Police pensions consultation – report of the Working Group on Police Pensions Finance Reform

Report: 10
Date: 23 June 2005
By: Commissioner and Treasurer

Summary

A Home Office led Working group, including representatives from stakeholders within the police service and other government departments, has now reported with proposals on how a new system of financing police pensions should be implemented. It is proposing that employer and employee contributions together would meet the full costs of pension liabilities being accrued in respect of current employees while Central Government would meet the costs of paying the pensions of retired officers, net of employee and the new employer contributions. Authorities would continue to administer and pay pension awards. Concern is expressed that the proposed arrangements are not budget neutral to the MPA/MPS. As the Finance Committee meeting was after the response deadline the draft response from the Chair of the Finance Committee was shared with the Budget and Overtime Group on 10 June.

A. Recommendation

That members note the response to the consultation paper.

B. Supporting information

Introduction

1. The Home Office has published a consultation paper (the Report of the Working Group on Police Pensions Finance Reform), which sets out detailed proposals for implementing a reformed system of police pensions financing. It is intended that the new system should be in place by April 2006 in line with the introduction of the new police pension scheme. A key point of the report is that the changes at an aggregate level will be cost neutral and will have no impact upon either the local or national taxpayer. A proposed response from the Chair was shared with the Budget and Overtime Group on 10 June and is attached at Appendix 1. A copy of the Working Group’s Executive Summary is attached at Appendix 2. The full report has been lodged in the Members’ Room. Responses to the consultation were due with the Home Office by June 17.

Context – and case for reform

2. The police pension scheme is currently financed on a pay-as-you-go basis. This means that officers' pension contributions go into police authorities' operating accounts from which the pensions of retired officers are paid. There is no pension fund. Authorities receive central Government funding support to pension payments as part of police grant.

3. Disadvantages of the current system include:

• Volatility in pensions expenditure arising from the uneven incidence of lump sum retirement payments;
• Uncertainty about how to finance rising burdens of pensions expenditure;
• Uneven treatment between police authorities; and
• Insufficient separation of pensions costs from other expenditure, obscuring the real current cost of policing, and indicating that expenditure on pensions will eat into resources intended for operational commitments.

Proposed new financing arrangements

4. In 2001 a joint review by the Treasury, Home Office and DTLR recommended revised financial arrangements based on officers' contributions and a new employer's contribution being paid into a separate pensions account from which pensions payments would be made. The new pensions account would be locally administered but central Government would either top up the account or recover any surplus as necessary. This grant would be a separate grant outside the annual police formula grant. The recommended system is similar to those used for other unfunded public service pension schemes such as for teachers and civil servants. The new arrangements would cover the financing of both existing and new police pension schemes, but would have no impact on their terms and conditions.

5. The new arrangements purport to counter the shortcomings set out in paragraph 3 above:

• Authorities’ budgets would be protected from year to year fluctuations in pensions expenditure caused by variations in normal retirements;
• Authorities’ operational budgets would be protected from the expected steady rise in the costs of pensions due to increasing numbers of officers retiring during the coming years; and
• Authorities’ budgets would be more transparent as they would reflect the immediate and accruing costs of providing the front line service
• The changes at an aggregate level will be cost neutral.

Implications of the new financing arrangements

Cost of police pensions

6. The purpose of the employer and employee contributions under the proposed new system is to finance the accruing long term cost of the liabilities for the pensions to be paid in future to the serving officers on whose behalf they are paid. The current cost of accruing benefits under the current Police Pension Scheme is estimated at 37.1% of pensionable pay. The overall employer rate is now 26.1% given that officers pay 11%. On the basis of consistent assumptions the costs of the new Police Pension Scheme are estimated at 28.6% of pensionable pay with an employee contribution rate of 9.5% and an employer contribution rate of 19.1%. After 30 years or so the rate should have fallen to the level where it is based almost entirely on the long-term cost of the new scheme.

