Ministers’ Deputies

CM Documents

CM(2004)220 (restricted) 14 December 2004

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915 Meeting, 9 February 2005
11 Administration and Logistics

11.3b Review of the staff contribution rate to the New Pension Scheme – technical report by the Joint Pensions Administrative Section (JPAS)

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Summary

Background information on the NPS

1.         The New Pension Scheme (NPS) came into force on 1 January 2002 at the OECD. For staff recruited on or after that date it replaced the Co-ordinated Pension Scheme introduced in 1974.  The Council of Europe also adopted the NPS for staff recruited on or after 1 January 2003, apart from those concerned by the exceptional procedure.

2.         The NPS replaces the two pension schemes recommended in the Co-ordinating Committee on Remuneration's 105th report, which were not approved by the Co-ordinated Organisations' governing bodies. In particular, it offers the advantage of remaining true to the spirit of the 1974 scheme, but at a lower cost and without introducing more cumbersome management constraints.

3.         The NPS was developed on the basis of guidelines given by the governing bodies concerning changes to be made to:

 - the benefits provided under the Co-ordinated Pension Scheme (particularly the retirement age, the method of calculating the leaving allowance and adjustment of benefits) and;

 - the level of staff contributions (40% of the cost of the scheme instead of 33.3%).

4.         However, at the NPS’s inception, it was not possible to set an objective rate of contribution, which could be determined only when the final details of the benefits had been decided, and their cost could hence be calculated, and an objective method of calculating contributions had been established.  Since the governing bodies wished to take a decision affecting both benefits and the level of contributions, an interim solution was adopted, consisting in initially applying, for new staff, the maximum contribution provided for under the two options set out in the CCR's 105th report, i.e. 8.8% of basic salary.

5.         Article 41 of the NPS rules provides that the rate shall be reviewed by 31/12/2004 at the latest, and then every five years, but without specifying the precise method to be used.  An actuarial method must accordingly be adopted so that the rate can be reviewed before the end of the current year.

 

6.         However, choices made regarding the method of calculating the rate of contribution have extremely long-term implications (on a timescale corresponding to the organisations' life expectancy).  It is accordingly desirable to find a method offering stability over time, so that it does not have to be modified each time the rate is reviewed.

7.         The chosen actuarial method must:

 

 - give results that are reasonably stable over time;

 - be easy to continue to use from one review to the next. 

The proposed actuarial method

8.         It is recommended that the method chosen for the NPS should be similar to that used for the Co-ordinated Scheme, that is to say the method set out in the CCR's 34th report.

9.         This choice is justified in view of the very great similarities between the two schemes, which basically differ only as regards the values of certain variables, with benefits served being identical in nature.

10.        Moreover, the wording of Article 41 "Staff member's contribution" is the same in the Pension Scheme Rules applicable to the Co-ordinated Scheme and in those applicable to the NPS.  That being the case, it would be difficult to recommend a calculation method departing radically from that used for the Co‑ordinated Scheme, and, to do so, there would have to be a specific technical objection to the method set out in the 34th report, which is not the case.

11.        The method is indeed technically viable and gives results that are stable over time.

Description of the method

12.        The method used to calculate the rate of contribution to the Co-ordinated Scheme is based on projections of benefits payable and of income from salaries. It consists in estimating, over a lengthy period, the future amounts of payments to be made under the pension scheme, on the one hand, and the future annual salaries of staff affiliated to the scheme, on the other hand. The total of these future payments discounted to present worth and prorated to total discounted salaries gives the rate of contribution.

13.        As the scheme advances, the amount by which past contributions exceed the share of past expenses to be borne by staff (40% in the case of the NPS) is credited to the scheme, forming a provision covering the share of staff's accrued entitlement to be borne by the staff themselves at the date of calculation.

14.        This is a so-called long-memory method, since it includes both past and present pensioners and current and future serving staff. It moreover applies what is known as an open group approach: the working population is renewed as time goes by.

