What is the significance of “employer contribution” in the civil service pension?

IdéeFixe

I’m trying to understand what this number represents. For instance for salary between ___ and ___ thousand, the employee has to pay X% and the employer “contributes” Y%, eg. 27.3%. In the “Alpha” scheme.

Firstly, does it have any bearing on the lump sum you can claim? I know it doesn’t affect the recurring annual pension entitlement, which is basically a function of your salary each year that you were a member of the scheme.

Secondly, if it doesn’t link to your personal benefits, in what way does this number relate to the cost of running the scheme for the employer? Is it saying, to account for this scheme, this is the money we set aside in the budget? In which case, how exactly does that translate to the benefits they’re paying out? And if it’s not that, then what does it mean?

Tommyjw

Wouldnt worry about it, it means nothing to you.

At all stages fo your DB pension there are certain guarantees. Guarantees to increase in deferment before you retire, guarantees to increase in payment once you retire, these are costly and the employer contributes a high amount to fund these guarantees. 

JoeCrystal

Remember that the employer's contributions are nominal and do not reflect the actual cost. I mean, 27.3% is purely there as a part of a funding valuation using different assumptions. If they did the current service cost, then it would be 64% of your pay instead. Contributions from employees and employers are barely increasing over the last few years, while pensioners' costs are rising much faster.

In other words, the amounts of employees' and employers' contributions are meaningless since the HM Treasury covers all the shortfall anyway.

There is nothing for you to worry about in this case.

IdéeFixe

JoeCrystal said:

Remember that the employer's contributions are nominal and do not reflect the actual cost. I mean, 27.3% is purely there as a part of a funding valuation using different assumptions. If they did the current service cost, then it would be 64% of your pay instead. Contributions from employees and employers are barely increasing over the last few years, while pensioners' costs are rising much faster.

In other words, the amounts of employees' and employers' contributions are meaningless since the HM Treasury covers all the shortfall anyway.

Could you elaborate on what you mean by the “current cost basis” and 64%?

JoeCrystal

IdéeFixe said:

Could you elaborate on what you mean by the “current cost basis” and 64%?

You can always read the annual report for the civil service pension scheme. In this case:

The current service cost (expressed as a percentage of pensionable pay) in respect of accruing costs in the year ended 31 March 2021 was determined using the PUCM and the demographic and financial assumptions applicable at the start of the year; that is, those adopted as at 31 March 2020 in the 2019-20 account. 64% is the current service cost expressed as a % of pensionable pay.

So you got the employer's contribution already down as 27.3%, the employee contributions averaged out as 5.7%, which added up to a total contribution of 33%, which makes sense. But, since the combined employees and employers contributions is insufficient to cover pensions to the current pensioners, excess money to cover the cost got to come from somewhere else, aka HM Treasury so therefore 64% overall., 

hugheskevi

JoeCrystal said:

IdéeFixe said:

Could you elaborate on what you mean by the “current cost basis” and 64%?

You can always read the annual report for the civil service pension scheme. In this case:

The current service cost (expressed as a percentage of pensionable pay) in respect of accruing costs in the year ended 31 March 2021 was determined using the PUCM and the demographic and financial assumptions applicable at the start of the year; that is, those adopted as at 31 March 2020 in the 2019-20 account. 64% is the current service cost expressed as a % of pensionable pay.

So you got the employer's contribution already down as 27.3%, the employee contributions averaged out as 5.7%, which added up to a total contribution of 33%, which makes sense. But, since the combined employees and employers contributions is insufficient to cover pensions to the current pensioners, excess money to cover the cost got to come from somewhere else, aka HM Treasury so therefore 64% overall., 

I don't think that is quite the right interpretation.

Both the 33% and 64% figures are the estimated cost to fully fund the scheme, it isn't the case that 33% is underfunding the scheme.

