Public Sector Pensions – Participating in the Local Government Pension Scheme
By Christopher Nuttall
Posted: 5th September 2017 08:29
In December 2016, the Organisation for Economic Cooperation and Development (“OECD”) found that the gap between public and private sector pensions in Britain is the widest in the developed world. Public sector pensions can be expensive for employers to fund.
The Finance Act 2004 defines a public-service pension scheme as one which is established by or under enactment, approved by a relevant government or parliamentary person and specified in an order made by HM Treasury. The four main schemes are the Local Government Pension Scheme (“LGPS”), the Principal Civil Service Pension Scheme (“PCSPS”), the National Health Service Pension Scheme (“NHSPS”) and the Teacher’s Pension Scheme (“TPS”). The combined membership of these four arrangements is around 12 million individuals, with approximately five million of those being active members.
The Pensions Regulator is responsible for setting standards of governance and administration in public sector pension schemes and has regulatory oversight of such schemes. Three of the four main public sector pension schemes are unfunded (TPS, NHSPSs and PCSPS). They operate on a ‘pay as you go basis’ and are government backed. The LGPS is a funded arrangement.
There are 89 regional LGPS funds looked after by ‘administering authorities’ (in most cases London Boroughs and County Councils) which hold and invest their own distinct pool of assets. Benefits are guaranteed by legislation, with the local authority and the council tax payers being the final guarantors of each fund. Below, we explore some of the particular issues in relation to the LGPS when employers take on staff to work on services contracted-out to them by local government.
Transfers of employment from the public to private sector are subject to a policy known as ‘Fair Deal’. Broadly, this requires transferring employees to continue to have access to continued membership of their public sector pension scheme following the initial transfer and on any subsequent transfer, while they continue to be employed on the contracted-out service or function that they used to do in public sector employment. This policy does not apply to employees in the LGPS, but the government has consulted on extending it to them.
Currently, employees of ‘best value’ authorities are covered by the LGPS Best Value Staff Transfers (Pensions Direction) 2007 which requires the authority to ensure that the transferring employee has the right to acquire pension benefits that are the same as or count as being broadly comparable to or better than those that they had as an employee of the authority. In practice, this is usually achieved by the new employer being admitted to participate in the relevant LGPS fund under an admission agreement.
Once an employer becomes an admitted body within a LGPS fund, it becomes liable under the regulations that govern the LGPS for the contributions payable in relation to the employees who have transferred to it. The possibility of an admitted employer becoming insolvent or otherwise being unable to meet its contributions presents a funding risk to the LGPS fund to which the employer is admitted. Because the LGPS is a funded scheme, it is possible for it to have a shortfall.
A pension shortfall arises when the actuarial estimate of the liability that employers need to fund in order to provide the promised benefits exceeds the value of the assets of the fund. Broadly, contributions to the LGPS comprise two elements: contributions to fund the future service benefits and contributions designed to eliminate any funding shortfall. Further one-off contributions are also due if an employer exercises any discretions (i.e. powers given to them) which create a strain on the LGPS fund, such as to award additional pension or to pay an ill-health pension.
It is not realistic to expect employers to pay contributions to remove funding shortfalls in place at the date of transfer and that relate to benefits accrued by the transferring employees during their periods of service with the public sector employer. Therefore, new employers joining the LGPS are typically provided with a ‘clean slate’ in relation to the funding of the transferring employees’ past pension benefits (but would remain responsible for any shortfall relating to their employees which builds up during their participation in the LGPS).
Contributions are revised following each triennial valuation. Under the LGPS regulations, an employer has no opportunity to influence the level of contributions that they are required to pay.
In addition, an employer’s pension shortfall is due in full as an exit payment when its admission to the LGPS comes to an end. This will usually be when it stops providing services that are funded by the local authority or when its employees who are members of the LGPS stop spending the majority of their time working on the services funded by the local authority (unless they remain employed in another role alongside staff employed to work on those services).
The size of an exit payment can be significant and the time given to pay it is often short (sometimes as little as 30 days). The actuarial assumptions that the LGPS actuary uses to calculate the exit payment are not prescribed. The assumptions used may well be more prudent than those used when calculating on-going contributions, resulting in a larger shortfall on exit than on an on-going basis.
Before an employer joins the LGPS, a risk assessment is carried out to the satisfaction of the local authority (and is subsequently kept under review), as a result the employer may be asked to provide a bond, indemnity or, if neither is desirable, a guarantee to protect the LGPS fund against the risk of the employer’s insolvency.
The statutory mechanisms that allow employers participating in private sector pension schemes to, for example, apportion their exit payment or pension liabilities to other employers in the scheme are not available in the LGPS. To manage the risk of a large exit payment making an employer insolvent, an employer participating in the LGPS may choose to pre-fund for termination by changing their funding approach to a least risk methodology and set of actuarial assumptions. This will reduce the risk of a potentially large exit payment being due to the LGPS fund at termination. However, adopting such an approach is also likely give rise to a substantial increase in contributions.
Other approaches to managing the risks associated with pension provision include agreeing fixed or capped employer contribution rates. Using these mechanisms, an employer could claim back from the local authority any ‘excess’ payable over the agreed contribution rate. Any such approaches should be agreed between the local authority and the employer during contract negotiations and included within the outsourcing agreement.
Employers taking on employees who have access to the LGPS as part of an outsourcing need to have a clear, up to date, picture of their pension obligations and a plan to manage likely contribution increases. They should think about how to tackle the risk of a pension shortfall and agree any risk management mechanisms with the local authority at as early a stage in the outsourcing process as possible. Doing so will help to show that public sector pension issues are being tackled appropriately.
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Christopher’s work involves finding solutions to pension problems, drafting scheme documentation and advising on transactions involving schemes. He advises employers and trustees on technical and administrative issues and projects like scheme mergers, closures and buy-outs. Christopher also has expertise in public sector pensions.
Christopher is a full member of the Association of Pension Lawyers with over 11 years’ experience. After reading English at the University of Oxford, Christopher trained and worked in the pensions team of Harvey Ingram (now Shakespeare Martineau) before joining Wragge & Co (now Gowling WLG). Christopher joined Hewitsons in 2013 and is their Head of Pensions.