Contact: Nick Weaver, (01962) 847587; email: [email protected]

1 Summary

1.1 The Department for Communities and Local Government (CLG) have issued a consultation on cost sharing in the Local Government Pension Scheme (LGPS). The consultation closes on 30 May 2008.

1.2 Cost sharing means that employees and employers share the costs associated with various changes that change the costs of the LGPS (for example, increased longevity or changes to the benefit structure).

1.3 The new scheme regulations provide for a cost sharing mechanism to be in place by 31 March 2009.

1.4 The consultation paper proposes establishing a notional fund on which the agreed actuarial assumptions and calculations can be run, producing a notional cost that can then be fed back to local funds.

1.5 Hampshire County Council's response to the consultation recognises the need to introduce cost share in order to provide longer term sustainability for the LGPS. However, the proposed 14% cap on employer contributions appears to be set at too low a level to be practical, given that the current future service rate in the Hampshire Pension Fund is 14.5%.

1.6 There is a further concern that the practical implications of altering the member contribution rate have not been adequately covered in the consultation document.

2 Recommendation

That the response to the Government's consultation on cost sharing set out in Appendix 3 be noted.

3 Cost sharing

3.1 The Department for Communities and Local Government (CLG) have an overriding policy objective for the LGPS which is that it remains `affordable, viable and fair to all'.

3.2 In order to continue to meet this objective, CLG require further reform of the LGPS. The new scheme regulations require a cost sharing mechanism to be in place no later than 31 March 2009.

3.3 The costs of the Local Government Pension Scheme (LGPS) are already shared between the employers and employees, as each pay contributions to the scheme. However, in the main, it is the employers who take on the increased costs when there is a shortfall in funding.

3.4 A cost sharing mechanism would allow a more fundamental shift of pension risk (changing costs due to, for example, changes in longevity, benefit structures, pay increases) from employers to employees.

4 Consultation on cost sharing

4.1 Communities and Local Government (CLG) have issued an informal consultation paper seeking views on the proposals for a cost sharing mechanism, with responses requested by 30 May 2008.

4.2 Following the informal consultation, a statutory, national consultation will be conducted so that arrangements for cost sharing can be put in place, no later than 31 March 2009.

5 Proposal for cost sharing

5.1 The CLG paper `Sustaining the Local Government Pension Scheme in England and Wales' sets out proposals for developing and implementing a cost share mechanism.

5.2 The mechanism needs to be workable, evidence based, equitable and transparent. Other public sector schemes have taken a detailed, formulaic approach to cost share but this would not work in the LGPS, given its local arrangements (i.e. 89 separately managed Funds).

5.3 The proposal sets out six core objectives that any mechanism needs to achieve:

· to share future cost risks between employers and pension scheme members

· to provide a framework within which a satisfactory control of the cost risks can be achieved

· to ensure effective cost stability for employees and employers by helping to manage the effects of changing liabilities and other variables

· to provide a rigorous framework within which to manage specific necessary changes to contribution levels or benefits

· to raise awareness among the membership of the full costs of guaranteed, final salary pensions

· to foster a mutuality of responsibility between employers, scheme providers and members.

5.4 The proposed approach is to establish a notional fund, based on national membership data. This would not include past service deficits, which would remain the responsibility of employers.

5.5 The paper suggests a matrix of risks that would be shared and who should bear the cost of any changes (based on who has best control of the risk or who ultimately benefits from other risks that cannot be influenced such as increasing longevity). This matrix is attached in Appendix 1.

5.6 All the LGPS funds would submit data to be fed into the model fund. The Government Actuary's Department (GAD) would then use agreed assumptions to calculate the cost of the notional fund. This would then be fed back to local funds via actuaries, to establish the Fund employer rate.

5.7 The paper asks how feasible it will be to have the first cost share implemented by 1 April 2011, which would fit in with the normal triennial valuation timetable. The paper also sets out an alternative timetable for the first cost share by 1 April 2012, if 2011 is not considered feasible. Both are shown in Appendix 2.

5.8 Although the consultation details how the cost share mechanism would work using the notional fund, there is little detail of how these costs would be fed through to changes in the employee contribution rate.

