Posts by David

David Davison

David Davison

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

I’m often asked to explain why contractors have finished up with a substantial bill payable to an LGPS at the end of an out-sourced contract. I’ve therefore compiled this very simplistic worked example to highlight the issues contractors face. The figures are for representative purposes only and are not intended to be either detailed or LGPS liability specific.

Let’s assume we had just one individual, aged 55 and on a salary of £40,000, who transitioned to an out-sourced contract for three years on 1 April 2014. The individual had been working for the Council for over 20 years, so the value of the benefits they’ve built up on an on-going (or pay-as-you-go) basis at the date of the transfer of service is valued at around £100,000. They will then have accrued additional liabilities at a rate of around £5,000 p.a. over the three year term of the contract. The Fund was only 90% funded (i.e. equivalent assets of £90,000) at the date of the transfer, so there was a shortfall of £10,000 at outset. As part of the contract negotiation, the Council agreed it would assume that the scheme was fully funded and the £90,000 actual assets were notionally viewed as £100,000. The contractor felt that this protected them from the under-funding risk.

We’re now three years down the line and the contract ended in April 2017. The total notional liabilities should be £115,000 (i.e. £100,000 + £15,000), but in reality they’ve increased as a result of a fall in bond yields over the three year period, which places a higher value on the liabilities. The liabilities are now 10% higher at £126,500 and unfortunately the asset value, including contributions paid over the three years, is still £100,000. There is now a deficit of £26,500 and the scheme is funded to around 80% on an on-going basis. Now, no-one would argue that the contractor should have to fund the liability for the period of the contract in full, i.e. the £15,000, now valued at £16,500. This, given the scheme is 80% funded would leave a shortfall of £3,300.

However, the Fund is likely to be looking for the contractor to fund the whole of the balance of £26,500, even though £23,200 of these liabilities have nothing to do with the contract, or that contractor, and were accrued prior to the contract.

In addition, the position could be worse, as if the contract came to an end and wasn’t renewed or taken over by anther contractor (who was prepared to accept the pension liabilities), the Fund could chose to look for a cessation debt. The cessation debt is calculated on a gilts basis which is very low risk – this places a higher value on the liabilities. The likely cessation liabilities could be around £180,000, leaving a shortfall of £80,000 payable by the contractor. Clearly this is only one member, so it’s not difficult to imagine what the figures may look like where many more individuals are involved.

The application of a cessation debt on a gilts basis for contractual out-sourcing is wholly inconsistent with other public sector schemes. This approach does not reflect the usually short term nature of contracting, and represents an unreasonable funding premium over the costs that could have been achieved by the contracting authority pre tender.

As if that wasn’t bad enough, if the funding position had deteriorated prior to an actuarial valuation which was happening within the three year contract period, this could result in higher contributions during the contracting period, again based on the whole of the liabilities and not just the contractors share.

In our example, as the member is aged 55, if the contractor looked to make them redundant, there would be strain on fund costs payable as the member would be entitled to their pension at normal retirement date, unreduced from age 55. The contractor would be liable in full for these costs (again unless any alternative arrangement was agreed at outset), and they could run in to tens of thousands of pounds. This is the result, despite the fact that they were only responsible for about 13% of the total liabilities. Similarly, the contractor could be responsible for ill health early retirement strain costs.

This scenario does raise some pretty pertinent questions. How can this possibly be equitable? Why should the original employer who accrued these liabilities suddenly lose responsibility for them? Equally, why would any new contractor wish to take them on knowing that they’re effectively assuming liabilities from another unconnected employer?

The answer from contracting authorities and Funds is effectively ‘caveat emptor’. If the contractor didn’t seek or achieve any form of contractual protection over these issues, then effectively that’s the deal they signed up for. Authorities and Funds have currently no obligation to explain these risks.

This highlights just how important it is to make sure that the contractual negotiation prior to agreement deals with all these issues. This process can be complex, time consuming and costly, and even then can still result in inequitable outcomes with many bidders being put off by it, resulting in poor outcomes for the contracting authority. What is also frustrating is that each local authority can adopt completely different contractual arrangements and approaches to outsourcing.

Being able to accurately allocate liabilities by employer service to more effectively deal with legacy past service benefits would greatly simplify the whole process, make it fairer and more cost effective for all, as well as being likely to produce much better outcomes for the procurer. This, in conjunction with a consistent pass through mechanism on these accrued contractual liabilities, would greatly improve the tendering process.

Contractors need to be aware of the issues and there is some good guidance available to assist. Contractors need to engage relevant professional support and be prepared to walk away if the risks are ultimately too great. Government needs to be more transparent about the risks and come up with a consistent process which can be applied UK wide.

David Davison

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. Read more »

David Davison

We are delighted at Spence to be able to support a further two publications launched over the last week.

  • The 4th Edition of Charity Finance Group (‘CFG’) “Navigating the Charity Pensions Maze” was published in London on Thursday 23rd March. Spence were pleased to sponsor this invaluable publication and our Director and Head of our Charities Practice, David Davison, provided technical input on the Guide content. The Guide contains an excellent section on “Navigating the Local Government Scheme” compiled by leading legal firm Charles Russell Speechlys. This covers the benefits and risks of membership and provides a list of helpful questions charities should be asking about their participation. The CFG accompanying blog can be found here.
  • Leading representative body the Pension & Long Term Savings Association (‘PLSA’), formerly the NAPF, have launched the third of their guides covering Best Practice for Employers in LGPS with David Davison again providing technical input on the content. This was launched on the 28th March and a link to the launch information can be found here.

