Item 2 is consideration of Audit Scotland’s spring budget revision for 2019-20, a copy of which members have in their meeting papers. I welcome to the meeting Ian Leitch, chair of the board of Audit Scotland, who is, of course, accompanied by Caroline Gardner, the Auditor General for Scotland. They are joined by, from Audit Scotland, Diane McGiffen, chief operating officer, and Stuart Dennis, corporate finance manager.
Today is a very significant day, because this is Ian Leitch’s last appearance in front of the commission before he demits office. I put on record the commission’s thanks to Ian for his hard work and the great efforts that he has put in as chair of the board over the past period, which are really appreciated.
I invite Ian Leitch and Caroline Gardner to make some short introductory remarks.
Thank you for those nice comments, chair. My introductory remarks will be very brief, given that this is my last appearance before the commission, barring some unforeseen circumstance, and I have been cautioned not to get demob happy as a consequence. I would be happy to talk through the proposals and answer any questions that members have on our budget.
As you are well aware, we live in unique if not thoroughly interesting times. We have been going through a period of significant change, and there are more changes on the horizon. Although the full implications of the United Kingdom’s withdrawal from the European Union are still very unclear, it will have a profound impact on Scotland’s public sector, which includes Audit Scotland. In the short term, beyond the current and the coming financial year, it could have a profound impact on our budgets if, for example, there is no replacement for the European agricultural fund account audit fee. That would account for approximately £1 million of our income. Obviously, we need to take great care and look at our responsibilities in that regard.
Like others, we are having to steer our organisation through the current situation and manage the increases in our responsibilities, and the wider risks and uncertainties, in that environment. In doing so, we are balancing our recognition of the limitations on public resources and the need to provide a cost-effective audit service with the need to continue to improve the quality of audit and cater for Scotland’s growing powers and public spending. Our budget reflects those factors throughout and aims to ensure that Audit Scotland is as well placed as it can be for what comes next.
With your permission, chair, I will hand over to Caroline Gardner in her capacity as accountable officer.
Thank you, Ian.
I will step back from Ian Leitch’s general introduction to focus on the spring budget revision initially, after which we will pause.
As members know, each year we bring a proposal to the commission for the annually managed expenditure funding to cover the non-cash pension charges that we need to meet in respect of the local government superannuation scheme. The overall AME cover for Scotland is redetermined once a year through the spring budget revision, and we have a routine process for coming to the commission at this point in the year.
Unlike in previous years, this year there are two elements to our proposal, the first of which is due to a reduction in the discount rate since our budget proposal for 2019-20 was submitted to the commission in December 2018. Based on the actuary’s report that we received in April 2019, we estimate that the pension service cost for this year will be £4.1 million higher than the available budget.
The second results from the impact of the McCloud case on pension liabilities. In June last year, the United Kingdom Government was refused leave to appeal the decision in that case, and the affected employees will need to be compensated. The costs of that are unclear, although the UK Government estimates that they might be around £4 billion UK-wide. Initial estimates by the local government pension scheme actuary indicate that the potential past service cost for Audit Scotland might be in the region of £2 million, but the figure could be significantly higher or lower depending on the agreement that is finally reached. It is also expected that the in-year pension benefit cost will increase from the original forecast.
As we are unable to carry forward reserves, any significant shortfall would leave us with a final outturn deficit at the end of the financial year. Therefore, the Scottish Government finance directorate has advised us to request sufficient AME budget cover to meet potential movements in the non-cash pension charge.
In our proposal, we have, therefore, requested the £4.1 million that was forecast by the actuary in April, plus a further £5.9 million to cover any liabilities that are linked to the McCloud case. Obviously, any budget cover that is unused cannot be used for any other purpose and will be returned to the Scottish Government for recycling in the usual way.
We will pause there, chair, and Stuart Dennis and I will do our best to answer the commission’s questions, recognising that this is a particularly complicated aspect of our accounting.
Over as many years as I can remember, with one year’s exception, it seems that there have been adjustments for pension deficits; they seem to accumulate every year. I realise that there is an actuarial calculation behind that and that changes to long-term interest rates impact on that calculation. However, when will we come to an end to providing for pensions?