7. Over a period then there will be a cost saving of some 8.5% of pensionable pay. Some of this will be reflected in lower police officer’s contributions (1.5%), but there will be a saving to the public purse of some 7% of police pay – representing some £63m (based on 2003/04) million in the Authority’s case. However this is the long term position, in the medium term pensions costs will continue to rise – a fact exacerbated by new entrants paying lower contributions while pensions in payment costs are maintained. Within the revised arrangements for the financing of police pensions it is essential that the government makes appropriate upward adjustment for this increasing cost in SR2006 and future settlements.

Treatment of discretionary payments

8. Responsibility for the cost of discretionary awards will remain with police authorities and these will be a direct charge on the Authority’s budget. A new separate budget will be established for these costs to be charged and monitored. There is a need to continually review policies and procedures in respect of the awarding of discretionary pension benefits to ensure best practice is being followed. The government are bound to assume a rigorous approach is being taken when it considers future revenue grant settlements.

Grant Changes

9. The consultation document sets out the establishment of a different basis for annual formula grant distribution in respect of pensions costs in order to reflect the impact of employer’s contributions and discretionary payments. At a national level the same resources are being put in for pensions financing by the Home Office. The intention is to have a reasonably budget neutral arrangement to avoid the situation where individual authorities are disadvantaged by the consequent changes to grant distribution. The Consultation Paper does note that the grant formula provides overall protection through the floor and ceiling mechanism, though this may be inappropriate for significantly large losses or gains.

10. The Working Group prepared an exemplification based on 2003 pensions data. The exemplification shows a net loss for this Authority of some £29.3 million, but this included the loss of £20 million, which related to the MPA’s Civil Staff Pension uplift (the retention of which will need separate consideration by the Home Office) giving a £9.3m million true net loss position. Testing of this exemplification by the MPS Finance department has indicated that this loss should be some £12 million higher once injury payments and capitalised costs of discretionary payments are properly included. The Working Party will clearly need to reconsider the exemplification again, using more current data. While it is accepted that some gainers and losers are to be expected the size of net loss at some £21 million is unacceptable and is of such a magnitude that it needs to be addressed rather than damped.

Reserves

11. There will still be a need for the Authority to hold reserves to guard against unusually high levels of injury benefits or capital equivalent charges for ill health retirements. The Authority has previously agreed retaining a reduced level of pension reserve and this will be addressed further during the 2006/07 financial planning process. Paragraph 10.12 of the consultation document refers to the reserves built up to help with the peaks and troughs in the current financing of pensions expenditure. The report does state that these reserves will not be clawed back by the government on the implementation of these new arrangements.

C. Race and equality impact

The consultation document has identified the following:

• New arrangements counter a number of shortcomings around volatility in pensions expenditure and uncertainty around how to finance the rising burden in pensions expenditure
• Increased transparency: budgets accurately reflect all the immediate and accruing costs of providing frontline service
• The changes should be cost neutral and have no impact on either the local or national taxpayer
• The arrangements would apply to both the existing and new Police Pension schemes but would not affect the terms and conditions of officers as members of either scheme

However, as indicated in paragraph 8 above the MPA will need to review with the MPS the management of discretionary payments under the pension scheme to ensure that they support management objectives without creating an undue financial burden.

D. Financial implications

The financial implications of the proposed new pension scheme and financing arrangements are set out above and in the response to the consultation paper at Appendix 1. However, it is worth reinforcing that there is a need for the government to make adequate provision in future public spending reviews for the increasing national cost of police pensions even with the introduction of a new scheme for new entrants. The consequential changes to grant distribution should be determined as far as possible to ensure budget-neutral implementation. The proposed approach will help achieve some consistency and identify the real cost of policing.

