higher rate of pension.

1.32 This would certainly make the Scheme more flexible. However, it would inevitably become more complex and costs of administration would rise.

1.33 It is difficult to see how choices could be allowed at different stages of a career. Such flexibility would need to be tied in with the overall remuneration package (for example converting salary to pension or vice versa). It might be more appropriate just to vary employees' contribution rates, but maintain a set employers' rate in such circumstances.

Mandatory annual benefit statements to assist with long-term pension planning

1.34 These are already provided to the Hampshire Fund's contributors. It is good practice, but not necessary to produce more regulations to make it mandatory..

The "earnings cap"

1.35 This Inland Revenue regulation limits the maximum level of pay on which the employee can pay tax-exempt contributions to £97,200 in 2002/03 for anyone who joined the LGPS after May 1989. Employees earning more than this limit are currently not able to contribute to the Scheme on earnings in excess of this limit.

1.36 The easiest solution would be to set up a separate funded, unapproved retirement benefit scheme (a "FURBS") for contributions which would not be tax-exempt.

Experience from other European Union countries

1.37 The paper suggests that something could be learned from other EU countries. As the UK is the only country in the EU with a funded local government scheme, this is unlikely to achieve much.

Conclusions

1.38 The suggestions made in the discussion paper offer little to assist those part-time staff, career-break employees, the low paid, contract workers or term-time employees, and do not address the perceived shortcomings of the LGPS set out in paragraph 2.4. Instead they focus on trying to make the Scheme more attractive to new and existing members.

1.39 However, the suggestions made would make the LGPS more administratively complex and difficult to understand at the very time the Government is identifying its complexity as one of its major drawbacks. For example, employees may be reluctant early in their careers to be faced with a decision on whether to increase their contributions to a "stepped" scheme. It could be argued that one of the main advantages of the Scheme is its single employees' rate, which is easy for everyone to understand.

2 Simplification of the LGPS regulatory framework

2.1 As long ago as 1995 the Government referred to the need to "consider whether it is possible for local government pension responsibilities to be handled more effectively with less centralised prescription and less over-bearing detail, leading to improved local decision-making and accountability".

2.2 The Pickering Review of the legislation governing private sector pensions was published in July 2002. One of its main objectives was to simplify the legislation and provide encouragement to employers to offer pension schemes and for employees to save for their retirement. The Government plans to issue its response to the Review in a Green Paper by the end of this year.

2.3 The second of the ODPM discussion papers asks two main questions:

· Are the current LGPS regulations too detailed? If so which regulations could be simplified or dropped?

· Could information on the LGPS be made available in a user-friendly way electronically, for example on pensions websites and CD-ROM?

The LGPS Regulations

2.4 As far as the regulations governing the management and investment of funds are concerned, the Panel has commented previously that they work well and have no substantial deficiencies. Some of the prudential limits on holdings could be marginally relaxed, but otherwise there does not seem to be any pressing need for change.

2.5 Previous attempts to simplify the regulations governing benefits and administration have had the opposite effect. Simplifications to the Scheme have reduced its flexibility in practice.

Availability of information

2.6 The electronic provision of LGPS information to employers, employees and pensioners in a comprehensible and user-friendly format should be encouraged. Guides to the Scheme should be produced for all three groups, fully cross-referenced to the regulations, and in Plain English.

2.7 The Hampshire Fund has already made substantial progress in this area. Simplified scheme guides and summarised information on performance and the Fund's accounts are provided both in paper form and on the Fund's website. These documents have received awards from the Plain English Commission.

Recommendations

1 That the County Treasurer be authorised to agree with the Chairman responses to the two discussion papers by the deadlines set on the basis of the comments in this report and the Panel's views (and those of other fund employers) in the light of the forthcoming Government Green Paper on pension reform and LGPC paper.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

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