6 Response to the informal consultation

6.1 Hampshire County Council's response to the informal consultation recognises that changes to the LGPS are needed in order to achieve longer term sustainability.

6.2 The requirement for a cap on the employer rate is accepted but the indicative figure of 14% is considered to be too low, given that the current future service rate in the Hampshire Pension Fund has been calculated at 14.5%.

6.3 A concern is raised that the practical implications of changing the employee contribution rate have not been fully explored in this consultation document and that further work is needed to demonstrate how the cost sharing would actually be implemented.

6.4 The full response is shown in Appendix 3.

Section 100D - Local Government Act 1972 - background documents

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

NB: The list excludes:

None.

Appendix 1

Government consultation paper on cost sharing in the LGPS

Matrix of risks to be considered for cost sharing

Appendix 2

Timetable for Cost Sharing

Appendix 3

Hampshire County Council - response to cost sharing consultation

Hampshire County Council recognises that in the interests of longer term sustainability, changes to the Local Government Pension Scheme are required.

We would question to the extent to which cost sharing (however it is implemented in practice) will be able to extend the life of the current scheme and how soon other options (such as those set out in the 2006 `Where next? Options for a new look Local Government Pension Scheme paper) will need to be re-considered.

Although we accept the need for an employer contribution cap, we would argue that this needs to be set at a level that recognises the current position. The paper suggests that the employer rate in the notional fund is likely to start at 13.7% with a cap at 14%. Our actual future service rate, following the 2007 valuation, is 14.5%.

We therefore feel that the proposed cap is too low. Unless the cap is set at a level that will allow employers to take on some of the risk, the exercise will not be one of cost sharing but purely one of increasing the employee contribution rate. In the light of recent tax and national insurance changes, this is likely to have the counter productive effect of forcing members to opt out of the scheme.

We are concerned that the consultation does not fully explore or explain how any changes to the employee contribution rate would work in practice. There does not appear to be sufficient time in the timetable to allow changes to the tiered rates to be implemented or communicated to employees.

The rest of this document sets out Hampshire County Council's response to the specific questions outlined in the consultation paper.

1. Consultees may wish to consider and comment on how best the range of relevant views on governance could be involved as part of this exercise, and how these might be factored into the exercise, and at what particular stages?

We agree with the governance principles set out in the consultation paper. We would like to see the Policy Review Group (PRG) continue its active involvement in the process, to ensure transparency.

It is possible that the PRG should have member representation wider than the current Union involvement, especially if there is an employer cap on contributions.

As long as there is transparency over the process, there is less need to be transparency over the assumptions and calculations. As these are necessarily subjective and only verifiable by actuaries, it is difficult to see the benefit in sharing the details of these with other stakeholders.

2. As the cost-share mechanism is already a statutory requirement of the new LGPS, from 1 April 2008, consultees' views on how most effectively to take the process and delivery of the whole exercise forward would be welcomed.

We agree that it should not be necessary to legislate for the precise steps needed within the cost share process but that there should be some legislation to begin and end the exercise, provide the framework and clarify the statutory role of Ministers and the active involvement of stakeholders.

3. It may be that some of the actual content of each of the above stages (and others) could be set in the regulatory framework, for example in a dedicated schedule to a statutory instrument or, alternatively, in statutory (or non-statutory) guidance prepared by CLG. Consultees' views would be welcomed on this aspect.

The timescales for the implementation of cost share are very tight so the overall process and the aim of each stage needs to be clear from the start.

However, as there will always be unforeseen factors that need to be accommodated, we believe that these details should be subject to statutory guidance rather than legislation to allow for flexibility and avoid over-regulation.

4. Do consultees envisage any problems in providing detail as set out in paragraph 20 (types of cost risk)?

We do not hold information on married / partnership rates.

5. Consultees' views on approaches to maintaining longer term sustainability are invited.

We agree that change is needed in order to improve the longer term sustainability of the LGPS. However, we are concerned that cost sharing as envisaged by the consultation paper will not prove sufficient to maintain the LGPS in its current form.

