The recent reduction in the Scape discount rate could add billions to employer costs, the Institute for Fiscal Studies (IFS) has warned, although the government has promised to provide funding to compensate for these additional costs.

The comments were made after the government's recent decision to maintain the existing methodology for the Scape discount rate, which is used in the valuation of unfunded public service pension schemes to set employer contribution rates.

However, the IFS noted that whilst the methodology has stayed the same, the discount rate will not, as downgrades in the UK’s estimated long-term growth prospects since the exercise was last conducted in 2018 mean a lower discount rate, and therefore higher pension contributions for public sector employers.

This means that, from April 2024, public sector pensions will become even more expensive to provide, with the IFS warning that the NHS, schools, and other public sector employers will need to spend billions more on the contributions they pay to the Treasury.

Indeed, LCP previously warned that the 0.7 per cent per annum reduction in the Scape discount rate could push independent schools’ costs up significantly, potentially as far as 30 per cent of salaries.

However, the government has committed to providing funding to compensate for these additional costs for employers whose employment costs are centrally funded by departments.

The IFS pointed out that this decision will be fiscally neutral, as the Treasury is providing extra funds to departments to pay for pension contributions which, essentially, then flow back to the Treasury.

The think tank highlighted this as a "sensible" approach, noting however, that while departments won’t lose out, they will face what the government thinks is the true cost of employing staff.

It also suggested that this could skew departmental spending numbers at the next spending reviews, as whilst it may look like public service funding is increasing more quickly after this compensation, the real resources available to departments will be unchanged, as all of the extra funding goes towards paying higher pension contributions.

IFS research economist, Laurence O’Brien, stated: “The big picture is that worse long-term economic growth prospects imply a smaller economy in the future, which means it will be harder to meet present-day promises to pay future public service pensions.

"It is therefore sensible to reflect that by making it costlier for public sector employers to provide these pensions today, by increasing the contributions they have to make. The government has committed to compensate departments for these increased costs.

"This decision does not change overall spending or borrowing now, but it is one that could make it easier for the government, or others, to overstate the extent to which public service funding is meaningfully increasing in coming years.”

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