E. Background papers

• Home Office Consultation on Working Group report on a New System of Police Pensions Financing

F. Contact details

Report author: Ken Hunt Treasurer & Terry Price Director of Strategic Finance MPS

For more information contact:

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

Appendix 1: Draft Letter from the Chair of the Metropolitan Police Authority Finance Committee

Ed Barnard
Police Pensions Section
Police Human Resources Unit
6th floor, Fry Building
Home Office
2 Marsham Street
LONDON SW1P 4DF

Dear Mr Barnard

Police Pensions Finance Reform: Consultation

The MPA welcomes the commitment to improving the system of financing police pensions outlined by the Working Group. The following points address the specific issues identified as being of particular importance in the overall process.

1. The Working Group recommends [paragraph 2.13] starting the new system in 2006/07 – is this feasible in your view?

The proposal to start the new system in 2006/07 is feasible and the MPA/MPS will be ready to implement the new pension scheme by April 2006 and will ensure that the necessary accounting arrangements are in place for the separate pensions account. However, implementing the new financing arrangements will depend largely on acceptable ‘budget neutral’ changes to funding. At present, based on information collated within the Authority it appears that this neutrality is not achieved, with an estimated net loss of c. £21 million (excluding the civil staff pension uplift loss of £20 million).

There is concern that it will be necessary to restate the 2005/06 pension payments for comparison purposes when the 2006/07 final accounts are produced for audit and publication. This means that although the new financing regime does not start until 2006/07 the Authority will by default be required to ensure it can collect the data for the 2005/06 financial year in the same format. With the final details of the new arrangements not due until October 2005 this will leave a very short timescale for the pensions contractor to make any changes that might be necessary to comply with the requirement. It is proposed that the Working Group press the Audit Commission to consider the need to restate previous year comparators.

2. The Working Group recommends [paragraph 4.11] a single employer contribution rate covering both current and new Police Pension Scheme – do you think this is more practical than police authorities having to pay two different rates at the same time, on for the current and one for the new scheme, or do you see advantages in having separate rates?

A single employer contribution rate will certainly be more practical from a number of points of view, especially for setting budgets within a devolved environment.

The proposals for future review of the rate should ensure that forces gain the benefit of the progressively reducing cost of the new scheme within a reasonable timescale, and this seems a reasonable trade-off against the simplicity of a single rate.

3. The Working Group recommends [paragraph 5.17] that ill-health pensions should be paid entirely out of the pensions account but on the basis that the police authority will pay a capital-equivalent charge into the account in order to make up for the added cost to the scheme of the ill-health pensions – do you agree that this is the most effective way of paying ill-health pensions under the new system?

The payment of a capital-equivalent charge for ill health pensions to the pensions account is supported. This ensures proper accountability rests with the MPA/MPS with the pension scheme paying the benefits, but with the employer being charged for the discretionary elements.

4. The Working Group recommends [paragraph 5.21] that the capital-equivalent payments be set at twice the average pensionable pay of the officer being retired and be spread over four years by even instalments – do you think this is:

(a) a reasonable amount and

(b) are you in favour of the four-year spread to avoid lumpiness in such expenditure?

(a) The capital equivalent payment seems reasonable based on the data that is presently available.

(b) The Authority would prefer to be able to choose how to spread the cost. If there were available resources it would be preferable to charge all the cost to one year. Forces would have a greater incentive to control the level of ill-health retirements if the capital-equivalent charge were to be paid fully in the year of retirement. This would also avoid the administration necessary to ensure that the four annual transfers to the pension fund were made. Forces could, if necessary, use reserves to mitigate any exceptional increase in the number of medical retirements. It is also thought likely that accounting rules will require the full accrual of the liability in the operating account in any event, although the balance sheet provision that is then available could still be released to the new pensions account over a four-year period.

5. The Working Group recommends [paragraph 7.5] that the central agency which has an officer seconded to it should reimburse the sending force with the full cost of the officer including employer and employee’s contributions. Since such agencies either do not have to make both such payments at present or pass on only the officers’ contributions, the Group recommends a way to finance this now burden [paragraph 7.7]. Are you content with the way it is proposed to enable the central agencies to meet their new costs?

