Winners and Losers
50. Inevitably, if there is no additional money
going into the scheme but simply a redistribution of existing
resources, there will be some who gain from the proposed new arrangements,
but equally some who lose out. The Minister told us
It is right to say that in making some winners
there then has to be reductions elsewhere that is the
very nature of the way in which the sum of money is being
The Minister's assessment was that inequities
in the present scheme were being 'smoothed out'.
The overall effect of the proposals is that retirement benefits
are being reduced to pay for improvements in survivor and ill
health retirement benefits. The rebalancing effect is summarised
Costs of pension benefits as a percentage of pensionable
Proposed pension scheme
Death in service (lump sum)
Source: Ev 52
It should be noted that no serving personnel
will actually see their benefits change, unless they choose to
join the new scheme, as they will have the option of remaining
with the present scheme. They will, however, have to gamble in
making the choice between better retirement provision under the
old scheme; and higher death in service and other benefits for
their dependants under the new scheme. Once the new proposals
have been adopted, entrants to the Armed Forces will automatically
enter the new pension scheme and will therefore potentially be
disadvantaged, compared with their counterparts in the present
51. The consultation document provides no examples
of how the proposed new scheme will affect individuals and we
therefore asked for worked examples, comparing the old scheme
with the new.
52. Examples of categories of Service personnel
who will lose out under the new arrangements include
- a lieutenant colonel retiring on a compulsory basis after
18 years' service who will receive about £2,500 less in annual
pension and £8,000 less in his lump sum. Calculated as a capital
figure, this means a reduction from £356,000 to £302,000.
- a sergeant retiring after 22 years who will see a small
decrease in annual pension (about £500) and about £1,000 reduction
in lump sum, giving a reduction in the capital figure of £8,000.
On the other hand:
- a sergeant retiring after 32 years' service at age 50 would
receive an additional £1,000 in lump sum payment, and a £300
a year increase in pension, giving an increase in the capital
figure of £6,000.
Death in service benefits
53. Benefits for dependants are significantly
enhanced: the death-in-service grant will be increased from one
or one-and-a-half times pay to three times pensionable pay; and
widow(er)s' pensions will be increased to half of the highest
tier ill-health pension which the member would have been entitled
to. An example of
how improvements in benefits affect individuals is
- the spouse of a sergeant, aged 28, who died after 10 years'
service, would receive a pension of £4,088 a year, compared
to £2,446 now and a lump sum of £73,069 compared to £24,456.
Calculated as a capital figure, this is an increase of £61,000.
Ill health benefits
54. A three-tier structure for ill health benefits
is envisaged. Tier 1 provides for those whose earning capacity
as a civilian is not affected, who would receive an invaliding
gratuity based on salary and number of years of service. Tier
2 provides for those whose earning capacity is assessed as significantly
reduced, who would receive a pension on discharge based on length
of service and enhanced by one-third of remaining service up to
normal retirement age. Tier 3, for those unlikely to be fit for
any work, would provide a minimum pension guarantee of 20 years'
accrued pension, with remaining service enhanced by a half. An
example of the effect on individuals is
- a colonel retiring on ill health grounds which
are not attributable to his service, after 10 years' in the
Army, would receive a pension of £16,046 a year (currently
£13,811) and a lump sum of £48,137 (currently £41,433). If
he died, his spouse would receive a pension of £8,023 (currently
£6,906). Calculated as a capital figure, this is an increase
to £335,000, from £288,000 under the present scheme.
55. The Forces Pension Society's overall impression
is that 'we judge that there are going to be an enormous number
of 'losers', possibly the majority'.
The Minister told us that 'the inevitability of the logic' of
the redistribution of benefits meant that some would lose out.
From the range of examples which the MoD has provided, which were
presumably selected as being representative of the effects of
the new proposals, it certainly appears that there will be many
Service personnel who will receive worse pension benefits under
the new scheme than are available at present. The net effect
of the new arrangements is that those who are not killed or injured
during their military service are penalised so that the benefits
for those who are can be increased to acceptable levels. We welcome
the proposed improvements to dependants' and ill health benefits
but regard it as unacceptable that these are achieved by reductions
in benefits elsewhere in the pension scheme.
