UK civil servants' radical departure
Fairly or unfairly, the UK Civil Service is perceived by the public as an organisation that is suspicious of change. Its conservatism and dislike of innovation has been regularly, if affectionately, satirised.
However, the Civil Service’s new pension scheme, launched last October, can claim to be truly innovatory. The arrangements, which cover more than half a million employees, have set the pace in public sector pension schemes, particularly in its provision of benefits for unmarried partners.
It has also provided an unexpected challenge to the approach of the private sector where companies are closing final salary defined benefit (DB) schemes and replacing them with defined contribution (DC) type schemes. The new pension arrangements for the Civil Service offer a choice of both DB and DC pension plans to most employees.
The agendas are, of course different. Private sector companies want to limit liabilities and cut funding costs, while the Civil Service initiative is designed to be cost neutral. However, it does demonstrate that DB and DC schemes can co-exist as employee choices. They are not mutually exclusive.
The new Civil Service pension plan is a product of the Civil Service reform programme started by Sir Richard Wilson in 1999. One of the aims of the programme is to recruit more widely from the private and voluntary sectors, attracting people who may not necessarily see the Civil Service as a job for life.
Peter Spain, pensions manager at Civil Service Pensions, says the new pension arrangements have been designed to underpin this objective. “The reform agenda envisages people coming in and out of the Civil Service from both the public and private sectors and we wanted pension arrangements that supported that in terms of recruitment, retention and reward.”
Merely upgrading the old pension scheme was not enough, he says. “The Principal Civil Service Pension Scheme, the PCSPS, was 30 years old. So rather than tinkering with the existing scheme, we decided to provide something that was better for employers and that better represented the way we live today.
“We felt that the choice of a DC scheme provided something that was perhaps more suitable for people who changed jobs frequently, and who maybe had a history of money purchase types of arrangement. But equally a final salary DB option would still be attractive to people who envisaged a longer term career in the Civil Service.”
Under the new dual arrangements, people employed by the Civil Service before 1 October 2002 have three choices. They can remain in the original final salary DB scheme, now renamed the ‘classic’ pension plan. In this scheme, they will continue to earn a pension based on one-eightieth of pay for each year of service plus a retirement lump sum of three times pension. The employee contribution rate will remain at 1.5%.
Alternatively, they can transfer to the new DB scheme, named the ‘premium’ plan. This is an enhanced DB plan that provides a pension based on one-sixtieth of final pensionable pay for each year of service with an option to exchange a proportion for a lump sum. Other improvements include a higher death in service lump sum than the ‘classic’ scheme – increased from two times to three times pay – and survivors’ pension rights for eligible unmarried partners. The employee contribution rate is 3.5%.
People who switch from the ‘classic’ to the ‘premium’ plan will have their past service reduced – typically to 92% of the previous amount – to take account of the improved benefit structure.
Pensions for unmarried partners is a big step. Although common in the UK’s private sector, it is rare in public sector schemes. The move has been warmly welcomed by the trade unions, who have been lobbying for a change to pensions legislation.
Spain says that the inclusion of the unmarried partners enhancement was a further reason for radically re-designing the pension arrangements rather than bolting on improvements to the original design: “From an administrative point of view it would have been very difficult to change the existing arrangements and introduce the pensions for unmarried partners. Government policy has always been that the member should pay for that improvement, and the best way of doing that was to have a choice of new arrangements.”
The third option is a combination of the ‘classic’ and the ‘premium’ plans called the ‘classic plus’. In this plan, members are pensioned broadly under the old ‘classic’ arrangements until 31 September 2002 and under the new ‘premium’ arrangements from October 2002.
New entrants to the Civil Service are offered a different set of choices. People who have joined the Civil Service after 1 October 2002 have been offered a choice of the new ‘premium’ DB scheme or a DC stakeholder scheme called ‘partnership’. In the DC scheme, employers pay age-related contributions ranging from 3% for employees under 21 to 12.5% for those aged 46 and over. Employees do not have to contribute, but employers will match any employee contributions up to 3% to encourage them to do so.
People who opt for a ‘partnership’ pension account can draw their pension at any time between 50 and 75, whether or not they are still working. They can also take up to 25% of their pension pot as a tax-free lump sum. They have an “open market option” to shop around for annuity and considerable flexibility in the type of annuity they can buy. They can choose to buy an income solely for themselves, or can arrange for their spouse or partner to continue to receive an income after they die.
Members of the ‘partnership’ plan can choose their stakeholder provider from a panel of four – AMP-NPI, Scottish Widows, Standard Life and the TUC. These were chosen through a competitive procurement process, says Spain: “We selected them all on the basis of their financial strength and their expected ability to survive in the stakeholder market. We also tried to pick providers that offered something in their own right – a lower charge, a slightly different governance structure, or a slightly different investment choice.”
A willingness to work with the other providers was also an important consideration, he adds. “We are very pleased at the way they have worked together because obviously there are certain processes that they have had to standardise to make it easier for our employers to deal with them.”
Unlike many DC schemes in the private sector, the ‘partnership’ scheme is no cheaper than the new ‘premium’ DB scheme. The Government Actuary’s Department has constructed the level of employers’ contributions on the basis of parity of costs between the new DC and DB schemes. The overall costs have been designed to be broadly similar, whichever pension option is chosen, bearing in mind that the DC option will be more attractive to people with short service.
“The agenda has never been to cut costs,” Spain emphasises. “It has always been that changes should be cost-neutral and that any improvements in scheme benefits should be paid for by the members.”
Employees are not compelled to stick with their initial choice of DB or DC, he adds. They are given the opportunity to make one switch in either direction – from ‘partnership’ to ‘premium’ or vice versa. “A common scenario is someone who did not expect to stay very long and thinks the DC plan is going to provide him with a better deal but then ends up staying longer than they expected. They will able to switch into the DB scheme.”
One useful spin-off from re-design has been an increased interest in pensions on the part of employees. Spain explains: “It’s been a massive exercise. Each member has been written to, and the choices have been explained to them. By giving people choice, the entire exercise has raised awareness of the pensions element of the reward package. It has also raised appreciation of pensions. We’ve found that even if people haven’t decided to move schemes, they’ve become much more knowledgeable. There’s been great interest, for instance, in paying additional contributions, just because it has been raised in their minds that pensions are important.”
At a time when public confidence in pensions and pensions plans is faltering, this can only be to the good.