The adjustment proposed to finance the agencies is generally acceptable. Greater transparency in the costs of central agencies is desirable, although the reference to “directly recruited officers serving in central agencies” is somewhat confusing – presumably paragraph 7.5 should refer to “seconded officers”.

Financing the additional costs of the central agencies from the top-up grant top-slice seems somewhat convoluted. To ensure that adequate provision is made for top-up grant some estimate will need to be made of the additional costs of central agencies – can this not simply be added to their annual budget/grant settlement?

6. The Working Group recommends [paragraph 7.12] that directly recruited officers serving in central agencies should have their pensions costs covered by the same system of financing as for Forces, and that the central agencies involved should explore the possibility of having the pensions account and police pensions administered by a large force such as the Met.

It is agreed that the same system should apply.

The MPA/MPS would require further discussions around its own legal powers and details of how this would work before making any commitment to undertake this function.

7. The Working Group recommends [paragraph 8.7] a method for identifying the amount of resources needed for the Central Government top-up grant. Do you think that this is a fair way of ensuring that a fair share of resources for the cost of pensions in payment between Central Government on the one hand and police authorities on the other? If not, what alternative way would you suggest?

Theoretically the proposals seem reasonable, but they must be placed in the context of practical application to be seen as ‘fair’ – see response at the next item below.

8. The Working Group recommends [paragraph 8.26] that the outcome of the modelling exercise based on 2003-04 figures shows that the degree to which authorities may be winners or losers is manageable, given the long-term benefits of moving to the new system. Do you:

(a) agree with this unreservedly? Or

(b) agree because you expect that the general damping mechanisms likely to be in place for 2006-07, coupled with use of your reserves, should be enough to smooth out winners and losers? Or

(c) want additional damping mechanisms in place and, if so, what mechanisms?

The figures in the modelling exercise appear to understate the costs remaining with Forces’ revenue accounts under the new system. In the case of the MPA/MPS it is believed that, if the employer’s rate was 26.1% as shown in the exemplifications then the cost to the revenue account in 2003/04, including injury pensions to officers, would have been nearer to £253m than the £233m shown-and results in a net loss to the MPA of c.£21million. This is a significantly different picture to the net loss of approximately £10m shown in the exemplifications (even after assuming some way is found to make good the MPA/MPS’s civil (police) staff pensions uplift of c. £20 million). We consider that this demonstrates a possible fundamental flaw in the proposals and is of such magnitude that it needs to be addressed rather than damped.

9. The Working Group recommends [paragraph 9.3] that the introduction of the new system is not accompanied by a transfer of formal responsibility for the payment of police pensions to the Home Office. Do you agree this is the most practical solution for the time being?

It is agreed that this is the most practical solution.

10. The Working Group recommends [paragraph 9.8] a timetable for bidding for and receiving top-up grant. Are you content with what is proposed?

While the timetable appears reasonable, the proposal to pay only 80% of the top-up grant in-year seems particularly low and the missing 20% is certainly not made good by the cash flow advantage of receiving the 80% all in July (especially as any outstanding balance is not paid until the following July). The aim should presumably be for the new arrangements to be cash flow neutral.

11. The Working Group recommends a classification of the different types of pension payments which should be separately identified in the pensions account. Do you think this strikes the right balance between precision on the one hand and avoiding being over-detailed on the other?

The balance appears right; we agree that the level of accounting detail proposed is reasonable.

We consider that if the proposed top-up grant arrangements are implemented as proposed then there will need to be entries on both the income and expenditure side for potential interest charges or receipts depending on the individual Force’s experience of cash flow relating to the pensions account.

It is not clear in what circumstances income categorised “payments from other organisations to offset pensions liabilities” would apply. Presumably it would be simpler to make employer and employee contributions for all officers on the payroll directly into the pensions account each month. If these costs were subsequently recovered then the income would need to be credited to the revenue account to offset the employer’s contribution.

12. The Working Group recommends [paragraph 12.3] a list of issues to be reviewed after 3 to 5 years. Do you agree with this timescale and do you have any further items to add to the list?