56. In the current AFPS, individuals receive
a pension and an automatic lump sum (terminal grant) which accrue
separately. The drawbacks of a lump sum payment are that, when
interest rates are low, the value of having a lump sum to invest
can be lower than the value of having a guaranteed index-linked
benefit. The Review document says that in principle it would be
possible for entitlement to accrue wholly as a pension and then
for individuals to have the option of commuting part of this to
a lump sum, but that offering a positive choice on retirement,
when the vast majority of people would choose commutation in any
case, 'could add administrative complexity'. Instead, the proposals
offer an automatic lump sum, with the right of 'inverse commutation'
which would enable individuals to convert terminal grant back
to pension rights, if they choose to do so.
57. We believe the MoD is exaggerating the administrative
complexity of offering the option to commute: almost all private
sector schemes have commutation, and the new Civil Service scheme
is providing it. We note that the MoD is considering the adaptation
of an existing commercial pension package for the administration
of the new scheme,
and any such package will certainly include commutation as a feature.
The Director General, Service Personnel Policy, told us he was
aware that the Civil Service scheme is offering the commutation
option and that this was one of the issues which the MoD was re-examining.
We recommend that the MoD follows good practice found elsewhere
in pension schemes by offering the option of commutation on retirement,
rather than the potentially disadvantageous automatic lump sum.
58. The Armed Forces are unique in the way in
which they use the Pension Scheme as a man management tool, as
an incentive to trained personnel to remain in the Services. They
do this through Immediate Pensions, currently paid to officers
who delay leaving the Services until age 38 (or after 16 years'
service, whichever is later) and to other ranks at age 40 (or
after 22 years' service). In practice, service manning patterns
are complex and, of those leaving the Services each year, fewer
than 20 per cent of the Armed Forces as a whole do so at their
Immediate Pension Point. The Government Actuary's Department works
on the assumption that 52 per cent of officers and 13 per cent
of other ranks stay in service to the IP point or beyond.
The table below sets out departure statistics for each of the
three Services for the last three years.
59. Although only a limited number of personnel
stay in the Services long enough to enjoy the benefits of the
Immediate Pension (IP), all contribute towards it through the
abatement which the Armed Forces Pay Review Body includes in its
calculations of appropriate levels of Service pay. The IP is an
expensive element of the pension scheme, as the Review document
for 30 per cent of the total scheme costs.
The Government Actuary costs the total benefits of the pension
scheme for officers at 33.8 per cent of pensionable pay, but at
only 18.1 per cent for others ranks, which is accounted for mainly
by the much higher proportion of officers who stay in the Services
until they reach the Immediate Pension point.
60. The Review examined the role of the Immediate
Pension only in terms of its effectiveness as a retention incentive.
It did not consider whether its costs had an adverse impact on
scheme benefits. It concluded that it is an effective retention
incentive and that to alter it substantially 'would place manpower
planning at risk'.
It suggested some modification in the arrangements which would
allow individuals to decide in their early thirties that they
will opt for bonuses instead of an immediate pension at age 40,
with pension entitlement then deferred to 55 or 60.
No details are given about the amounts which would be payable
under this bonus scheme. The MoD indicated in an answer to a written
Parliamentary question that it has not undertaken a costing of
alternative measures, or a net costing of the early Immediate
Pension. We have been
told that Immediate Pensions and bonuses are being re-examined
but that at present 'there are no detailed descriptions of options,
costings or estimates of the different impact on retention'.
61. The Forces Pension Society believed it was
'remarkable' that the MoD had not costed alternative retention
incentives as without such an exercise they could not be sure
that Immediate Pensions were the most cost-effective method available.
The Society's view is that the Immediate Pension is 'a costly
manning tool ... financed at the expense of full career pensioners
and survivors' and that this is indefensible. The use of pensions
as a manning regulator is regarded as 'perverse' because of the
effect it has in depressing full-career benefits.
Their view is that the MoD should offer a wide range of incentives
to retain the Service personnel they require, some of which might
be linked to pensions.
62. The Services already use a range of mechanisms
to retain particular groups of personnel, particularly where civilian
employment offers an attractive alternative. In its Report for
2002, the Armed Forces Pay Review Body recommended financial retention
incentives of £30,000 for pilots, navigators and other aircrew
at five years before the IP point, in return for five years service;
and £50,000 at the IP point for a similar return. This followed
a review of aircrew retention by an MoD working group.
