An alternative approach to cessation

David Davison

or Subscribe to Feed

In my last bulletin I outlined the issues that charities are likely to face should they look to exit an LGPS. The cessation debt is calculated by the Fund Actuary in most cases using a least risk approach based on Gilts. For many employers in LGPS the dramatic reduction in gilt yields over the last 10 years has resulted in very significant increases in applicable cessation debts.

Based on the table above an admitted body with a cessation debt of a few £100,000 10 years ago could well now have a debt well in to the £millions.

This I believe highlights a fundamental flaw in the cessation approach adopted in LGPS. In a private sector standalone or segmented multi-employer scheme to manage risk it could be agreed that no further benefits would be accrued. The trustees and employer could then agree to continue to fund the scheme on an on-going basis only deciding to buyout / secure the liabilities when market conditions, and the scheme and employer financial position, merited it.

Charities have recognised the issues over many years and have sought to address them however have been met with an inappropriate legislative framework and Funds who are not prepared to employ any degree of common sense in applying flexibility. In my view the approach being taken borders on seeking to defend the indefensible.

The consistent mantra has been that the LGPS Funds are only looking out for other employers participating in their Fund and indeed the tax payer. If that was the case would Funds not have looked to try to find ways to limit accrual in cases they deemed to be high risk and look for funding mechanisms which didn’t just seek to maximise their contributions but also considered how unpaid cessation liabilities could be better avoided.

Let’s consider some of the background in a bit more detail:-

  • Charities have been forced to continue participating in Funds as should they want not to do so they are hit with a cessation debt which is usually well beyond the level they can afford. This is not a new issue but Funds have consistently refused to meet it head on over many years. Only very recently have some begun to look at offering additional flexibility in relation to payment terms.
  • In addition Funds have chosen to blindly continue to adopt a nil risk gilts basis to calculate these exit debts without any consideration of the impact or indeed of the lost potential contribution income from driving organisations to insolvency and not being able to recoup the deficits due.
  • The application of a gilts basis on exit is for the most part a one way street in favour of the Funds. Ultimately Funds do not know how much the payment of future benefits will cost but they persist in suggesting that they do and this is the gilts based cost – it is not!! The calculation is a figure derived using a scheme membership and a series of economic assumptions at a point in time. The economic assumptions could be right but more likely they will not be. Future conditions could be very different and while I recognise they could deteriorate further over the longer term you would expect that there might be some expectation of improvement. But that is speculative I know. The one way street in relation to membership is not. By settling a debt based upon a membership at a particular time this ignores the fact that this membership will change over time. People will die, transfer out or draw benefits early or in different formats than expected and none of this will be taken in to account once a settlement figure is imposed. A very recent example I witnessed was with a small charity which was being pressed to pay a cessation debt of just over £1m and over the period a senior member of staff accounting for around 50% of the liabilities unfortunately died. Had the debt been settled this would have been windfall to the Fund.
  • These issues have been recognised in stand alone schemes and employers cease accrual and continue to fund on an on-going basis only settling the final cessation debt when they chose to do so. Payment on this basis allows the liabilities to unwind over a period of time.
  • The issue doesn’t just impact now on exit as many Funds look to apply this gilts basis for employers where they have a limited period to go until the last member retires or where the membership numbers are particularly low. However this is a sledgehammer to crack a nut. Another charity I’ve been dealing with have seen their deficit increase 20-fold as a result of this change which has seen two members of staff in their 30’s compulsorily moved to investing in gilts for a further 30 years. This just can’t make any sense. The Fund has absolutely no idea how much these individuals benefits will cost in 30 years time.
  • For many charities in this position the introduction of FRS102 is also hugely problematic as the net present value of their deficit contributions effectively means that they are adding cessation liabilities to their balance sheet, which again impacts on their ability to compete for contracts and grants and/or encourage donations which again impacts on their solvency.
  • Many charities recognised the issue of unaffordable defined benefit costs and looked to limit these by not allowing further staff to join the Funds however over time as members have left and not been replaced membership numbers have fallen to now being at a point where these issues become much more serious.
  • The gilts based approach is justified by Funds on the grounds that this level of prudence is necessary to protect other participants and the tax payer. Now I recognise that some prudence is necessary but the level adopted is excessive. This is something which was also recognised in the PWC report on deficit management with LGPS on behalf of the Scheme Advisory Board. I would hope that many of the suggestions in this paper are followed through in to regulation.
  • If organisations are forced to continue to contribute beyond the level which is affordable to them, as historically they have been, a day of reckoning awaits. By forcing these employers to pay contributions on a three or fours times multiple over a short period they are placed at risk of insolvency and if they do become insolvent then the Funds will have very little chance of recovery. In all my discussions with LGPS I haven’t come across any that factor in loss of potential future income in to this equation.
  • A fundamental issue is also missed in all this. Should organisations be allowed to close to future accrual without automatically triggering a cessation debt the liabilities pre and post this event are effectively the same. On this basis I find it hard to understand why the Funds call for additional security to allow this to happen, especially when the risk to the Fund is actually reduced as no further accrual is possible. In this scenario all contributions can be directed to reducing the deficit for the liabilities already built up rather than funding for further future liabilities which are likely unaffordable. For this to work there needs to be recognition that the current Regulations are flawed and need to be changed.
  • Frustratingly many Funds also continue to deny the issue of inherited liabilities. It is totally inequitable to expect a small charity to pick up a cessation liability for benefits they previously inherited from a public sector body on an on-going basis, or even in many cases a funding basis well below this. One Fund has sensibly identified this and looked to deal with it fairly and I can only hope that all others will follow. Indeed these liabilities should just be re-allocated to public sector ownership which means that the Fund has them guaranteed with no cessation debt requiring to be paid.

Many of the approaches adopted have been knee-jerk and not fully consulted upon and I believe that a totally independent root and branch review of the operation of LGPS in relation to admitted bodies is required and the findings should drive reform of the Regulation. With the SAB’s in place and a review underway I can only hope that a revised, more sensible, approach is imminent.

David Davison

Post by David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers

Comments