Pension costs 2001/02 to 2010/11

Report: 10
Date: 20 February 2001
By: Treasurer and Commissioner

Summary

The report gives a profile of police pension costs over the next 10 years to identify peaks of expenditure that will need to be reflected in medium to long-term planning. It suggests a strategy to manage the emerging issue.

A. Recommendations

1. That the Committee notes the projected financial costs of police pensions over the next 10 years.
2. That the Committee agrees the need for a funding policy which would smooth the annual budget increases and provide a reserve to meet exceptional increases.
3. That the Committee agrees a provisional policy in line with the model set out in Appendix 5 (see Supporting material), subject to reconsideration as part of the medium term financial review.
4. That the Authority makes representations through the national expenditure negotiations to ensure that future pension costs are recognised and adequately reflected in annual financial settlements.

B. Supporting information

Introduction

1. Pensions for police are not part of a funded scheme and the costs are therefore met from each year's revenue budget. Contributions from serving staff meet part of the cost, with the rest being funded from the normal sources of grant and precept. Serving police officers are required to pay 11 per cent of their pensionable pay towards the cost of their pensions.

2. As well as the gradually increasing cost of pensions in payment, peaks of expenditure can be experienced as a result of the age and length of service profile of serving officers. Because police officers have the option to commute some of their pension and receive a lump sum instead, even a relatively small change in the number of retirements can have a significant financial impact.

Civil staff pensions

3. The MPS, in common with other forces, has been flagging up for some years the gradually increasing proportion of the revenue budget which is being pre-empted each year to meet police pension costs. However, the MPS is unique in having an unfunded civil staff scheme as well.

4. Consultants have now been appointed to examine the civil staff pension options open to the MPA. Hymans Robertson were appointed from a shortlist of four firms by the member panel set up jointly by the Finance Planning and Best Value and the Human Resources Committees. The panel considered that Hymans Robertson had particularly relevant experience and that their approach fitted well the requirements of the project. They also offered the lowest price. The intention is that, assuming they are able to receive information in a timely fashion, the consultants will report around the end of March.

5. A significant part of Hymans Robertson's work will involve a detailed projection of the future costs of the present civil staff pension arrangements. Preliminary analysis by the MPS suggests that civil staff pension costs will increase by around 7.5 per cent pa over the next three years. This assumption will be built into the medium term financial projections currently in preparation pending confirmation by the consultants. The remainder of this report deals exclusively with the police officers' pension scheme.

Background

6. Police officers are able to retire on a full pension on reaching 30 years' pensionable service. This means that in practice the youngest age at which a 30 year service officer could retire would be 48½ years of age. Officers may retire with between 25 and 30 years' service but the pensions would not be paid before age 50. The compulsory retirement age - regardless of length of service - for officers up to and including chief superintendent is 55 years, although annual extensions may be granted up to age 60. Slightly different rules apply for ACPO ranks but for the purposes of this paper these are ignored as the effect of the variation is considered to be de minimis.

7. The number of retirements in a given year is therefore heavily influenced by the number of officers recruited 30 years earlier. The length of service profile of the MPS at March 2000 is shown in Appendix 1. It indicates an upsurge in recruitment in the mid-1970s and another in the late-1970s/early-1980s, the latter following implementation of the improvements in pay and conditions recommended by the Edmund Davies Inquiry.

8. The table below shows the projected numbers of retirements on both ordinary and medical pensions in the period 2000/01 to 2010/11.

*For projection purposes medical retirements are assumed to account for 33 per cent of all retirements in line with HMIC's target. The significance of medical retirements is that, as well as a pension and commuted lump sum based on actual service - which may be enhanced in some cases – they may also involve a lump sum injury gratuity and an injury pension.

9. The retirement projections shown above have been derived by:

• taking a current length of service profile of the Service;
• analysing historical wastage data from 1999-2000 to establish the proportion of each length of service leaving for each of 5 types of wastage (ordinary pensions, medical pensions, resignation, transfer and "other" (death, dismissal, required to resign);
• applying the historical data to the current length of service profile such that as the population of each length of service year progresses in time it is affected by the wastage rates that apply to each year for each category.

10. The figures give a clear indication of a steep rise in retirements in 2005/06, a further increase in 2006/07 and then a temporary reduction (but not to current levels) for a couple of years until numbers begin to increase again. The total number of retirements in 2005/06 is around 30 per cent more than in 2004/05; the number in 2006/07 is over 50 per cent more than 2004/05.

11. It has not been possible in the current analysis to take account of any non-police pensionable service which serving officers may have transferred which could result in their reaching 30 years' pensionable service earlier than present records indicate. This information will become readily accessible with the development of the new personnel system. For the purposes of the present exercise it is assumed that this factor will not significantly alter the broad picture.