The current economic climate means that levels of funding are likely to decline, placing even more pressure on the viability of the scheme. With an employer cap set at the suggested 14% level, these cost pressures will fall directly onto employees.

This is therefore unlikely to prove a long term sustainable option and we believe that we will need to re-visit the whole basis of the LGPS (e.g. re-consider fundamental changes such as moving to a CARE scheme).

6. Consultees' views are invited on the three columns' contents (see pages 7 to 9 inclusive) and further suggestions and commentary will be welcomed.

We recognise that there is a trade-off between complexity and volatility and that the GAD model has been designed to balance these.

However, if cost sharing is implemented with an employer cap that is close to the current future service rates already being paid, there is little relevance to the rationale behind the risk sharing. This is because all the costs will be borne by the employee, regardless of who is better placed to control them.

The cost list appears reasonable but there should be an opportunity to revise this at a later date in light of experience.

7. It is suggested to consultees that surpluses or deficits which exist in the local funds at the commencement date of the model scheme would be excluded from the notional fund and should not form part of any cost-sharing envelope, as these are related to experience which occurred prior to the implementation date. Views on such an approach are therefore sought.

We agree with the proposed approach. The inclusion of existing deficiencies would imply the need to include ongoing investment performance which would make a very volatile cost share mechanism.

8. The current 2007 actuarial valuation average amortisation period could, at the outset, be adopted in the notional fund. Views are sought on whether this approach - or some other approach would provide stability (see paragraph 32).

We do not think that it is unreasonable to use an average amortisation period, with future amortisation periods being set to reflect average periods at subsequent valuations.

9. Consultees are asked to consider if inter-valuation experience impacts on cost sharing calculations?

We think that changes between valuations should be taken into account but not that there should be intervaluation re-assessments.

10. Consultees' views on ill health and related experience issues are sought (see paragraph 38).

The mechanism, as set out in the consultation paper, requires that a smoothed best estimate is used. We cannot see any alternative to this, even though it will add another area of subjectivity.

11. Consultees' views on how best to achieve inter-generational balance are invited (see paragraph 39).

Any cost share mechanism is likely to introduce some inter-generational cross subsidy. We do not think this is perfect but accept it as a necessary part of cost sharing.

12. (a) The share need not necessarily be 50:50; consultees may wish to consider the range of possible alternatives and (b) to justify alternative ratios as part of this informal consultation exercise.

We agree that a 50:50 ratio is acceptable but that it could be irrelevant if the employer cap is reached too quickly following implementation of the cost share arrangement.

13. Consultees' views are invited on the principle of a notional cap within the cost share framework, and on its initial level going forward from April 2009.

We accept the need for an employer contribution cap in the interests of the longer term sustainability of the scheme. However, we do not accept that the indicative figure of 14% is realistic. The paper predicts that the notional fund will have an initial employer rate of around 13.7% and our actual future service rate following the 2007 valuation is 14.5%.

This means that in practice, with a cap at 14%, any changes in costs will fall 100% on the employee, regardless of the risk table. This undermines the whole exercise and could lead to the counter productive effect of members leaving the scheme.

14. (a) Consultees' views on the most appropriate and beneficial timetable position are invited, given the objectives set out in paragraph 18. (b) Consultees may also wish to comment on the timetable and process needed to establish the cost share arrangements, given the 31 March 2009 regulatory timetable and the earliest date from which the results of the first cost share (should one be needed) is implemented.

We agree that the aim should be to implement the results of the first cost share in April 2011 as this will fit with the normal valuation timetable.

However, we are concerned that the timetable as it stands is out of sync with the budget setting process and would like to see the results fed back locally by 30 September 2010, rather than 30 November 2010.

We recognise that by implementing from April 2011, we will need to provide membership data in 2009 as well as in 2010 for the triennial valuation.

We do not understand how the practical implementation of any changes to the employee contribution rate fits with the proposed timetable. We believe that there will not be sufficient notice to make changes to payroll systems and communicate the changes to employees. Further practical examples should be included in the statutory consultation to ensure the cost sharing exercise is feasible and can be implemented.