My Lords, we have come to another important part of the Bill. I recognise that the operation of the cost control mechanism
is of considerable interest to the Committee, particularly the noble Lord, Lord Davies, whom I thank once again for his remarks, and the noble Lord, Lord Ponsonby, who—I remind myself—gave some valuable contributions at Second Reading and touched on this topic. We should also remember that the cost control mechanism should be considered within the wider context within which the Bill should be considered.
I hope that my subsequent letters on this topic have proved informative on progress being made in this area. I am happy to be able to expand on some of those key areas during this debate, but obviously there are some questions that need answers arising from this particular debate, and I will do my best to answer them.
First, on the subject of letters, I deposited a letter in the Library last week to bring to the Committee’s attention the fact that, on 7 October, the Treasury published amending directions that will allow schemes to complete the cost control element of the 2016 valuation process. As previously announced, these amending directions confirm that the McCloud remedy will be captured as a member cost in the completion of the 2016 valuations. This is right, given that addressing the discrimination identified in the McCloud and Sergeant judgments, giving members a choice of scheme benefits for the remedy period, involves increasing the value of schemes to members.
This matter led to a couple of questions being raised, first by the noble Lord, Lord Davies, who made the point that he thought that it was not appropriate for members to pay the costs of remedy. Separately, the noble Lord, Lord Ponsonby, raised the question of the inclusion of remedy in the 2016 valuations. Indeed, he questioned the role of the Treasury and government.
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Let me try to give some answers. When the cost-control mechanism was established, it was agreed that it would consider only costs that affect the value of the schemes to members, known, as we know, as member costs. Addressing the discrimination identified in the McCloud and Sargeant judgments by giving members a choice of scheme benefits for the remedy period involves increasing the value of schemes to members. Costs associated with this therefore fall into the member cost category. As a member cost, the McCloud remedy will be taken into account in the completion of the cost-control element for the valuation process.
I think it is fair to make a few more comments about why it is necessary for these costs to be allowed for in the valuations at all. I shall expand a bit further on this. Schemes are required to complete valuations by statute. Given this requirement, it is appropriate that these are completed based on an accurate assessment of the value of schemes to members, which necessarily includes remedy. Failing to capture the value of remedy could mean that members’ benefits are changed based on an incomplete and inaccurate assessment of the value of these pension schemes. This would represent an acceptable risk to the taxpayer, introduce volatility into the mechanism at future valuations and, we believe, fundamentally undermine the stated purpose of the mechanism to fairly assess the value of schemes to members in a way that is consistent and transparent.
Following publication of these amending directions, schemes can now finalise their 2016 valuations, providing certainty on the outcome to scheme members. I recognise that there are wider concerns about the operation of the mechanism, in particular whether the mechanism is too volatile under its current design. I will discuss the Government Actuary’s review of the mechanism shortly. However, I highlight that, in light of the concerns regarding whether the mechanism is working in line with the original policy aims, the Government have previously announced their intent to waive any ceiling breaches that arise from the 2016 valuations, while honouring any floor breaches. This means, as I am sure the Committee will know, that any benefit reductions that would ordinarily occur following ceiling breaches at the 2016 valuations will not be implemented. No member will see a reduction to their benefits as a result. The Government have legislated for this in Clause 80 of this Bill, to which this amendment relates.
Secondly, looking at the cost-control mechanism review, I wrote to your Lordships to state that the Government have responded on consultation proposals to improve the cost-control mechanism for the 2020 valuations onwards. In brief, the reforms are three-fold. First, they take forward the reformed scheme-only design. This reform ensures that costs associated with legacy schemes will be excluded from the mechanism. The second of these reforms is including a symmetrical economic check. This will ensure that any breach of the mechanism would be implemented only if it would still have occurred had long-term economic assumptions been considered.
