Occupational and Personal Pension Schemes Review of Certain Contracting-out Terms

The principle of contracting-out continued after the introduction of the state second pension (S2P), which replaced SERPS in April 2002.

The legal background of contracting-out is set out in Appendix A. This gives the relevant statutory references and a summary of the effect on members of contracting-out.

The contracted-out rebate

The ‘contracted-out rebate’ refers to the effective reduction of National Insurance contributions for members of pension schemes, and their employers, which are contracted-out of the state Additional Pension.

The contracted-out rebate is set having regard to the cost of providing benefits of equivalent actuarial value to the state Additional Pension that is forgone by workers who are contracted-out.

COSRS, COMPS and APPs

Individuals may contract out through membership of:
a Contracted Out Salary Related Scheme (COSRS),
a Contracted Out Money Purchase Scheme (COMPS), or
an Appropriate Personal Pension (APP).

Those who contract out through the first arrangement are considered to be ‘contracted-out on a defined benefit basis’. Those who contract out through the second and third arrangements are considered to be ‘contracted-out on a defined contribution basis’.

In respect of members of COSRS, both the employer and employee pay reduced rates of National Insurance contributions.

For members of APPS, HM Revenue & Customs makes payments directly to the pension scheme in respect of contracted-out members.

A combination of the above occurs for members of COMPS. Reduced rates of National Insurance are paid and the employer pays the balance of the contracted- out rebates into the pension scheme. Age related top up payments are also made to the pension scheme by HMRC.

A single contracted-out rebate percentage is applied in respect of all members of COSRS.

Tables of age related rebates are applied in respect of members of COMPS and APPs.

Abolition of contracting-out on a defined contribution basis

Enabling legislation now provides for the abolition of contracting-out on a defined contribution basis. The abolition date is expected to be 6 April 2012. Therefore, this report restricts itself to determining the issues and costs relating to the defined benefit contracted-out rebate. I am required by legislation to propose defined contribution contracted-out rebate percentages for, as a minimum, the year 2012/13, even though it is expected that they will not come into force. These proposed rebates will be set out in a supplementary report which will be provided separately.

The Government Actuary’s and the Secretary of State’s obligations

The Secretary of State is required by statute to lay before Parliament, at intervals of not more than five years, a report setting out the Government Actuary’s opinion on: For COSRS, changes since the last report in the factors affecting the cost of providing benefits of equivalent actuarial value to the Additional Pension that is forgone by workers who are contracted-out, and for COMPs and APPs, the percentages required to reflect the cost of providing benefits of equivalent actuarial value to the Additional Pension that is forgone by workers who are contracted-out.

At the request of the Department for Work and Pensions, my report is extended to include advice on the appropriate level of the contracted-out rebate for members of COSRS.

It has become established practice for the Government Actuary’s advice to be informed by public consultation, as discussed in sections 3.6 to 3.10.

My role, as Government Actuary, is limited to providing advice on the contracted-out rebates. The power to decide and set the rebate rates (and the split between the employee and employer) is vested in the Secretary of State for Work and Pensions.

In addition, I have been asked by the Department for Work and Pensions to propose a rate for the revaluation of Guaranteed Minimum Pension (GMP) for contracted-out members who leave pensionable service in the period 2012 to 2017. This is covered in section 15.