What did the 2016 Budget have to say about public sector pensions?

Written on 22 Mar 2016

Reduction of discount rate, and the new “British Wealth Funds”

Our Budget article published on 17 March 2016 contains a summary of the pension highlights in the Budget, including the new Lifetime ISA. Here we focus on the Chancellor’s specific announcements on public sector pensions.

Reduction of discount rate and impact on employer contributions

The key point for the public sector is the announcement that the discount rate used to set employer contributions to the unfunded public service pension schemes is to be reduced from 2019-20 onwards. This will have an impact on employer contributions to the so-called “pay as you go” public sector pension schemes, which includes the NHS, Teachers and Civil Service schemes (but not the funded Local Government Pension Scheme).

The discount rate is based on the Office of Budget Responsibility’s long-term projections of GDP growth. It is used to work out asset values needed
today (and therefore employer contributions) in order to meet pension liabilities in the future. The Budget sets out that the recent assessment has
resulted in a reduction of the discount rate to 2.8% (from 3%). This means that employers will pay higher contributions to the affected schemes from 2019-20, when the new reduced discount rate is implemented. The contribution increase is anticipated to be in the region of £2 billion, which the Chancellor expects to be funded from existing spending plans – rather than by new money from the Treasury.

Osborne Clarke comment: the Chancellor turns up the heat on employers

Having previously promised public sector employees a freeze on changes to public sector pension benefits for at least 25 years, the Chancellor appears to be turning up the heat on the employer contributions required to fund these benefits. Higher employer pension contributions may well lead to cuts elsewhere in individual Government department budgets, leaving Ministers with difficult and potentially unpopular decisions. Some would argue that this only reflects the decisions which have been affecting employers of defined benefit pension schemes in the private sector for the best part of 20 years.

LGPS collective asset pooling

On 25 November 2015, the government issued Local Government Pension Scheme: Investment Reform Criteria and Guidance which required all LGPS administering authorities to submit their initial proposals on asset pooling to the government by 19 February 2016, with final submissions to be submitted to the government by 15 July 2016. At the same time as issuing the investment reform criteria and guidance, the Government also issued new draft LGPS investment regulations to facilitate the asset pooling process by requiring each LGPS fund to comply with government guidance. Once the assets of LGPS funds have been pooled, this will create the so called ‘British Wealth Funds’. The Chancellor has targeted having up to six such British Wealth Funds, each having (LGPS) assets of at least £25bn.

The government made it clear that submissions should contain detail on how infrastructure will feature in authorities’ investment strategies, and on how the capacity and capability to invest in this asset class could be improved.

In the Budget the government reiterated its desire that these ‘British Wealth Funds’ have a strategy for increasing LGPS investment in infrastructure. The government also stated it would work with local administering authorities to establish a new Local Government Pension Scheme infrastructure investment platform to boost infrastructure investment.

Osborne Clarke comment: Clarity needed on investment in infrastructure

It is clear that investment in infrastructure – such as roads, rail and airports – by LGPS pension funds, and more widely, is now very high on the Government’s agenda. While the draft LGPS investment regulations aim to encourage the asset pooling process, they do not contain any obligation on
funds to invest in infrastructure and details of how the Government will work with the British Wealth Funds to establish the infrastructure investment platform have not been released. It is not known whether LGPS funds will need to include proposals for investing in infrastructure in their final asset pooling submissions to the government due in July 2016, or whether government will meet its policy objective by including an infrastructure investment obligation in guidance issued under the new LGPS investment regulations.

Ultimately, any government proposal compelling the British Wealth Funds to invest in infrastructure will need to be weighed up carefully against the fiduciary duty of each individual LGPS fund to seek the best available investment return for its members.