This led to a question from the noble Lord, Lord Davies. He asked why member costs are spread over four years, and I shall try to answer that. The Government believe that it is right to capture the full impact of remedy at the 2016 valuations given the remedy period will end by the end of the implementation period for this set of valuations. This means that remedy will not need to be allowed for at future valuations. In addition, one of the Government’s aims for how the remedy should be dealt with in completing the 2016 cost-cap valuations is that it should not unduly reduce intergenerational fairness. Therefore, capturing remedy over four years also more closely aligns those who benefit from remedy with those who pay for it. A long spreading period would likely exacerbate intergenerational unfairness. The Government Actuary has advised that a four-year spreading period is a reasonable way of achieving the intergenerational fairness objective. I hope that provides a reasonable explanation.
Lastly, on the three aims, the Government will widen the corridor from 2% to 3% of pensionable pay. This will ensure a more stable mechanism, which was intended when the mechanism was originally established.
The amendment in the name of the noble Lord, Lord Davies, seeks to remove reference to connected schemes from the list of costs which the Treasury may specify for inclusion in the scheme’s assessment of their costs against the cost cap, but this is precisely what the Government intend to do by moving to a reformed scheme-only design, starting from the 2020 valuations. This reform ensures consistency between the set of benefits being assessed and the set of benefits
potentially being adjusted. It also allows the mechanism to better meet its objectives of stability and will reduce intergenerational unfairness.
Now that the Government’s response has been published, I would like to make one important point to the Committee: I invite your Lordships to discuss the reforms as soon as possible in the coming days. This is because, of course, it has just come out recently. I recognise that these reforms are an area of close interest for many noble Lords, and I would welcome the opportunity to further understand their positions on the reforms. These discussions are a matter of priority for me, so as to give your Lordships, particularly the noble Lords, Lord Ponsonby and Lord Davies, adequate time to consider the proposed changes, so my department will be in touch on this matter. Furthermore, we believe that this will be beneficial, as I understand that the amendment proposed by the noble Lord may not have the intended effect of preventing legacy costs from being included in the mechanism. This is because Clause 12(4)(b) of the Public Service Pensions Act 2013 still gives the Treasury a wide scope to specify which costs should be accounted for in cost control valuations. This is a crucial reform, and one that we must get right.
Moving on to the use of Treasury directions, I recognise there is a strong interest here; it is a theme that has been covered in some detail in this debate and previously. It may be helpful to recap some of the themes to provide some further assurances. In respect of the cost control mechanism, the framework for this has been established in primary and secondary legislation, and so is subject to parliamentary scrutiny. Within this statutory framework, the use of Treasury directions ensures that the Treasury can take a consistent approach across schemes in England, Scotland and Wales. The directions themselves are published, and therefore provide transparency about the Government’s approach.
It is also important to be clear that the directions we are referring to here are technical instructions for scheme actuaries. They are complex and granular in detail and require to be updated regularly to reflect new developments and revisions to assumptions. The established approach across government has been that directions provide a suitable means for making technical instructions of this nature. In contrast, technical instructions of this nature are unlikely to provide a suitable platform for a parliamentary debate on the constitution of the cost control mechanism, if that is the noble Lord’s intention. In the case of the Treasury directions published on 7 October in relation to the 2016 cost control process, the Treasury engaged closely with stakeholders to ensure that the amending directions support schemes to accurately reflect changes to the value of member benefits as a result of McCloud remedy. Drafts of the amending directions were shared with schemes and scheme advisory boards to allow feedback and provide schemes with the opportunity to make any necessary updates to their 2016 valuation data and, indeed, their assumptions. In line with our statutory requirements, the Government also sought the formal view of the Government Actuary, who has confirmed that the amending directions are technically complete and reflect
a reasonable way to ensure the 2016 valuations are completed, based on the best estimate of the value of these pensions.
More broadly, the use of Treasury directions in this context is in accordance with long-standing practice in public service pensions policy. I have addressed some broader points on the use of Treasury directions in relation to previous amendments, as the Committee will know. I also highlight again that the Delegated Powers and Regulatory Reform Committee has considered this Bill and the powers within it and has reported no single issue to bring to the attention of the House. I know that I have said that in the past, but I say it again in relation to this amendment. I hope this rather lengthy response provides the noble Lord, Lord Davies, in particular, with some reassurance on the purpose and use of Treasury directions and I ask him to withdraw his amendment.