Many public sector pensions – including those for the police, firefighters, armed forces, teachers, the NHS and the civil service – are unfunded public sector defined benefit (DB) schemes. Unfunded public sector DB schemes work differently to private sector DB schemes.
They do not have a pot of money sitting behind them – they operate on a ‘pay as you go’ basis, with contributions from current members funding the benefits of those already retired.
As a result, unfunded public sector pensions are not sensitive to market movements and gilt yields – instead the government sets down rules as to how they should be valued and schemes use what is known as the ‘SCAPE rate’ to work out the Cash Equivalent Value (CEV).
SCAPE stands for Superannuation Contributions Adjusted for Past Experience. The government sets the SCAPE rate using long-term GDP growth assumptions from the Office for Budget Responsibility (OBR).
It is expressed as a percentage above inflation (currently CPI + 1.7% per annum) and is used to value unfunded public sector DB pensions. The rate is reviewed periodically, most recently in April 2023.
An unfunded public sector DB scheme knows how much pension it has to pay to a member in the future. The CEV is a way of putting a monetary figure on the current value of that future pension benefit. The future value is calculated and then discounted back to today’s value using the SCAPE rate for each year from normal retirement.
If the SCAPE rate increases, a higher discount is applied each year. This means less capital is needed today to provide the same future pension, so the CEV falls.
If the SCAPE rate decreases, the opposite applies: the future pension is discounted less heavily, and the CEV increases.
On 1 April 2023, the SCAPE discount was reduced from CPI + 2.4% per annum down to CPI + 1.7% per annum. This means that all unfunded public sector DB schemes are now calculated based on a lower discount rate and therefore the CEV will be higher than before.
Over a similar period, CEVs for private sector DB schemes have decreased significantly, largely due to rising gilt yields.
The result is a significant shift: it is no longer safe to assume that unfunded public sector pensions are undervalued compared to private sector schemes. This has not been the case for some time now. Since around September 2022, you may find that the same amount of guaranteed pension has a higher value if it is secured through an unfunded public sector scheme compared to a similar pension within a private sector DB scheme.
This is a general observation for the typical scheme member – please remember the usual caveats apply where you have uniformed services pensions and special early retirement conditions or accelerated receipt of pension benefits.
Cheryl Bowden, Bowden Evolve