15.        In 1994 this method, applied to all the Co-ordinated Organisations, resulted in an increase in the staff rate of contribution to 8%, compared with the initial 7%. The rate was subsequently raised to 8.3 % in 1999, and the CCR recommended in its 158th report that it be raised to 8.9% with effect from 1 January 2005.

16.        This method offers the benefit of being known. A further advantage is that it is insensitive to the scheme's initial growth period and accordingly guarantees some stability of the results (fluctuations in economic variables apart).

17.        As was the case with the Co-ordinated Pension Scheme, the principal features of this method should be described in an Appendix to Article 41 of the NPS rules. A draft text for this purpose is to be found in Appendix 1.

Other elements specific to the NPS

18.        With a view to stabilising the results even further, it is recommended that the calculation be consolidated (a single average rate) for all the organisations that have adopted the NPS, as was the case in the 34th report.

19.        At the same time, observation of the "seven reference countries" in order to determine the discount rate is no longer justified for the two organisations concerned, which both have their seats in France. It is accordingly proposed to take as a basis, firstly, the indicator of the trend in euro-zone government bond yields (the zero coupon yield curve published by Eurostat), and, secondly, the euro-zone harmonised consumer price index (HCPI) (to estimate real-value rates).

20.        Under this method the discount rate obtained at present is 3.6% in real value, which is slightly lower than the rate used in reviewing the rate of contribution to the Co-ordinated Scheme (3.7% in real value).

Result

21.        Application of this method by the JPAS, on a consolidated basis for the two organisations, results in a rate of contribution of 9.2% for staff affiliated to the NPS.

Recommendation

22.        It is recommended that:

 - the actuarial method used to calculate the rate of contribution to the NPS should be that described in the Appendix to this document and that it be appended to Article 41 of the NPS rules;

 - on the basis of the calculations performed using that method, the rate of contribution of staff affiliated to the NPS be raised from 8.8% to 9.2% of basic salary as from 1 January 2005;

 - Article 41.3 of the NPS rules be amended accordingly.

Appendix 1

Proposed amendments to Article 41

Article 41 - STAFF MEMBER'S CONTRIBUTION - COSTING THE SCHEME -

1.         Staff members shall contribute to the NPS.

2.         The staff members' contribution to the scheme shall be calculated as a percentage of their salaries and shall be deducted monthly.

3.         The rate of the staff contribution shall be set so as to represent the cost, in the long term, of 40% of the benefits provided under these Rules. The rate shall be 9.2 %.  This rate shall be reviewed every five years on the basis of an actuarial study, the procedures for which are appended hereto.

4.         Contributions properly deducted shall not be recoverable. Contributions improperly deducted shall confer no rights to pension benefits; they shall be refunded at the request of the staff member concerned or those entitled under him without interest.

Appendix 2                              

Appendix to Article 41 -- Acturial Studies

Method

1.         Calculation, as at the effective date of the study, for all the Co-ordinated Organisations which have adopted the NPS, of the rate of contribution payable by staff in order to finance 40% of benefits provided under the Scheme, establishing the present value of past contributions and benefits and of future benefits and salaries.

2.         To establish the present value of past contributions and benefits, reference is made, year-by-year, to the actual amounts of validation payments, of contributions paid by staff and of 40% of benefits paid since the Pension Scheme was created.

3.         Projections of annual amounts of benefits that will be paid under  the Scheme as from the date of the study are also established, as are projections, year-by-year, of the salaries of staff currently affiliated and also of staff who will be recruited and affiliated to the Pension Scheme in the years to come. Each of these amounts is projected over a period of eighty years and discounted to present worth.

4.         Combining these past and future results will make it possible to determine the rate of contribution needed to finance 40% of benefits provided under the Scheme.

