Change to cost of voluntary pension benefits and early retirement in public sector

hugheskevi

I haven't seen any discussion on this board of the recent change to the SCAPE discount rate, reducing it from CPI+2.4% to CPI+1.7% so thought I'd flag it for awareness. The limited coverage I have seen of the change all focuses on the impact this change will have on employer contribution rates, as it will lead to a significant increase in those rates. This is not of direct concern to members of the schemes though as it will not have an effect on the pension they are accruing.

However, the discount rate is also used to calculate the cost of voluntary member benefits in public service pension schemes such as Added Pension, EPA, ERRBO, Buy-Out, Faster Accrual, etc. The cost of these will all increase too once actuarial factors are updated based on the new discount rate, although not necessarily for members already purchasing these if payment terms are set at the commencement of the contract. On the positive side, it should reduce early retirement actuarial reductions.

So for anyone either purchasing voluntary benefits, taking early retirement, or thinking of doing so, it would be worth ensuring you understand the financial consequences of the change to the SCAPE discount rate, and how it might impact your decisions.

For context, when the SCAPE discount rate was changed over to CPI it was set at CPI+3.0%, it was then reduced to CPI+2.8%, then to CPI+2.4% and now to CPI+1.7%. The policy intent of the SCAPE discount rate is to reflect expected GDP growth - importantly, it does not mirror financial markets where recently interest and gilt/bond rates have been increasing.

MX5huggy

@hugheskevi Can you explain:- “On the positive side, it should reduce early retirement actuarial reductions.” Vs the need to understand for those taking early retirement (which I take to mean if retiring early you’ll get less). 

m_c_s

hugheskevi said:

On the positive side, it should reduce early retirement actuarial reductions.

Thanks hugheskvi, I was aware of this happening and waiting for the new Alpha reduction factors to come out. I assume they will appear sometime before April 2024 when this new SCAPE discount rate starts.

michaels

Really useful, thanks.

I am purchasing EPA and added pension but also hoping to retire early so I guess swings and roundabouts.  Seems like I should max out added purchases by the end of the current FY if changes are due to take effect from April 24.  The increase in AA to 60k will be useful.

m_c_s

As I understand things Pension schemes were asked to suspend some calculations such as cash-equivalent transfer values (CETVs), early and late retirements and additional pension purchases, because these are based on the SCAPE rate.

I have just checked and I think this now seems to happening this FY so seems to have started from April 2023 and not 2024. I would assume then that the new factors should be available this month.

m_c_s

Additionally I would expect the new lower discount rate to result in smaller actuarial reductions applying where pensions are drawn early (a positive) but conversely any uplift applied on late retirement after NPA would be smaller (a negative).

michaels

m_c_s said:

As I understand things Pension schemes were asked to suspend some calculations such as cash-equivalent transfer values (CETVs), early and late retirements and additional pension purchases, because these are based on the SCAPE rate.

I have just checked and I think this now seems to happening this FY so seems to have started from April 2023 and not 2024. I would assume then that the new factors should be available this month.

Thanks.

So does this mean that my EPA and added pension contributions I am making this year may be buying me less pension than I thought they were?

michaels

hugheskevi said:

I haven't seen any discussion on this board of the recent change to the SCAPE discount rate, reducing it from CPI+2.4% to CPI+1.7% so thought I'd flag it for awareness. The limited coverage I have seen of the change all focuses on the impact this change will have on employer contribution rates, as it will lead to a significant increase in those rates. This is not of direct concern to members of the schemes though as it will not have an effect on the pension they are accruing.

However, the discount rate is also used to calculate the cost of voluntary member benefits in public service pension schemes such as Added Pension, EPA, ERRBO, Buy-Out, Faster Accrual, etc. The cost of these will all increase too once actuarial factors are updated based on the new discount rate, although not necessarily for members already purchasing these if payment terms are set at the commencement of the contract. On the positive side, it should reduce early retirement actuarial reductions.

So for anyone either purchasing voluntary benefits, taking early retirement, or thinking of doing so, it would be worth ensuring you understand the financial consequences of the change to the SCAPE discount rate, and how it might impact your decisions.

For context, when the SCAPE discount rate was changed over to CPI it was set at CPI+3.0%, it was then reduced to CPI+2.8%, then to CPI+2.4% and now to CPI+1.7%. The policy intent of the SCAPE discount rate is to reflect expected GDP growth - importantly, it does not mirror financial markets where recently interest and gilt/bond rates have been increasing.