We agree with the proposals to review aspects of the new arrangements but with the proviso that earlier review should be undertaken in the event of any obvious and significant problems emerging earlier than the 3 to 5 years outlined. Generally though the review should dovetail with the government’s three year funding regime.

Other Comments

It is not clear whether large specific grants and the MPS’s special payment in respect of national, international and capital city functions will be increased to cover the employer’s pension contribution.

The Working Group may wish to consider lobbying CIPFA/LASAAC Joint Committee to enable the MPA’s present pensions balance sheet liability figure (c. £8 billion) to be removed from the Authority’s balance sheet once the new system starts in April 2006.

The Authority’s position in respect of the Civil Staff Pension Uplift will need to be urgently resolved by the Home Office as presently there is a c.£20 million shortfall identified in the Working Group’s exemplification.

Yours sincerely

Graham Tope, AM
Chair of the Metropolitan Police Authority Finance Committee

Appendix 2: Report of the Working Group on Police Pensions Finance Reform: Executive Summary

Background and the case for reform

1. The Police Pension Scheme is currently financed on a ‘pay-as-you-go’ basis. This means that officers’ pension contributions are paid into police authorities’ operating accounts, out of which the authorities in turn pay the pension awards of former officers as and when they fall due. There is no pension fund from which pension awards are made. Authorities receive funding from Central Government to support payments of pensions as part of general Police Grant.

2. Shortcomings of the current system of financing pensions include:

• volatility in pensions expenditure arising from the uneven incidence of lump sum retirement payments;
• uncertainty about how to finance rising burdens of pensions expenditure;
• uneven treatment between authorities; and
• insufficient separation of pensions costs from other Force expenditure, giving rise to confusion as to the real current cost of policing and to headlines that expenditure on pensions will eat into resources available for their operational commitments.

New system recommended by Joint Review

3. In 2001 a working party of officials from the Treasury, Home Office and Department of Transport, Local Government and the Regions completed their joint review of arrangements for the financing of police and fire pensions. The Joint Review recommended that employee contributions and a new employer's contribution should be paid into a separate pensions account from which pensions outgo (such as pensions awards and lump sums) would be paid. Central Government would top up the account at the end of the year, or recover any surplus, as necessary.

4. The underlying principle is that employer and employee contributions together would meet the full costs of pension liabilities being accrued in respect of current employees while Central Government would meet the costs of paying the pensions of retired officers, net of employee and the new employer contributions. Authorities would continue to administer and pay pension awards.

Status of this Report

5. In 2003 Home Office Ministers agreed in principle to the Joint Review’s recommended reform of police pensions finance but asked that further work be carried out by a group of officials under Home Office chairmanship to examine the details of the new system and how to introduce it successfully. The Working Group recommends that the proposals of Joint Review are developed and implemented as set out in the rest of the report, for introduction in 2006-07. Paragraph 2.13 of Report.

6. All the Working Group’s recommendations are set out in this executive summary together with a brief explanation of the context. Before the detailed recommendations are put into effect they will subject to public consultation. Chapter 13 of this report invites comments on the issues covered by it and also sets out a list of points on which comments are specifically invited, together with details of how to send in comments. A parallel group was set up by the Office of the Deputy Prime Minister (ODPM) to consider fire pensions finance issues. It is proposing similar changes for the financing of the Fire Pension Scheme and making them subject to a parallel consultation exercise.

Details of the new arrangements

7. The new arrangements would counter the shortcomings set out in paragraph 2 above and increase transparency in that authorities' budgets would accurately reflect the all the immediate and accruing costs of providing the frontline service. The changes, at an aggregate level, will be cost neutral and have no impact on either the local or national tax payer. They would apply to both the existing and new Police Pension Schemes but would not affect the terms and conditions of officers as members of either scheme.