12. The financial implications of the resulting retirement profile are shown in Appendix 2 (see Supporting material). It can be seen that the total for pensions in payment reflects a progressively rising cost where the rate of increase varies between 7-8½ per cent. Commuted lump sums, however, will vary in direct proportion to the number of retirements in any year and therefore present a pattern of peaks and troughs of expenditure. This is demonstrated graphically in Appendix 3. Around 98 per cent of all officers retiring elect to commute a part of their pension. The average lump sum is around £80,000 so a variation of only 12 in the number of commutations would change expenditure by around £1 million.

13. The graph in Appendix 4 shows the relatively smoother increase in the cost of pensions in payment and also the impact of the profile of commuted pensions on the total costs.

Changes to pension provisions

14. The projected costs in Appendix 2 (see Supporting material) assume that the existing pension rules continue throughout the period under consideration. There has, however, been consultation about suggested changes to the police pension scheme which would mean that new recruits would receive less favourable pension benefits in exchange for a lower contribution rate than the existing 11 per cent. The impact of such a change would be a progressive loss of income in the earlier stages, with cost savings coming through much later in the process. The earliest any change would be made is 2002; realistically it is likely to be later.

Implications of the expenditure profile

15. Total pensions expenditure in 2005/06 will rise by around 12 per cent, with a further increase of nearly 11 per cent in the following year. Expressed as a value, in 2005/06 we will need to fund more than £20m over and above the normal trend of expenditure increase (which is in itself more than the rate of increase in overall police funding). In 2006/07 the extra cash requirement is over £40m.

16. The Government 'takes account' of pensions growth nationally in setting annual financial settlements. However, the overall level of settlements generally falls short of meeting all the rising cost demands on police and there can be no certainty that the extraordinary increases identified in this report would be fully reflected. In relation to pensions the formula allocates resources specifically in accordance with forces' projected relative costs. The Authority needs to play its part, through the national expenditure negotiations, in ensuring that the impact of future pension costs is recognized and adequately reflected in financial settlements.

17. In any case it would be imprudent to assume that external funding will absolve the Authority from the need to make appropriate provision for future cost increases of this magnitude. The Authority should have a strategy for meeting higher pension costs which would ideally comprise two elements:

• an acceptance of an appropriate level of annual budget increase. This is essential because of the ongoing nature of the cost of pensions in payment;
• the establishment of reserves to facilitate the management of the fluctuations in the cost of pension commutations. This would protect the Authority from having to make exceptional budget increases in any one year.

18. Clearly there is a balance to be struck between the two elements. Commitment to a higher annual budget increase would reduce the requirement for building reserves, and vice versa.

Reserves

19. In the opening balance sheet we have created an earmarked reserve of £8 million for commuted pensions which is intended to be a first step towards covering the MPA's liability in respect of officers eligible to retire at one month's notice at any given time. The magnitude of this liability is presently assessed at around £100m, of which around one half is covered by current budget and accounting provisions. The Authority will need to consider separately how much of the remaining liability should be covered by reserves.

20. Any intention to build up a reserve to smooth the impact of the increasing number of retirees identified in this report would therefore constitute a separate policy by the Authority. The potential size of such a reserve would depend on a view of what constitutes the extraordinary element of each year's projected costs. Appendix 5 (see Supporting material) illustrates the process with a particular model based on a budget increase of just over 7 per cent per year over the ten year period. There is a higher increase in the first year (2002/03) in order to kick start the process of setting aside contributions to the reserve. The profile of the annual contributions to the reserve is a function of the total increase allowed in the pensions budget and the incidence of actual costs. In this model a total of £138 million is contributed to the reserve over the ten year period and the reserve is fully expended by the final year.

21. It is suggested that the Authority should consider adopting a provisional policy for funding anticipated future pension costs in accordance with the model set out in Appendix 5. This would provide a basis for reflecting pension costs in the forthcoming medium term financial review. The implementation of the policy would be subject to review as part of that wider financial consideration. Furthermore the policy could not be binding on the budget decisions in respect of any particular year. It would always be necessary to consider the resource requirement to meet this policy in the context of all the other budget demands and the overall impact on policing capability. The projections upon which the policy is based should also be subject to periodic review.

22. There will be further reports on this key issue as the need arises.

C. Financial implications

The figures in this report will be included in the medium term budget plan to be presented to the Committee shortly.

D. Background papers

• MPS Finance Department Budget Files
• MPA Treasurer's Budget Files

E. Contact details

The author of this report is Peter Martin, MPA.

For information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

Appendix 1

Length of service profile of police officers as at 31 March 2000

*Records relate to length of police service. Transferred-in non-police service is not presently captured.

Appendix 3

Projected costs of commuted pensions 2001/02 to 2010/11

Appendix 4

Projected costs of pensions 2001/02 to 2010/11

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