1992 Firefighters’ Pension Scheme (FPS) – Review of commutation factors

CIRCULAR 2011HOC0158SS
1^st April 2011
TO: ALL MEMBERS

Dear Brother/Sister,

Members will be aware that the Government has announced that they intend to uprate pensions in the future using the Consumer Price Index (CPI) rather than the Retail Price Index (RPI) as has been the case in the past. Firefighters Pension Scheme Circular 4/2011 confirmed that public service pensions which have been in payment for a year will be increased by 3.1 per cent the CPI figure from 11^th April 2011 in line with the September-to-September increase in prices, (the figure for RPI for that period was 4.6%). The difference between the increase in the RPI and the CPI varies from year to year, but the Government’s view is that, in the long term, the CPI increases at a rate that in 0.87% behind the RPI increase.

The FBU has opposed the change from RPI to CPI. It is also important to highlights some of the detrimental potential knock on effects of changing the indexation factors used.

One area that members have been very concerned about is whether the change has any effect upon the age-related commutation factors in the FPS, that are used to calculate the lump sum a member can opt to receive on their retirement. The FBU is aware that the change from RPI to CPI may impact upon these factors and has been communicating with the Department for Communities and Local Government (CLG) to find out how they intend to deal with this issue.

CLG have informed the FBU that they had already started a review into the 1992 FPS commutation factors but that this had been suspended. The Government began consultation on an unrelated issue, namely the one of the financial assumptions that should be used to assess the liabilities of all of the unfunded public service pension schemes. This consultation has now been completed and the result was one of the announcements made by the Chancellor of the Exchequer in his budget statement on 23^rd March 2011.

The FBU have contacted CLG since that date and have been informed that the review of the commutation factors has recommenced. The FBU has also been informed that any outcome does not require a period of consultation and that its findings can be implemented immediately if required.

Since the decision to switch the indexation from RPI to CPI the FBU have been working with an independent actuary (First Actuarial) and part of this work has been to try and get an idea of how this may affect the commutation value of a member of the FPS.

The FBU have received a report from First Actuarial which includes examples of how the commutation factors may be affected and the potential reduction in any lump sum that may arise.

The extracts of the report below show this in detail;

HOW MUCH CASH CAN I GET AT RETIREMENT?

The amount of pension that can be given up for cash at retirement is set out in the FPS regulations. In most cases, up to 25% of pension at retirement can be given up for cash or “commuted”. In some circumstances, the amount of pension that can be commuted may need to be restricted further to avoid penal tax charges imposed by HMRC. Cash is calculated as the amount of pension given up multiplied by a factor.

HOW IS THE FACTOR CALCULATED?

The factor is calculated as the ‘value’ of the pension given up.The ‘value’ of the pension is determined mainly by how long it is expected to be paid (i.e.how old you are at retirement and how long you are expected to live) and how much the pension increases each year. Therefore, the younger you are at retirement, the more valuable the pension given up because it is expected to be paid for a longer time. Hence,the factor is higher at younger ages. For a firefighter retiring on pension directly from firefighter service the cash payable can be determined as follows:

Table showing possible changes to the current commutation factors based on now using CPI

EXAMPLE 1 – FPS: retiring from active service (using current cash commutation factors)

Date of birth: 22 December 1952
Date pension commences: 22 December 2007
Total pension payable: £20,000 pa
Age on day pension commences: 55 years
Maximum pension that can be commuted: £5,000 pa
Residual pension at retirement: £15,000 pa
Lump sum payable = pension given up x current factor from table (using RPI)
= 5,000 x 18 (the current factor for a 55 year old)
= £90,000

HOW COULD THE FACTOR CHANGE DUE TO THE MOVE FROM RPI TO CPI PENSION INCREASES?

Although increases in the CPI have exceeded increases in the RPI from time to time, over the long term CPI is expected to be lower than RPI.So, the ‘value’ of a pension linked to CPI is expected to be lower than the ‘value’ of a pensionlinked to RPI, and hence the factor will reduce. Based on typical expectations of the difference between future CPI and future RPI, the ‘value‘ of a pension linked to CPI could be in the region of 8% – 9% lower. This has a knock-on effect on the amount of cash that can be taken at retirement. Taking the example from above, this could have the following effect.

EXAMPLE 1 (REVISITED) – FPS: retiring from active service

Date of birth: 22 December 1952
Date pension commences: 22 December 2007
Total pension payable: £20,000 pa
Age on day pension commences: 55 years
Maximum pension that can be commuted: £5,000 pa
Residual pension at retirement: £15,000 pa 

Current cash commutation factors (RPI)

Lump sum payable = pension given up x factor from table 1 (RPI)
= 5,000 x 18(the current factor for a 55 year old)
= £90,000

Possible alternative cash commutation factors (CPI)

Lump sum payable = pension given up x factor from table 1 (CPI)
= 5,000 x 16.15(the potential factor for a 55 year old using CPI instead of RPI)
= £80,750

Members will immediately recognise that First actuarial are highlighting that there could be a potential change in the commutation factor for a 55 year old from 18:1 to 16.5:1 as a result of using CPI instead of RPI and that in this example the lump sum available is reduced by £9,250.

N.B. Members must be aware that this is only an assumption from First Actuarial on the potential implications of any review of commutation factors and that the result of the CLG commissioned review may not produce the same figures. Members should also note that in some cases the amount of pension that can be commuted for a cash lump sum is less than 25%. Members who have reached age 55 or  have completed at least 30 years’ pensionable service can commute 25% of their pension. For other members the amount that can be commuted is restricted to the extent that the lump sum cannot exceed 2.25 times the pension (and so the proportion of pension that can be commuted is restricted). The same commutation rates apply whether or not this additional restriction applies.

The intention of this circular not to be alarmist but simply to report that CLG have confirmed that a review of commutation factors is currently being undertaken and to give members the opportunity to consider the findings of an independent actuary. It is also very important to understand that CLG will not be consulting on the outcome and that they may decide to act on the results immediately.

I am sure that you are aware that this is an extremely testing time reference pension issues but you can be assured that the FBU is looking at these attacks from all angles will continue to oppose all detrimental changes to the fire service pension schemes.

Yours in Unity,

SEANSTARBUCK
National Officer
SS/EMH

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