Does anyone have any knowledge of how the change might impact the actuarial reductions for taking alpha early (order of magnitude)?  Perhaps old data on what impact the previous reductions made might help? Thanks

A quick google suggests it is not compulsory for schemes to use the SCAPE rate when calculating actuarial reductions so I guess there could be no change to these.  It would be a bummer if contribution rates were increased for EPA/Added on the back of a cut in SCAPE but actuarial reductions remained the same

hugheskevi

MX5huggy said:

@hugheskevi Can you explain:- “On the positive side, it should reduce early retirement actuarial reductions.” Vs the need to understand for those taking early retirement (which I take to mean if retiring early you’ll get less). 

The discount rate determines the value of the pension (other things being equal, eg, longevity assumptions). A lower discount rate means a higher pension value and vice-versa.

A higher value of pension is bad if purchasing pension, as it obviously costs more. In the case of early retirement you can imagine all the future pension payments. The discount rate has relatively little effect on the first few years, but over time the compounded difference means that pension which will be paid later in life is now much more valuable. Hence when making the trade of a lower pension in return for it to be paid longer, as the pension is more valuable the reduction to achieve actuarial neutrality is now lower.

As an aside, this is a good example of why one should always be skeptical about anything described as being actuarially neutral,, and seek to understand the assumptions underlying the calculations - at some point, all the factors will change and be materially different from one day to the next, yet will always be described as being actuarially neutral.m_c_s said:

hugheskevi said:

On the positive side, it should reduce early retirement actuarial reductions.

Thanks hugheskvi, I was aware of this happening and waiting for the new Alpha reduction factors to come out. I assume they will appear sometime before April 2024 when this new SCAPE discount rate starts.

I think schemes have to implement new factors as soon as practicable, rather than delaying to a future date. Otherwise they are not offering the 'correct' factors.

m_c_s said:

As I understand things Pension schemes were asked to suspend some calculations such as cash-equivalent transfer values (CETVs), early and late retirements and additional pension purchases, because these are based on the SCAPE rate.

I have just checked and I think this now seems to happening this FY so seems to have started from April 2023 and not 2024. I would assume then that the new factors should be available this month.

This page suggests the following have been suspended: 

• Cash Equivalent Transfer Values (CETVs)
• Non-Club transfers
• Divorce quotations

In the past I think at least one scheme has rolled out updated factors at different dates as they become available, with higher priority factors rolled out first.

m_c_s said:

As I understand things Pension schemes were asked to suspend some calculations such as cash-equivalent transfer values (CETVs), early and late retirements and additional pension purchases, because these are based on the SCAPE rate.

I have just checked and I think this now seems to happening this FY so seems to have started from April 2023 and not 2024. I would assume then that the new factors should be available this month.

Thanks.

So does this mean that my EPA and added pension contributions I am making this year may be buying me less pension than I thought they were?

I very much doubt the EPA purchase would be affected, as you were notified of the price of that before 2023/24 started.

If you are buying monthly Added Pension purchases then they may well be affected from whatever the date of change is though, and members are only usually notified of the details at the outset of the purchase, and not informed if the discount rate (and hence the price) changes.michaels said:

hugheskevi said:

I haven't seen any discussion on this board of the recent change to the SCAPE discount rate, reducing it from CPI+2.4% to CPI+1.7% so thought I'd flag it for awareness. The limited coverage I have seen of the change all focuses on the impact this change will have on employer contribution rates, as it will lead to a significant increase in those rates. This is not of direct concern to members of the schemes though as it will not have an effect on the pension they are accruing.

However, the discount rate is also used to calculate the cost of voluntary member benefits in public service pension schemes such as Added Pension, EPA, ERRBO, Buy-Out, Faster Accrual, etc. The cost of these will all increase too once actuarial factors are updated based on the new discount rate, although not necessarily for members already purchasing these if payment terms are set at the commencement of the contract. On the positive side, it should reduce early retirement actuarial reductions.

So for anyone either purchasing voluntary benefits, taking early retirement, or thinking of doing so, it would be worth ensuring you understand the financial consequences of the change to the SCAPE discount rate, and how it might impact your decisions.

For context, when the SCAPE discount rate was changed over to CPI it was set at CPI+3.0%, it was then reduced to CPI+2.8%, then to CPI+2.4% and now to CPI+1.7%. The policy intent of the SCAPE discount rate is to reflect expected GDP growth - importantly, it does not mirror financial markets where recently interest and gilt/bond rates have been increasing.

Does anyone have any knowledge of how the change might impact the actuarial reductions for taking alpha early (order of magnitude)?  Perhaps old data on what impact the previous reductions made might help? Thanks

I don't, sorry. However, this is a very significant reduction to the discount rate, so I think the difference in factors will similarly be significant, leading to a large cliff-edge difference on the implementation date.

michaels

I wonder what happens with transfers in.  Mine is complete, but for others I wonder if you have a quote whether it will be honoured or will depend on the cost when the transfer actually happens?

michaels

I have done some random spread-sheeting as I don't really know how the maths works which comes up with the actuarial reduction being about 2% lower for a pension taken 10 years early.