School and college contributions to teacher pensions may rise above 18%

In this week's budget, the Treasury has made a technical change which is expected to increase costs for public service employers by £2 billion in three year's time (in 2019-20). This note explains why this could see the employer contribution to the Teachers Pension Scheme rise above 18% (all other things being equal). The Treasury decision is explained on Page 93 of the budget book (paragraph 2.13) in the following way: "The government has reviewed the discount rate used to set employer contributions to the unfunded public service pension schemes. The discount rate is being set at 2.8% and employers will pay higher contributions to the schemes from 2019-20 as a result" In the budget scorecard (on Page 84), the decision is recorded as saving the Treasury £1,970 million in 2019-20 and £2,005 million in 2020-21. The Office of Budget Responsibility discusses this forecast briefly in its Economic and Fiscal Outlook and said that the saving might have been £2.5 billion a year were it not for expected job losses and pay restraint in public service employers. This saving for the Treasury is a cost paid by public service employers, including schools, colleges, hospitals and the armed forces. The amount that they pay as employers to public sector schemes is set by the Treasury following a valuation by the Government Actuary. The lower discount rate (interest rate) on public sector pensions means that the next valuation of various schemes (teachers, NHS, civil service etc) will report a higher net present value (NPV) for future pension costs and thus a higher liability. This means that the deficit will be bigger and there will be a greater need for future contributions. In the distant past, HM Treasury might have covered this from general taxation but the rules on public sector pensions now require costs to be picked up either by staff or employers. There are statutory cost sharing mechanisms but these limit the cases where staff pay more and leave employers with the biggest risk of higher contributions. This is the route from a lower discount rate to higher costs for schools and colleges. The last valuation of the Teacher Pension Scheme was published in 2014 and valued the scheme as it stood in 2012. The valuation estimated that there was a £15 billion deficit (a 92% funding level) and led the Treasury and DFE to increase employer contributions from 14.1% to 16.48% in September 2015. Combined with the National Insurance increase in April 2016, this has increased the cost of employing a teacher by 5% and has resulted in a redirection of school and college funds away from payroll into pension contributions. The net effect has been job losses at a time of increasing pupil, student and apprentice numbers (see an explanatory note from 2014). The next TPS valuation will be carried out between 2017 and 2018 and will value the scheme as it stands in 2016. There will be consultations involving employers and employees and any changes to contributions are scheduled for April 2019. OBR publishes Information on public sector pensions every time there is a budget or autumn statement. Table 2.22 reports a budget for total employer contributions of £19 billion in 2019-20 of which £4.2 billion is from TPS employers. On the assumption that the Treasury estimates are right and there are no other changes in the valuation, this implies an extra cost for TPS employers (state schools, private schools, colleges and new universities) of about £430 million. Or, to put it another way, the employer contribution rate can be expected to rise from its current level at 16.48% to just over 18%. On the same basis, the cost for the NHS in 2019-20 will be £665 million and the cost for the cost for the Armed services £300 million. The exact amounts will be different because of the different characteristics, funding levels, age profiles and employee contributions in each scheme. Nevertheless it is important to understand that the saving for the Treasury is a disguised cut to departmental spending. All of this is fairly speculative because the government actuary may make other changes when he/she comes to do the TPS valuation. The last valuation involved an increase in the expected lives of teachers reaching retirement. Teachers who are currently in the 40s are forecast to live to their early 90s.‎ Good news for them. Bad news for the finances of the scheme. The impact on school and college budgets should not be ignored. Pension costs are a major issue for colleges, schools and universities because all three sectors employ long serving staff who value their pensions and campaign to preserve their benefits. However too little has been done to contain the costs at a reasonable level. When DFE ministers and officials negotiated the last set of reforms, they anticipated a 12.1% cost ceiling. The Coalition government also made a promise that the reforms would last for 25 years. Sections 21 and 22 of the 2013 Public Service Pension Act enshrines this promise in law. This is fine in principle but the consequence is that colleges and the rest of the education sector locked into schemes which take a rising share of their budgets for pension costs and mean that it is harder to pay competitive salaries or employ the right people for core tasks.