As part of what are known as the "Hutton reforms" on public sector pension provision (named after Lord Hutton who chaired the Independent Public Service Pensions Commission which made various recommendations in relation to reform of public service pension provision), the Government introduced via legislation a ‘cost control mechanism’, which was effectively a form of risk-sharing arrangement that sought to maintain the level of employer support for the public service pension schemes. Its intended goals were: to protect taxpayers from unforeseen costs; maintain the value of pension schemes to their members; and provide stability and certainty to benefit levels, the latter which was to be achieved by a provision that the mechanism should only be triggered in “extraordinary, unpredictable events” (emphasis intended!).

The government made provisions to establish the cost control mechanism in the Public Service Pensions Act 2013. 

The control mechanism is expressed as a percentage of pensionable pay. The upper margin forms a ‘ceiling’ and the lower margin forms a ‘floor’. For example, if the employer cost cap is set at 14 percent of pensionable pay, the ceiling and floor would be set at 16 and 12 percent respectively.

Where the cost of a scheme goes beyond those margins on either side of the employer cost cap, pension benefits or member contributions must be adjusted to bring costs back to the target. However it has become clear since the introduction of the mechanism that it has not been operating as intended (in that it has been continuously triggered) or indeed operating at all for some periods (as explained below).

The operation of the cost control mechanism in relation to the 2016 valuations was paused on 30 January 2019 due to uncertainty about scheme costs following the Court of Appeal judgement in McCloud v Ministry of Justice (please see our previous blog which explained about this ruling).

However, the preliminary results of the 2016 valuations which were calculated prior to the pause for the McCloud judgement, the first at which the cost control mechanism was assessed, showed a breach of the cost cap floor in all schemes for which results were assessed. Effectively meaning that costs were deemed to have decreased by more than 2% of pensionable pay and therefore members' benefits should have been increased proportionate to that.

This clearly did not reflect the underlying economic conditions and seemed perverse given the financial conditions prevailing at the time of the preliminary results assessment. Additionally, much of the cost reduction leading to that floor being breached arose in the legal schemes (i.e. the versions of the public service pension schemes in place prior to 2015 when they were replaced by Career Average Revalued Earnings schemes). This seems inherently unfair as any benefit adjustment would need to be applied in the reformed (post-2015) schemes thereby creating intergenerational unfairness between older members with benefits in the legacy schemes and younger members whose main period of benefit accrual will be under the post 2015 schemes.

As a result, Martin Clarke, the Government Actuary, was asked by HM Treasury to carry out a review of the cost control mechanism in the reformed public service pension schemes.

Mr Clarke noted in his report on the cost control mechanism that “Based on this experience, it does not seem possible for the mechanism to be able to protect taxpayers unless it takes into account more of the factors affecting the actual cost of providing a pension”. Whilst Mr Clarke recognised the intended risk-sharing objective of the cost cap mechanism, he noted in his report that difficulties can arise “in the precise choice of components of the mechanism, and the balance of these elements can lead to consequences that might be considered unintended or inequitable”.

Mr Clarke set out various recommendations as to how the cost cap could be improved with the objective of making it fairer and more equitable. Those included:-

  • (a) Changes could be made to the core mechanism to:-
    • only assess costs associated with the newer Reformed schemes (both past and future service); or
    • or, only assess costs associated with the future service of the newer Reformed schemes; or
    • widen the corridor from its current level of +/- 2% of pensionable pay.
  • (b) The effects of the core mechanism could be moderated by:
    • an affordability check whereby a breach of the corridor would only be addressed if it would still have occurred had the long-term economic assumptions been considered within the mechanism; or
    • a qualitative layer of review which allows for reasoned judgement to be used to determine whether to apply the results determined by the core mechanism.

Following the publication of Mr Clarke's report, the government issued a consultation on reform of the cost control mechanism (entitled "Public Service Pensions: cost control mechanism consultation – Proposal to reform the mechanism"). The Treasury said its planned changes were all based on the Government Actuary's recommendations and would “establish a fairer balance of risks between the Exchequer and scheme members and create a more stable mechanism”.

The consultation set out three proposals which were all recommended by Mr Clarke (the first, third and fourth bullets above). The consultation closed on 19 August 2021 and HOT OFF THE PRESS – the Government has just announced yesterday that it is pressing ahead with reforms of the cost control mechanism. We will report further on this in our next public sector newsletter (see here for the most recent edition).

Alongside and related to it, the Government was also running a consultation on timing of reviews of the Superannuation Contributions Adjusted for Past Experience discount rate which is used to determine contribution levels paid into unfunded public sector defined benefit schemes. The Government is proposing to align the discount rate review periods with the valuation cycles of public service pension schemes.

If you would like to discuss anything raised in this blog, please get in touch with a member of the pensions team or your usual contact at Brodies.