Police pensions – forecast costs

Report: 08
Date: 9 June 2003
By: Treasurer

Summary

The report presents the conclusions of the independent actuaries’ review of future police pension costs. The long term budget implications are assessed and a possible strategy proposed to mitigate the budget impact. Proposals are made to engage the principal funding agents, i.e. the Mayor and the Home Office.

A. Recommendation

That

1. members note the projections of future police pension costs produced by independent actuaries and the consequent requirement for annual budget increases of 6-7% over the next decade;
2. agree the appropriateness of establishing an earmarked reserve to mitigate the future cost of lump sum commutations;
3. include consideration of establishing such a reserve in the review of the 2002/03 outturn; and
4. agree that information on the projections be provided to the GLA, on behalf of the Mayor, the Home Office and the police expenditure forecasting group.

B. Supporting information

Introduction

1. An internal review of future police pension costs was reported to the Finance Planning and Best Value Committee in April 2001. This identified a continuing increase in costs with accelerated increases from around 2005/06 and again from 2009/10, reflecting recruitment peaks thirty years previously. The financial impact was aggravated by the one-off cost of commuted lump sums payable to higher numbers of retiring officers.

2. This implied that there could be significant funding pressures in future years when these cost increases occurred. There is no guarantee that government grant will be increased adequately to reflect the increases in which case, without offsetting savings, there would be a substantial impact on the council tax.

3. Because of the critical effect on the Authority’s future finances and the complexity of forecasting pension costs it seemed appropriate to secure an independent actuarial assessment of the position. Accordingly members agreed in February 2002 to ask Hymans Robertson, who were going to provide an actuarial valuation for the purposes of FRS17 requirements in the Authority’s published accounts, to build on that work to produce forward projections of pension costs over the next ten years.

4. Members will appreciate that this is a separate issue from the requirement to make adequate provision in the accounts for the current liability in respect of lump sum commutations payable to officers who have already earned their full pension entitlement. The subject of this report is the new future liability arising from an increase in the number of retirees.

Actuary’s report

5. The actuary’s report has taken longer to produce than planned because of the difficulties in modelling future police pension costs particularly with the amount of discretion exercisable by individual officers as to the timing of their retirement. There were also ambiguities in the data provided to Hymans which misled them initially.

6. Attached at Appendix 1 is the executive summary of Hymans Robertsons report. There is a detailed report setting out the assumptions on which the costing model has been based, which can be made available to members on request. The key information for members is the cost projections themselves and the knowledge that they have been produced by independent actuaries.

Financial results

7. The actuaries’ central projection is based on assumptions of 2.5% price inflation and 1.5% real earnings growth. It also assumes incapacity retirements broadly in line with 2001/02 levels. It reflects the planned officer growth to around 30,000 by March 2004. Lower and higher assumptions have also been modelled for each of these variables to test the sensitivity of the results.

8. The financial projections show a real terms increase in police pension costs, net of contributions, of around £150 million (over 60%) by 2012/13 compared with actual expenditure in 2001/02. That is an average real terms growth of 4.5% per year over the period. Hymans’ projections confirm the existence of peak increases in 2005/06, with a forecast increase of nearly 8%, and in 2009/10 when the increase is about 6.5%.

9. The cash increase over the whole period, based on the central projection assumptions, is £266 million (110%), an average annual increase of 7%. Appendix 2 attached reproduces Appendix F from the actuaries’ report, which details the cash projections.

10. Examination of the projections shows that the ongoing pension benefits expenditure grows at a relatively steady rate. From 2005/06 onwards the annual rate of increase varies between 6.5% and 7.2%. The expenditure on lump sum commutations on the other hand is much more volatile. From 2004/05 onwards the annual changes range from –3.0% to +18.8%.

11. The actuaries’ projections will be incorporated into the Authority’s medium term financial plan.

Possible strategy

12. The impact of growing pension costs can only be ameliorated to a limited extent. The ongoing costs inevitably have to be built into the base budget year-on-year to be funded from grant and precept. This itself implies annual budget increases of 6-7% over the next decade. However, it would be possible to smooth the impact of peak year costs particularly to the extent that they result from one-off commutation costs. Money could be set aside in an earmarked reserve for this purpose.

13. In order to ensure that the budget for pension commutations equated to the projected expenditure in 2012/13 an increase of 6.1% per annum would have to be provided. Even so, the excess cost above budgets constructed on this basis would be nearly £60 million over the period. A reserve of around £50 million would be necessary to cover just those years when the costs are projected to exceed budget by more than £8 million.

14. Given the current pressures on the Authority’s budget it is unrealistic to expect that a pension reserve could be funded by explicit budget provision. However, in-year underspendings could be used for this purpose. It should be appreciated that, including 2002/03 where there is still the opportunity to consider this requirement as part of the final outturn decisions, there are only three years to secure such a reserve before the first peak year of 2005/06.

15. Members are therefore asked to agree the appropriateness of seeking to establish an earmarked reserve to mitigate the impact of high lump sum commutation costs projected over the next ten years and to consider the possibility of making an initial contribution to such a reserve as part of the overall review of the outturn for 2002/03.

16. An early briefing on this issue should also be provided to the GLA to inform the Mayor’s forward budget planning. It is also proposed to provide specific information from the actuaries’ review to the police expenditure forecasting group which is preparing evidence for the next public spending round (SR2004), and directly to the Home Office.

C. Equality and diversity implications

None directly related to this report

D. Financial implications

The costs of the actuaries’ review have been set against the underspending of the police pensions budget in 2002/03.

E. Background papers

• The Metropolitan Police Authority: Modelling Future Pension Costs of Uniformed Staff – Hymans Robertson

F. Contact details

Report author: Peter Martin, MPA.

For more information contact:

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

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