I completely recognise your concern. If we look back at the 20-year history of Audit Scotland since it was established back in 2000, we see that, for the first 10 years or so, the picture was the other way round, and we returned funding to the consolidated fund, because it was not required. However, since about 2012, the movements have been in an adverse direction and they are getting bigger, as you can see from our proposal.
It is almost all down to movements in the discount rate. Stuart Dennis can keep me straight on this. A very small movement in the discount rate leads to quite a large change in the liabilities. Since last year, we have seen a reduction from 0.3 per cent to minus 0.1 per cent in the discount rate that is used to value future pension liabilities, which has a significant impact on the non-cash accounting charge that we need to make through our income and expenditure account. That will reverse at some point in the future, but none of us knows when that will be.
The frustrating thing is that all that money going into the pension fund does not increase the pension that staff will receive.
It is important for us to be clear that the accounting charge that we are talking about does not go into the pension fund. What goes into the pension fund is employer—and employee—contributions, which we budget for and routinely meet year in, year out. That is what will meet the pension liability in the future.
Under international accounting standards, we are required to put through our income and expenditure account an accounting charge that reflects the change in the liabilities for the future, as best as they can be estimated, which depend on things such as life expectancy. They also depend, very heavily, on the discount rate. When the discount rate changes, the value of the liabilities changes, without having any impact on the pension that our employees will receive, as you said. Those are purely accounting adjustments that are related to the relevant account standard.
With regard to the Lothian Pension Fund, which is where liability falls, one of the most important assurances that we need is about the discussions that you have had with the Scottish Government to confirm that the previously agreed arrangements with Her Majesty’s Treasury remain in place to meet the pension adjustment.
Two separate sets of discussions go on every year. There are the discussions that our corporate finance manager, Stuart Dennis, has with the Lothian Pension Fund and the actuary who values the liabilities. That leads to the agreement on the future rates of contributions that we and our staff make and on the accounting adjustments that we are talking about. Each year, the board looks at those closely to ensure that we are confident that the level of contributions and any top-up payments that we make are managing the liabilities.
Alongside that, Stuart engages with the Scottish Government on the amount of AME cover that we should be adjusting to cover the accounting charge—not a cash charge—to ensure that our accounts do not have a deficit at the end of the year. The Scottish Government is comfortable with the proposal that we are making this year, which reflects the level of uncertainty that is involved. The board is comfortable that the contributions that we are making to the Lothian Pension Fund are, over the long term, adequate to meet the liabilities that are being incurred as staff deliver their pensionable service. Stuart Dennis may wish to add something to that.
That is correct. There is a triennial valuation and the next one will be due from the start of April this year. That valuation is used to work out what contribution rates there will be from the employer. That is a cash adjustment. As the Auditor General says, this is purely an accounting adjustment to recognise the future liability. We then have a separate valuation to work out the employer’s contributions.
On the £5.9 million figure, I think that the Auditor General said in her introduction that the Scottish Government wants Audit Scotland to make an adjustment sufficient to meet the non-cash shortfall. The actuary suggested a figure of £2 million, but I think that the Auditor General said that it could be significantly less or significantly more. How exactly did the £5.9 million figure come about?
The initial estimate from the actuary of the potential past service cost that may be affected by the McCloud judgment is £2 million. That is an initial assessment before any negotiations have been entered into around what the agreement might be for compensating the pension scheme members who were affected. The actuary has indicated that there is a lot of uncertainty around the estimate in both directions.
On top of that, though, we expect that the in-year pension benefit will also increase as a result of the McCloud judgment, so we have the £2 million figure plus an unknown number and then quite a large band of uncertainty either side of that aggregate number.
As the commission knows, Audit Scotland is not able to hold reserves so any increase in our liability that has to go through the accounts would lead to an unbudgeted deficit unless we have AME cover. That would clearly not be a good position to be in for us or for the commission as the body that oversees our finances. We have the £2 million plus an unknown number for past pension cost and then the uncertain range either side of it.
But you have quantified the number. Is there a piece of paper that shows all the figures that add up to £5.9 million?