Employer contributions

8. The employer contribution rate (or accruing superannuation liability charge - aslc) for each serving officer under the new arrangements will in broad terms start at a level based almost entirely on the long-term cost of the current scheme (at present 26.1% of pensionable pay) since almost all officers will still be members of that scheme. After 30 or so years the rate should have fallen to the level where it is based almost entirely on the long-term cost of the new scheme.

9. It can be argued that there should be different employer contribution rates to reflect the different costs of pensions from Force to Force, rank to rank, and between current and new schemes. However, the Police Pension Scheme is a relatively small public service scheme, over 95% of officers are constables and sergeants, and it is in the interests of the service to encourage inter-Force transfers of experienced officers. The Working Group recommends there should be a single employer contribution rate, or alsc, across all Forces and ranks. The Working Group also recommends a single rate for both schemes which reflects the mix of the two schemes. It is also recommended that the choice between a unified rate changed every review period and one changed annually be put to police authorities for their views, since the issue is finely balanced. Paragraph 4.11 of Report.

10. There is a need for the employer contribution rate to be reviewed regularly enough to ensure it accurately reflects costs, but not so frequently that it causes administrative disruption. The Working Group recommends that such reviews be every 4 years with a mini-valuation at the mid-point, to help financial planning and support resource accounting. Paragraph 4.14 of Report.

Range of benefits paid for out of the pensions account

Injury awards

11. The Inland Revenue will require personal awards and death benefits for attributable injuries, which are not taxed-approved pension benefits, to be excluded from the Police Pension Scheme. As such they cannot be paid out of the pensions account. However, it will not be possible to identify all such awards made before the change in system except for injury pensions to former officers which are flagged up as exempt from income tax. The Working Group notes that from April 2006 injury-related awards should not be paid out of the pensions account. The Group therefore confirms that all new awards, and also existing injury pensions for officers, should be paid out of the operating account. However the Group recognises the severe practical difficulties of identifying other injury awards pre-dating April 2006, and recommends that Forces should be able to pay injury-related survivor pensions pre-dating April 2006 out of the new pensions account. Paragraph 5.3 of Report. This point is being taken up with the Inland Revenue.

Discretionary pension awards

12. The Working Group has considered to what extent awards made at police authorities’ discretion should be paid out of the pensions account. Apart from ill-health retirements discretionary awards apply only where Chief Constables and Deputy Chief Constables retire with an immediate pension before the expiry of their fixed-term appointment (FTA). The Working Group considers that the discretionary element involved is so narrow and the number of likely cases involved so small that it is unnecessary to set up accounting procedures to cover these cases. Paragraph 5.7 of Report.

Ill-health pensions

13. There is a need for equity in how the cost of ill-health pensions is shared between central and local tax payers, and also between authorities, some of which have a better record in relation to ill-health retirements than others. Authorities could pay ill-health pensions out of their operating account up to when the officer would have been retired in any case but this is administratively cumbersome and hides the true costs of ill-health retirement. The alternative is for authorities to make a payment into their pensions account which reflects the added capital-equivalent cost of the ill-health pension including the lump sum – ie the amount by which the one-off cost of financing the ill-health pension exceeds that needed to finance a deferred pension for the officer paid from age 60 (under the current scheme).

14. The Working Group recommends that the more attractive system is one based on the capital-equivalent value. As each retirement takes place a capital-equivalent sum is transferred to the pensions account which means there is a clean break and an asset is received by the pensions account which on average matches the liability that has been assumed, and enables the ill-health pension, including any lump sum, to be paid entirely from that account. In cash flow terms, all parties are left in a neutral position over the long term if experience matches the target. Paragraph 5.17 of Report.

15. The cost of an ill-health pension will vary according to the officer’s age and length of service on retirement. Also, even when well managed, the number of medical retirements each year is subject to fluctuation. The Working Group is keen to avoid complex scales for the capital-equivalent charge and also wants to minimise unevenness of such expenditure from year to year. There is also advantage in getting the new system off to a smooth start by authorities making payments for four years of retirements right from the outset in year one, as if the system had been introduced in 2003-04. The Working Group recommends a standard capital-equivalent charge of twice the pensionable pay of the officer concerned spread over four years, with the payments to be made in the first three years of the new system brought up to a four-year level by what would have been the remaining payments for the retirements during 2003-04 to 2005-06; 2004-05 to 2005-06; and 2005-06 respectively. Paragraph 5.21 of Report.

