Medium Term Financial Plan 2013 – 2015 (P.69/2012): sixth amendment.

STATES OF JERSEY

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MEDIUM TERM FINANCIAL PLAN 2013 – 2015 (P.69/2012):

SIXTH AMENDMENT

Lodged au Greffe on 23rd October 2012 by Senator L.J. Farnham

STATES GREFFE

2012   Price code: B  P.69 Amd.(6)

MEDIUM TERM FINANCIAL PLAN 2013 – 2015 (P.69/2012): SIXTH AMENDMENT

PAGE 2, PARAGRAPH (f) –

After paragraph (f) insert a new paragraph (g) as follows -

"(g)  to agree that, further to the proposal contained within the Medium

Term  Financial  Plan  to  increase  the  Public  Employees Contributory  Retirement  Scheme  (PECRS)  Pre-1987  debt repayments  by  £1 million  in  2013,  £2 million  in  2014  and £3 million in 2015 in order reduce the long-term costs to the States of  the  repayment,  the  Minister  for  Treasury  and  Resources  be requested to present to the States no later than 31st July 2013 further options for the early repayment of the PECRS Pre-1987 debt  and  the  Jersey  Teachers  Superannuation  Fund  (JTSF) Pre-2007  debt  to  provide  significant  additional  long-term  cost reductions."

SENATOR L.J. FARNHAM

REPORT

Background to the development of the pension PECRS pre-1987 debt and Jersey Teachers Superannuation Fund (JTSF) pre-2007 debt

In  1987  the  States  approved  proposition  P.123/87  dated  30th  June  1987,  which recommended significant changes to the Public Employees Contributory Retirement Scheme (PECRS). This included the transfer of responsibility for payment of pension increases from the States to PECRS. This transfer of liability created a debt known as the PECRS Pre-1987 Debt. This was identified by the Actuary in 1986 terms to be in the region of £55 million.

No capital lump sum was paid into PECRS to fund the take-on of the £55 million pension increase liability. The Employer's contribution rate was set at a rate which at the time was thought to be sufficiently above the then cost of benefits to leave a margin which was expected to pay off the liability over the long term. Since the 1980s there have been significant improvements in longevity, which means that the cost of providing pensions has increased by around 30%. Such significant improvements in longevity were not predicted in the 1980s and could not have been expected to be predicted.

Over time, it became evident that the Employer's contribution rate was not providing the  funding  necessary  to  repay  the  Pre-1987  Debt  and,  in  November  2003,  a framework was agreed by the then Policy and Resources Committee for dealing with the Pre-1987 Debt. This agreement, known as the 10 point plan, confirmed the States' responsibility for the Pre-1987 Debt, which by 31st December 2001 had grown to £192.1 million. An 82 year repayment period for the debt was established. The States commenced  annual  repayments  in  respect  of  the  Pre-1987  Debt  which  started  at £2.55 million in 2002, and have subsequently increased to £4 million per annum in 2012, in line with the agreement to increase payments by salary inflation over the 82 year term. Changes to market rates and, in particular, the reduction in long-term interest rates, have contributed to further increases in the value of the Pre-1987 Debt such that as at the end of 2011 it was valued at £252 million.

In 2007, the Jersey Teachers Superannuation Fund (JTSF) completed a similar transfer of liability as PECRS had completed in 1987. From 2007 onwards, the responsibility for payment of pension increases for teachers transferred from the States to JTSF. Since 2007, the States has been paying an additional 5.6% of teachers' pensionable salaries over and above the normal employer contribution rate to reflect the need to repay this debt over the long term. This arrangement was established pending a formal agreement by the States to accept the debt and establish annual repayments until full settlement is made.

In October 2012, the JTSF Management Board, on the advice of the Scheme Actuary, confirmed that in light of the latest actuarial funding position of the scheme, the level of the Pre-2007 Debt at 1st January 2012 was £94.6 million.

Structure of the PECRS pre-1987 debt

The  PECRS  Pre-1987  Debt  is  structured  such  that  repayments  are  linked  to  the increase  in  pensionable  salaries.  This  means  that  debt  repayments  are  heavily weighted towards the end of the 82 year period.

The  total  projected  future  cost  of  repaying  the  States  Pre-1987  Debt  under  this arrangement is estimated to be £2.7 billion, with the debt fully repaid by 2083.

Existing proposal within the Medium Term Financial Plan

The Medium Term Financial Plan identifies one of the most important local issues that needs to be considered, which is how best to manage the Pre-1987 Debt. Between 2013 and 2015, an additional contribution of £1 million in 2013, rising to £2 million in 2014 and to £3 million in 2015, is planned so as to repay the Pre-1987 Debt over a shorter period and reduce the long-term cost.

For example, the total projected future cost of repaying the States Pre-1987 Debt under the current proposal contained within the MTFP is estimated to be £0.9 billion, with  the  debt  fully  repaid  by  2054  (as  opposed  to  2083).  The  existing  proposal therefore reduces the term of the loan by 29 years and reduces the long-term cost of repayment by over £1.7 billion, making it clear that the allocation of relatively small additional  payments  to  the  repayment  of  the  Pre-1987  Debt  has  the  potential  to significantly reduce the long-term cost to the States.

One option could be for the States to replace the total pension debt on the balance sheet with an independent loan product of £350 million over 20 years, bearing an APR of 2.5%, the total cost of payments would be approximately £445 million. It would therefore be prudent to expeditiously explore further options around how the PECRS Pre-1987 Debt and JTSF Pre-2007 Debt could be repaid more quickly.

The rationale for early repayment

The structure of the Pre-1987 Debt with the repayments linked to pensionable salary increases and the interest rate assumptions inherent within the calculations of the repayment profile mean that it is advantageous for the States to repay the Debt early.

The  linking  of  repayments  to  increases  in  pensionable  pay  means  that  the  debt outstanding will increase in the early years, as the States is not paying a sufficient amount to meet the interest costs. The proposal contained within the Medium Term Financial Plan goes some way to address this, by increasing the regular repayments to over £7 million per annum by 2015. However, it remains the case that given the structure of the Debt, repayments in the early years will continue to be insufficient to cover the interest until such time as they increase in line with pensionable salaries by a sufficient amount to cover the interest costs.

At the time the Pre-1987 Debt agreement was reached, the structure of the debt arrangement  may  have  appeared  attractive,  but  the  market  environment  has  now changed and interest rates fallen to levels previously unexpected. Long-term interest rates are now at all-time lows, and the interest rate inherent in the Pre-1987 Debt no longer looks competitive. In addition, the structure of the debt means that the States is paying interest on the interest at this relatively high rate during the early years of the debt. It is for this reason that the proposal included within the Medium Term Financial Plan has such a significant impact on reducing the long-term costs to the States.

The  States  has  a  strong balance sheet and the Medium  Term  Financial  plan  has identified the need to actively manage the balance sheet with the most significant issue being the pension scheme liabilities. By managing the States assets and liabilities more effectively, a solution to reducing the considerable costs of the pension debts could be achieved.

It therefore stands that if the States were to adopt this amendment and the Minister for Treasury  and  Resources  was  to  return  to  the  States  in  2013  with  proposals  for significantly earlier repayment of the Pension Debts than currently proposed, then further reduced costs amounting to hundreds of millions of pounds could be achieved in the medium term.

Financial and manpower implications

The proposal requests that further options are considered for the early repayment of the PECRS Pre-1987 Debt and the JTSF Pre-2007 Debt so as to reduce long-term costs to the States.

There are no additional manpower implications arising from this proposed budget amendment.