To be frank, Mr Bowman, it is £2 million plus an unknown number. The only other parameters that we have are a significant degree of uncertainty from the actuary. You can see that we have taken £4.1 million plus £5.9 million to come up with a round number of £10 million. It is the best estimate that we can make at this stage and the Government has indicated that it thinks that that is an appropriate course of action for us to take.
Thank you for your frankness on that. Has the Government given you instructions or written acknowledgment that it is happy for you to have that number in the budget?
The Government has not given us an indication of the number that we should include. It knows that we are proposing a figure of £10 million to cover both the £4.1 million past service cost and the McCloud figure. It also knows that any budget cover that is not required will simply be recycled into the system in the usual way.
Excuse me for pursuing the issue, but I have been in the position where an organisation has told me that the funding body is very aware of everything and is quite in agreement but then it turns out that it is not. Do you have some form of formal arrangement with the Government that it will accept the £3.9 million figure?
Stuart Dennis can talk through the discussions that he has had with the Scottish Government.
Initially, I had discussions about the uncertainty of this arrangement. On top of that, every year, we submit details to the Scottish Government of our AME cover requirement. It then uses that as a tool to negotiate with HM Treasury. The Scottish Government is aware that this is what we are looking for and there has been no feedback to say that this is out of the ordinary, so that is what we expect—
Would you not be more comfortable if you wrote to the Scottish Government or had a formal exchange with it to say, “This is what we are putting in and we trust that you are comfortable with it,” for example?
I have an email audit trail to the Scottish Government submitting our requirement and an explanation of the reasoning behind that. The Scottish Government has accepted that as part of the whole of the Scottish negotiations for AME cover in the spring budget revision.
If you did not make this adjustment, and what you had was wrong, would it not just be part of another budget adjustment?
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No, because the proposal that we are making now relates to 2019-20. When we complete our final accounts for the current financial year between April and May, anything for which we do not have budget cover would lead to an unbudgeted overspend, which is clearly not the position that I want to be in as the Auditor General and the accountable officer.
I have one final question for you with your Auditor General hat on. Will you be seeing other organisations doing this?
Very few organisations are in the same position as us. Audit Scotland is unusual because almost all our staff are members of the local government pension scheme, which is a funded defined benefit scheme and so needs to be accounted for under international accounting standard—IAS—19. At the same time, we have to prepare our accounts under the Scottish financial reporting manual, and we cannot carry reserves. Those three things mean that we are one of the few organisations that needs to make AME provision in quite this way. Most local authorities can carry reserves that they can use to cover the accounting adjustment, and most central Government bodies are members of the principal civil service pension scheme, which is unfunded and whose liabilities and assets are not broken down by body. As Stuart Dennis says, the AME process is common to us and the other people who require it, but our particular circumstances are quite unusual.
On one final final point, have you spoken to your auditors about accepting this level of unquantifiable unknown in your accounts?
I will ask Stuart Dennis to come in in a moment, but the commission will be aware that, in our annual report and accounts of last year, we had a contingent liability for the McCloud judgment. That is now starting to crystallise and we are now into a slightly more certain picture. We hope that that will develop in the future. Stuart Dennis has been talking to our auditors since this first became an issue.
Yes, I have been in negotiation and discussions with our auditors about this issue.
Is that it?
As I understand the accounting requirements and why they apply to us in this particular way, our auditors will be concerned that we have AME budget cover for the figure, and that we are going through an appropriate process to estimate how large the figure will be. They recognise the degree of uncertainty that is involved.
On the same topic, has Audit Scotland received any information about when the full implications of the McCloud judgment will be known, including the likelihood of increased employer contributions for staff pensions?
Diane McGiffen is in a position to answer that.
As you can imagine, from an auditing perspective, we have auditors engaged in this core work. The latest information that we have relating to the Chartered Institute of Public Finance and Accountancy’s consideration of the issue is that clarity is not expected until later in 2021, and it will possibly go into 2021-22. That is what is being said at the moment, and it might change, but we have to operate with the best information that we have in great uncertainty. CIPFA is having a meeting about this on Monday, and there might be further papers or briefings after that.
As there are no further questions from members, I thank the witnesses for their contributions and move on.