Teachers’ Pension Scheme: SCAPE discount rate consultation

The Government has announced  the outcome of the 2021 'Superannuation Contributions Adjusted for Past Experience' (SCAPE) discount rate consultation.

Their decision is to retain the existing approach and, what’s more, to confirm that the new discount rate that will apply the 2020 Teachers Pension Scheme (TPS) and Scottish Teachers Pension Scheme (STPS) valuations has been reduced from inflation plus 2.4% pa to inflation plus 1.7% pa. This reduction in discount rate is likely to have a profound impact on the employer contribution rates arising from the valuation, with material increases in costs now seeming much more likely.

Recap: the key drivers for the cost of pension scheme benefits

Pensions are long-term arrangements and if we want to know how much to pay today to provide a pension decades from now, we have to make a series of assumptions about how that pension might look when today’s workforce comes to retire. 

Given a particular pension scheme’s structure (in other words, the formula for calculating benefits), assumptions are needed to determine the costs:

• How long will that pension be paid for? 
• How will the amount of pension change over the course of an individual’s life both before and after retiring?
• How much money is needed today to provide that pension in the future?

This calculation can become hugely complex, with assumptions covering life expectancies, population demographics, price inflation and salary growth key, but the assumption that converts all of this complexity into a final answer – “what is the cost today?” – is the discount rate.

Background: the discount rate consultation

The assumption that can have one of the largest impacts on the cost of pension benefits is the SCAPE discount rate. For the 2016 valuations, this was set by reference to long-term projections for UK GDP growth, but this was the subject of a planned consultation carried out during the summer of 2021.

The discount rate used to assess TPS and STPS pension costs has reduced in recent time. In the 2012 valuation it stood at 3.0% pa above inflation (reduced from 3.5% pa at the previous valuation). It was reduced further to 2.4% pa above inflation in the 2016 valuation.

The 2016 valuation report noted that the impact of a 0.25% pa reduction in discount rate was to increase the basic employer contribution rate by 5.3% of pensionable pay, while the 2021 consultation stated that a 0.25% pa change in the SCAPE discount rate could change employer contribution rates by between 4% and 11% of pensionable pay.

The Government had considered moving away from this approach and instead using what is known as the Social Time Preference Rate (STPR), a rate used when appraising projects that involve spending money in the short term to deliver future welfare benefit. STPR was also used to assess public sector pension costs prior to the 2011 review.

STPR is currently 3.5% above inflation. Even allowing for adjustments to this rate that had been proposed as part of the consultation, considering the adoption of STPR and a potential “economic check” raised the possibility that the discount rate to be used in the 2020 valuations might not be as low as some commentators had suggested. These alternative methodologies potentially opened the door to reductions or smaller changes to the contribution rate.

The outcome

The consultation response report is a lengthy document and discusses in detail the many responses received, included a large number from the independent schools sector. The impact on independent schools is noted in several places, including recognition of the fact that increasing costs is leading many such institutions to consider their long-term participation in the pension scheme. One of the consultation responses relayed was:

The consultation notes that the introduction of Phased Withdrawal is one way to reduce the short-term impact.

The report considers the arguments for and against a move away from SCAPE, but ultimately concludes that:

• the existing methodology best meets the balance of the Government’s objectives, noting some of the other methods may fair better against one particular objective;
• it therefore does not intend to change the methodology; but
• it will move to a four-year review cycle that coincides with the public sector valuation cycle.

The announcement to Parliament on 30 March 2023 then confirms that the SCAPE discount rate for use in the 2020 valuations will be CPI inflation plus 1.7% pa.

The Government recognises that this is likely to lead to higher employer contribution rates, and undertakes to provide additional funding to cover this additional cost but only in respect of those employers who are centrally funded through departmental expenditure by Government.

The impact

The 2020 valuations are still under way and the results depend on a whole raft of assumptions, some of which are set by the Treasury and some proposed by the Government Actuary. Some of these assumptions can have very significant impacts, such as life expectancy. However, the discount rate is, in most cases, the assumption that has the largest impact on the outcome and so the announcement of a 0.7% pa reduction in this rate makes it highly likely that employer costs will increase on the back of the 2020 valuation results.

How much of an increase is still an open question but, based on sensitivities set out in the 2016 TPS valuation report, and comments in the 2021 discount rate consultation document, it would not be unreasonable to expect the discount rate impact by itself to lead to an increase in contributions of over 10%, which would take the employer rate well over 30%. There may be some interaction with the cost control mechanism and the impact on each public sector scheme will be different. There may also be further changes in the Government’s position.

It should be stressed that other assumptions could have an offsetting effect (for example, if improvements in life expectancy are not as rapid as had been assumed in 2016), but the chances of a material school contribution rate increase now seem far higher.

The cost control mechanism has been significantly watered down following its own 2021 consultation, but the discount rate changes continue to operate outside of this. While the cost control mechanism has been amended so that it should be far less likely to result in the kind of ‘double whammy’ impact we saw in 2019, it doesn’t do anything to help schools with the impact of increased costs arising from the fall in the discount rate.

There is, as yet, no timescale given for the release of the final valuation results, but the Parliamentary statement does confirm that new employer contribution rates will be implemented from April 2024.

Please contact your Barnett Waddingham consultant if you would like to discuss the above topic in more detail. Alternatively get in with touch Tim Williams, Associate and FIA or Martin Willis, Partner and APFS.