16. The average rate of pensionable pay across the service may not be the same as the average for officers who are ill-health retired. Forces do not have information at present on the latter figure. The Working Group recommends that for the longer term consideration be given to the employer contribution rate being reduced by an amount related the actual average cost of capital-equivalent payments, but that in the first instance the reduction should relate to an assumed capital cost based on the average pensionable pay across the service. Paragraph 5.25 of Report.

17. If police authorities pay a capital-equivalent charge for each ill-health retirement, their employer contributions need not cover that cost as well. For the moment it is reasonable to reduce the cost of employer contributions on the assumption that Forces will match their current target for ill-health retirements The Working Group recommends that the reduction in the employer contribution rate should be based on the target of 6.5 ill-health retirements per 1,000 officers in service until the contribution rate is given its first review. Paragraph 5.31 of Report.

Pensions costs of officers on central service and transferred between Forces

Officers seconded to central service

18. The introduction of a new system of pension financing provides an opportunity to reform the way in which the costs of officers on central service are met and accounted for. At present the seconding Force is not reimbursed for the cost of their officer’s accruing pension. The Working Group recommends that under the new system the central agency should in all cases reimburse the Home Force with the full cost of salary, including NI and employee’s contribution, plus the full aslc, which would be credited to the new pensions account of the Force. Paragraph 7.5 of Report.

19. A problem with such a change is that central agencies will not have the resources to make the new payments to the sending Forces. The Working Group recommends that the additional resources required by the central agencies to pay to the sending Forces the employee and employer contributions in respect of their seconded officers should in the first year be met out of the total set aside for top-up grant. In this way the sending Forces will still have their pensions accounts fully topped up at no loss to their operational budgets. Paragraph 7.7 of Report.

Officers directly engaged by central agencies

20 There is also the issue of whether, and how, central agencies should change their financing of the pensions costs of their directly engaged officers. The Working Group recommends that directly recruited officers serving in central agencies should have their pensions costs covered by the same system of financing as is proposed for the Forces and that the central agencies involved should explore the possibility of having their pensions account and police pensions administered by a large Force such as the Met. Paragraph 7.12 of Report.

Transfer values

21 At present a certificate of the officer’s pensionable service is provided when an officer moves from one Force to another. The payment of a transfer value instead would confirm that a pensions liability was being passed for one pensions account to another. However, such an arrangement would be administratively cumbersome and have no real benefits since all pensions accounts will be topped up in any case. The Working Group recommends that transfers within employers operating under the Police Pension Scheme should continue to be accompanied by a certificate of service. Paragraph 7.16 of Report.

How to move to the new system

22. In the first year of the new financial arrangements the grant allocation will need to be divided between Police Grant and the funds that will be transferred to the new top-up grant.

23. The aim is that neither the national nor the local taxpayer is disadvantaged by the proposed changes. To achieve this, a fair split is needed between the funds left in Police Grant and the funds transferred to the new top-up grant. In future spending reviews there would be two separate funding streams: one for the new top-up grant and one for general operational expenditure.

25. Subject to the outcome of the consultation on the proposal for implementing three-year settlements, our intention is that we would take at least an initial decision on the split for both 2006/7 and 2007/8 in the 2006/7 local government settlement. The Working Group recommends that GAD should carry out the task of isolating the amount needed for central grant by applying the method set out [in paragraphs 22 and 23] above to their latest best estimates for pensions expenditure and pensionable pay in 2006/07. Paragraph 8.7 of Report.