The difference arises primarily because of the discount rate used to set the contribution rate (SCAPE rate, based on expected GDP growth) and the discount rate used in accounting calculations, which was much lower but due to recent interest and gilt yield increases is likely to be much higher when the figures are next updated.

Which is the most appropriate discount rate to use is the basis of a lot of discussion.

HMT pays the difference between the money paid out by the scheme to pensioner members, deaths in service, etc, and the amount received by the scheme from member and employer contributions. That is a different metric to the percentages above which seek to value the cost of the scheme.

IdéeFixe

So… there is some notion that this employer contribution (plus the employee one) is on average enough to “fully fund” the benefits that will be later paid out? Because the sums allocated are expected to accrue interest in accordance with the discount rates?

hugheskevi

IdéeFixe said:

So… there is some notion that this employer contribution (plus the employee one) is on average enough to “fully fund” the benefits that will be later paid out? Because the sums allocated are expected to accrue interest in accordance with the discount rates?

Yes, as well as fund administration costs and repaying a notional past service deficit.

Of course, the allocation is notional as the scheme is run on a pay as you go basis and so no returns are ever actually earned. And in practice, HM Treasury allocates money to employers then takes that money back in employer contributions, so it is all very circular.

Also remember that is all at overall fund level, and the value for an individual is much different, with the pension costing much more for older members than younger members.

MX5huggy

IdéeFixe said:

So… there is some notion that this employer contribution (plus the employee one) is on average enough to “fully fund” the benefits that will be later paid out? Because the sums allocated are expected to accrue interest in accordance with the discount rates?

No Civil Service DB pensions are “unfunded” there is no individual or collective pot building up and invested to pay pensions in the future, todays workers are paying the pensions of todays pensioners. In exchange you have a government guarantee to pay you the agreed pension just like national insurance works. Most other public sector pensions are the same (NHS, teachers, MoD) the big exception is Local Government (LGPS). This is a funded scheme where contributions are put into a big pot (actually 86 pots because LGPS is made up of different schemes covering different areas) this is invested and pays pensions out but on a DB basis. 

The only relevance of the employer contribution is to see how much the pension is worth, ie to be tempted to a job outside civil service with out a DB pension you would want about a 30% pay increase to be possibly equivalent to current salary including pension. 

IdéeFixe

MX5huggy said:

IdéeFixe said:

So… there is some notion that this employer contribution (plus the employee one) is on average enough to “fully fund” the benefits that will be later paid out? Because the sums allocated are expected to accrue interest in accordance with the discount rates?

No Civil Service DB pensions are “unfunded” there is no individual or collective pot building up and invested to pay pensions in the future, todays workers are paying the pensions of todays pensioners. In exchange you have a government guarantee to pay you the agreed pension just like national insurance works. Most other public sector pensions are the same (NHS, teachers, MoD) the big exception is Local Government (LGPS). This is a funded scheme where contributions are put into a big pot (actually 86 pots because LGPS is made up of different schemes covering different areas) this is invested and pays pensions out but on a DB basis. 

The only relevance of the employer contribution is to see how much the pension is worth, ie to be tempted to a job outside civil service with out a DB pension you would want about a 30% pay increase to be possibly equivalent to current salary including pension. 

Well this is kind of the crux of the matter. If I was on 50k salary and a member of the Alpha scheme, and I switched the private sector for an extra 15k (+30%) which I then put into retirement savings, would I be wealthier? Not with Gilt yields. True I could use riskier investments, but then I’ve lost the government guarantee. So the 30% figure (or 27.3%) doesn’t seem useful/accurate as a way to compare salaries (and also the value would vary greatly across the age range anyway). From what I can see.

MX5huggy

Exactly the DB pension is very valuable. £50 k per year gets you £1160 of index linked pension for life from pension age, if you die you dependent pensions but then the money stops when they die. 

alternatively you could have £15k to invest in a DC pension. If you can invest beating inflation great but 4% drawdown is £600 per year. But it doesn’t die with you. 

It’s swings and round abouts and what you value.