Retention incentives are also in place for members of the Royal
Signals, involving lump sum payments of £10,000 for further commitments
of three or five years. A one-off, taxable bonus of £3,000 is
available to Royal Navy Warfare Branch Leading Ratings in return
for a two and half year extension of service.
One of the problems of using bonuses rather than payments from
the pension scheme to a greater extent as a retention incentive
is that bonuses are taxable but pension terminal grants are not.
To reward personnel with the same net amount, therefore, bonuses
would have to be paid at a higher level,
but the net cost to the public purse would be the same. However,
the advantage of bonuses is that the timing and amount of payments
can be varied according to circumstances, whereas payments from
the pensions scheme are tied to the pension accrual rate and to
a common retirement age.
63. The Defence Committee in the last Parliament
examined a whole range of factors which affect retention, including
financial incentives and commented
The MoD needs to be flexible but also more
strategic in its approach if it is going to use additions
to pay as a retention tool, and in particular needs to assess
both the negative and positive effects of bonuses.
We agree and believe the MoD needs to look at
Immediate Pensions in the broad context of a strategic and flexible
approach to financial retention incentives. The MoD needs to justify
the cost of the Immediate Pension and demonstrate that it is an
appropriate component of a modern pension scheme.
64. The Immediate Pension also has another purpose:
it is a way of compensating personnel for whom the Services cannot
offer a full career for the reduced levels of pay they may receive
in subsequent employment.
The Review document states that the Armed Forces need to shed
a substantial proportion of manpower around the age of 40, and
that the current pension points at ages 38 and 40 thus provide
natural departure points.
For many Service personnel, leaving the Armed Forces at age 40
is not voluntary. Their career prospects may be less good than
those of civilians of a similar age, as their Service career may
not have prepared them for the types of civilian employment which
are available. If they are embarking on a new career, they may
be doing so later in their working lives than civilian counterparts,
and at a time when they are already likely to have families for
whom they need to provide.
65. The Armed Forces Pay Review Body periodically
commissions actuaries to assess the relative value of the Armed
Forces Pension Scheme against a range of measures. As part of
this work, re-employment surveys are conducted to ascertain the
level of income from employment which former members of the Armed
Forces receive. The results of the 2000 survey found that about
40 per cent of ex-Service personnel found employment at a relatively
low level of pay and that, even with the addition of the Immediate
Pension payment, there was a shortfall between their civilian
income and the Service pay they had received. For about 45 per
cent of personnel, civilian pay exceeded Service pay. For the
remaining 15 per cent, civilian salary was less than Service pay,
but when Armed Force pension was taken into account, total income
exceeded Service pay.
All personnel also receive a tax-free lump sum equivalent to three
times pension on leaving the Services, and this is taken into
account in the calculations. The actuaries' assessment is that
the proportion of Armed Forces pension which should be treated
as compensation for a short career is 50 per cent.
Should the Pension Scheme be used as a manning
66. Our view is that the Immediate Pension
remains an important means of recognising the different status
of employment in the Armed Forces. We recognise its function
in ensuring that the income Service personnel receive once they
leave the Services is adequate, and that they are not penalised
for choosing a Service career, which cannot be a full career in
most cases. We are less convinced of its value as a retention
incentive, given that the Government Actuary estimates that only
10-15 per cent of other ranks remain in the Services long enough
to qualify for an Immediate Pension.
It is a blunt management tool and the MoD needs to find incentives
which work more effectively.
67. It could be argued that using the pension
scheme to manage the Services' manning requirements is neither
appropriate nor wholly effective. Our predecessors in the last
Parliament examined the many factors which affect retention in
the three Services in their report on the Policy for People.
The Committee urged the MoD and the Services themselves to pursue
more radical and imaginative ideas to solve retention problems.