Modelling exercise

26. A key part of the remit of the Working Group has been to test that the transition to the new system would be manageable. This has been done by modelling exercise, based on 2003-04 figures, which showed the effect on the distribution of Police Grant of taking out about £90 million from the Grant Settlement for use as top-up grant. The overall picture was that while there were winners and losers among Forces as a result, the degree to which they would have won or lost appeared to be manageable, given the long-term benefits of moving to the new system. The Working Group recommends that change to the new system should proceed as proposed above, subject to the proposed consultation exercise launched by this report allowing Forces to judge for themselves and comment accordingly. Paragraph 8.26 of Report.

26. The police funding formula is currently being reviewed with a view to making changes to it in 2006/07. The effects of stripping out the amount needed for top-up payments may therefore be exacerbated or mitigated if there are other changes made. These changes would also be consulted on as part of a general consultation on the police funding formula in July-September 2005.

Central or local responsibility for pension payments

27. There is a case for the new arrangements to be accompanied by a move to make the Home Office formally responsible for the payment of police pensions to retired officers. However, such responsibility would carry with it a requirement to account for all such expenditure, with the need for the Home Office to receive regular and detailed reports from police authorities. The Working Group recommends that the introduction of a new system of pensions finance should not be overburdened by also bringing in a new reporting system and accompanying legislation. It recommends instead that formal responsibility should be left with police authorities for a trial period while the new finance system beds down and that the issue should be reviewed after 3 to 4 years. Paragraph 9.3 of Report.

New payment and accounting procedures

28. The existing powers of the Police Pensions Act 1976 are sufficient to provide for regulations to set up a new procedure for the Home Office to balance the pensions accounts each year, either by paying out top-up grant or receiving payments where such accounts are in surplus. The Working Group recommends that the top-up payment could be made by the Home Office within the following cycle:

• November 2005 – PA sends HO estimate of deficit/surplus in pensions account for 2006/07 and 2007-08
• July 2006 – HO pays to PA/deducts from PA 80% of approved estimate for 2006/07
• November 2006 – PA sends HO estimate of deficit/surplus in pensions account for 2007/08 and 2008-09
• May 2007 – PA sends HO unaudited account of deficit/surplus in pensions account for 2006/07
• July 2007 – HO pays to PA/deducts from PA:
  • remainder unaudited deficit/surplus for 2006/07
  • 80% of approved estimate for 2007/08
  • netting off as necessary.
• November 2007 – PA sends HO:
  • audited account of deficit /surplus in pensions account and final grant claim for 2006/07
  • estimate of deficit/surplus in pensions account for 2008/09 and 2009-10
• May 2008 – PA sends HO unaudited account of deficit/surplus in pensions account for 2007/08
• July 2008 – HO to PA/deducts from PA:
  • funds to settle audited account for 2006/07
  • remainder unaudited deficit/surplus for 2007/08
  • 80% of approved estimate for 2008/09
  • netting off as necessary etc Paragraph 9.8 of Report.

29. With the need to show that the pensions account has been used only for approved purposes, it would help if police authorities adopted standard categories of pension scheme expenditure. The Working Group recommends that accounts from April 2006 show the level of detail set out at paragraph 10.2 [of the report]. Paragraph 10.7 of Report.

30. There will still need to be reserves to guard against unusually high levels of injury benefits or capital-equivalent charges for ill-health retirements. The Working Group therefore recommends that police authorities should consider retaining reserves for expenditure on capital-equivalent payments for ill-health retirements and injury awards. Paragraph 10.14 of Report.

31. The Working Group recommends that the Government should review the new financial arrangements for the Police Pension Scheme within 3 to 5 years of their implementation. The key issues to be considered are likely to include:

• Further consideration of the employer’s contribution rate being reduced by an amount related the actual average cost of capital-equivalent payments for ill-health retirements.
• Whether Central Government should assume responsibility for the payment of police pensions;
• Whether the amount to be paid into the pensions account for each ill-health retirement needs to be adjusted;
• Whether the Welsh Forces should have a devolved system of financing separate from the English Forces. Paragraph 12.3 of Report.

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