Demographic and salary-related assumptions

5.         The demographic assumptions are derived from detailed demographic studies for each of the Co-ordinated Organisations which have adopted the NPS.  These studies examine past experience over a period of fifteen years, where the information is available, and also take account of available forecasts regarding future staff numbers.

6.         The assumptions relating to salaries are based on detailed observation of the past, over a period of fifteen years, where the information is available, and also take account of practices and forecasts available in this field.

7.         The rates obtained are adjusted so as to eliminate distortions resulting from insufficient data in certain organisations.

Economic assumptions

8.         The discounting process is based on observation of the curve showing nominal rates of return on zero coupon government bonds issued in the euro zone, as published by Eurostat.

9.         As regards the updating of the past, the figure taken for a given year is the nominal rate for bonds with a maturity of 30 years.

10.        As regards the discounting of future expenditure and resources, the rate used is net of inflation. It is equal to the arithmetical average of real rates for bonds with a maturity of 30 years, observed since the euro came into force, with an observation period of thirty years once sufficient time has elapsed.

11.        The average real rate for a past year is calculated as the difference between the nominal rate of return and inflation, as estimated by the euro-zone Harmonised Consumer Price Index (HCPI), published by Eurostat.

Appendix 3                              

Implementation of the method

Background information on the method

1.         Article 41 of the NPS rules provides that an actuarial study, for which the procedures shall be laid down by the governing body of the Organisation, shall be performed to determine the staff rate of contribution to the Pension Scheme. This rate, applicable to monthly salary, must be calculated so as to represent the cost, in the long term, of 40% of benefits provided for under the scheme. As explained in the body of the text, it is proposed that the long-term cost of benefits be obtained by establishing the present value of past contributions and benefits and of future benefits and salaries. These data are produced separately for each Co-ordinated Organisation that has adopted the NPS and then aggregated to obtain a single average rate.

Main actuarial elements specific to the NPS

2.         On the whole the actuarial elements have been derived from the studies conducted to review the rate of contribution for staff affiliated to the Co-ordinated Scheme. The only exceptions are as follows.

Reference date for the calculations

3.         The actuarial studies have been performed on the basis of data recorded at the end of 2003.

It should be noted that, since the NPS came into force as at 1/1/2002 at the OECD and 1/1/2003 at the Council of Europe, the past (one and a half years) is insignificant compared with the future life of the scheme (80 years). Moreover, as at the reference date for the calculations, the NPS did not yet have any pensioners.

Discount rate

4.         It is proposed that the discount rate for future expenditure and income be based on observation of the yield curve for euro-zone zero coupon government bonds.

5.         The yield curve shows the interest rates paid by sovereign issuers in the euro zone according to the term of the debt (hereafter designated the maturity).  When making actuarial calculations future expenditure is normally discounted using a single discount rate having a maturity consistent with the average foreseeable period over which expenditure will be incurred. Under our method the average period over which benefits will be paid far exceeds the maximum maturity - 30 years - of the yield curve, since the future is to be observed for a period of 80 years.  It is therefore the rate for the maximum maturity - 30 years - which must be used to be consistent with the average period over which expenditure will be incurred.

6.         At the date of the study the rate used to discount future amounts to present worth is 3.6% in real value, which is close to that used for the studies under the 34th report (3.7%).

Historical context of the work performed

7.         The Council of Europe and the OECD asked the JPAS, which was already carrying out the actuarial studies to review the rate of contribution to the Co-ordinated Pension Scheme, to determine a new rate of contribution to the NPS.

8.         The studies were performed using the actuarial model of the Co-ordinated Organisations' Pension Scheme, amended to take account of the particularities of the NPS. This model has been verified by the United Kingdom Government Actuary's Department, an independent government agency with internationally recognised actuarial skills.

9.         The individual studies having been completed, it is possible to determine a rate of contribution for staff of the Co-ordinated Organisations which have adopted the NPS in accordance with the approach described above.

Results

10.        The consolidated rate of contribution works out at 9.2%.