They also pointed out that the needs of the three Services in
terms of retaining personnel are different: in simple terms, the
Army, and to a lesser extent the Royal Navy, need large numbers
of young, fit people; the RAF in contrast needs to retain a significant
number of the people it has expensively trained for as long as
68. One approach the MoD could adopt would be
to cost and budget for Immediate Pensions separately, treating
this element specifically as an annual compensation payment, charged
to the MoD's running costs budget, rather than as part of the
pension scheme, and therefore removing it altogether from the
abatement calculation. The Government Actuary already excludes
some benefits from costing exercises, throughout the public sector,
defined as any provision for benefits initiated by the employer
(such as redundancy benefits).
Immediate Pensions are also already treated differently to normal
retirement benefits in that there is no protection from inflation
until recipients reach age 55.
69. Uncoupling the IP from the pension scheme
in this way would mean that it was no longer necessary to link
the size of lump sum or annual payments to pension accrual rates,
or the timing of such payments to a common retirement age point.
This would give the three Services greater flexibility to vary
the timing and structure of payments to allow each Service to
tailor its terms and conditions to its needs and to adapt to changing
circumstances. Removing an Immediate Pension arrangement from
the pension scheme would also allow the Services to target the
compensatory element of the IP on the 50 per cent or so of personnel
who earn less on leaving the Services, rather than making it a
universal benefit. Additional tax implications would be limited
to any lump sum payment paid as part of the IP (as pensions are
already taxed); this could be avoided by paying the whole IP as
an annual pension.
70. We recommend that the MoD continues to
examine options for removing Immediate Pensions from the Armed
Forces Pension Scheme and operating them as a separate component
of Service pay. The more extensive use of targeted bonuses to
improve retention in shortage areas throughout the three Services
should be pursued with more imagination and urgency. The net effect
of these measures would be that, without the distorting effect
of Immediate Pensions, greater resources would be available within
the Armed Forces Pension Scheme for full career and other benefits.
71. We do not believe the MoD's review of
the Armed Forces Pension Scheme has been sufficiently thorough.
We welcome the improvements proposed in some areas, particularly
dependants' and ill health benefits. However, we reject the MoD's
view that these should be funded by reductions elsewhere in the
Scheme. We challenge the assumption that the Armed Forces have
a generous pension scheme. This has led the MoD to limit its options
at an early stage by imposing the constraint of cost neutrality
on the review process and we fundamentally disagree with this
starting point. It has had the effect of stifling innovation in
the whole approach to the pensions review, and what has resulted
is therefore what the Minister himself described as 'a reshuffling
of the pack'. We believe the Armed Forces deserve better than
76 Q 162 Back
Q 162 Back
Ev 48-51 Back
Ev 48 Back
Ev 49 Back
Ev 49 Back
Pension Review document, op cit, paragraph 4.19-4.20 Back
Ev 50 Back
Ev 51 Back
Q 76 Back
Q 162 Back
Pensions Review document, op cit, paragraph 4.14 Back
Ev 113, paragraph 1 Back
QQ 176-178 Back
Ev 41 and 53, Annex D Back
Pensions Review document, op cit, paragraphs 3.4 and 4.6 Back
Ev 40 Back
Ev 120 Back
Pension Review document, op cit, paragraph 4.9 Back
ibid, paragraphs 4.7-4.9 Back
HC Deb, 28 January 2002, c 16w Back
Ev 41 Back
Q 84 Back
Q 84; Ev 16, paragraph 5d and Ev 18, paragraph 18 Back
Q 84 Back
Armed Forces Pay Review Body, Thirty-First Report, January 2002,
Cm 5361, Session 2001-02, pp 27-30 Back
Armed Forces Pay Review Body, Thirtieth Report, February 2001,
op cit, p 16 and Thirty-First Report, January 2002, op
cit, p 36 Back
Q 165 Back
HC 29-I, Session 2000-01, op cit, paragraph 88 Back
Pensions Review document, op cit, paragraph 4.6 Back
Pensions Review document, op cit, paragraphs 3.4 and paragraph
Comparative Valuation of the Armed Forces Pension Scheme,
Report to the Armed Forces Pay Review Body by the Actuary, Watson
Wyatt Partners, Annex G Back
AFPRB, Thirtieth Report, February 2001, op cit, Appendix
4, paragraphs 4.44-4.47 Back
Ev 41 and 119 Back
Second Report, Session 2000-01, HC 29-I, op cit, paragraphs
ibid, paragraph 161 Back
Ev 120 Back