We believe these documents, and those published previously, will provide an excellent resource for charity trustees and senior personnel to assist them in dealing with the issues associated with LGPS membership.

David Davison

An Amicable Divorce

The question I’m asked about most often is about the cost of exiting a LGPS, as for most charities the costs can come as a bit of a surprise. One organisation I worked with recently had a small surplus at their last actuarial review and in their accounts, but when a couple of their staff left unexpectedly they were immediately hit with a bill from the fund in excess of £500,000, pretty much wiping out all their assets and placing them on the brink of insolvency. So what do you need to know?

Should you run out of active members in your LGPS fund (and not be in a position to add any new ones, for example if you have a closed agreement or a local authority contract has come to an end) under the LGPS Regulations the fund must commission the Fund Actuary to complete a cessation valuation. Whilst the Regulations do not prescribe how this calculation should be carried out, the actuaries undertaking the calculation will use very prudent ‘least risk’ assumptions based on gilt yields. This will result in liabilities being much higher than is the case on either a funding or accounting measure. Often this is the first point that an admitted body may be aware of this liability, as unfortunately numerous funds still do not provide organisations with an annual estimate of the potential cessation debt.

The conservative approach taken reflects that once an organisation exits an LGPS, the fund cannot pursue them for any extra money if the cost of providing members’ benefits is higher than expected. The fund therefore wants to make sure that there is a minimal risk that other employers in the fund would be responsible for paying for any of these exiting liabilities. As such the approach is a protection for all. However, what has been called in to question more recently is whether the basis adopted is reasonable, and indeed suitable in all circumstances. What is clear however, is that there is a great reluctance on the part of the funds to change, not surprisingly.

Whilst the approach to calculating a cessation debt across Funds, and across the various fund actuaries, tends to be consistent, the circumstances in which it applies can vary significantly. For example, some funds offer public sector out-sourcers ‘pass through’ protection, which means that any cessation debt is calculated on the much lower on-going funding basis. Other funds recognise where the last employer has inherited significant liabilities from a public sector body, and will account for these by ensuring that the public sector body picks up their fair share. Unfortunately, though the vast majority of funds do not.

Some funds are prepared to negotiate around the cessation amount payable, subject to affordability and the term of any repayment. However, in most circumstances these negotiations need to be conducted in advance of any formal debt trigger / calculation.

Admitted bodies therefore need to be aware of their situation and look to plan for it, as far in advance as possible, as allowing a cessation event to just happen could have catastrophic implications for the charity.

In my next bulletin I’ll consider why change should be considered.

David Davison

They always say that sequels are never as good – well here’s a publication that well and truly proves that adage wrong.  This fourth edition has taken over nine months to compile and provides over 50 pages of invaluable information, compiled by industry experts, which will hopefully allow finance directors, HR managers and CEO’s to find information on the issues which affect their charity and therefore help them get the most from their pension provision.    

I am delighted to have been able to contribute to, and indeed sponsor, the publication of “Navigating the Charity Pensions Maze” produced by Charity Finance Group (CFG) having provided input in the area of Section 75 debts in non-associated multi-employer defined benefit schemes, and providing our experience on how the problems can be addressed.  We believe that this document will provide charities with an invaluable reference guide to the complex pension issues they face.

Read more »

David Davison

Fortunately my expectations for the Green Paper published last week weren’t high which was good as at least I didn’t have to deal with crushing disappointment. I did have some hopes that after a myriad of working parties and consultation on Section 75 and multi-employer schemes over the last few years, that expectant charities at last may see some revelation on an issue that has been dogging the sector for well over a decade. There was indeed a revelation, of sorts! It was just that they needed more consultation!! How could anyone not understand the issues here? The problem isn’t about lack of understanding of the issues, but about lack of will to do something about them.

The commentary on multi-employer DB schemes is contained in paragraphs 400-407 in the ‘Consolidation of Schemes’ section, which is somewhat ironic given that most of the necessary change for multi-employer schemes results in anything but consolidation!!

In point 405 there is one tantalising comment, namely “We intend to consult on a new option employers can consider to manage the employer debt in these circumstances.” Ah, what could this be, and why was it not actually in the Green Paper?

My greater concern is that at the end of the Consolidation section there are three key questions posed in relation to multi-employer schemes:- Read more »

David Davison

Many charities participating in local government pension schemes (‘LGPS’) have been increasingly frustrated by the lack of recognition of the issues they face by the schemes they participate in and, indeed, from Department of Communities and Local Government (‘DCLG’) who oversee them. The issues are not new but there remains an element of denial and finger pointing, and it’s very easy to see how charities could be understandably frustrated.

I often experience a feeling amongst charitable admitted bodies that Councils and LGPS encouraged them to join Funds, without ensuring independent advice was sought or providing any risk warnings about the step they were taking, and have now just abandoned them to their fate. Whilst, to a great extent, the problem has been capped over recent years as admission to Funds has become much more rigorous, this unfortunately does nothing for all those employers admitted before that stable door was closed.

For those employers, LGPS have sat on their hands allowing organisations to continue to accrue liabilities even when they clearly couldn’t afford to do so, and without providing the flexibility to address the issue. Many charities I’m aware of have approached LGPS over many years looking to stop accrual, and arrange a payment plan and were just provided with pay up or keep participating as options. Now, as funding positions have deteriorated and funding costs have increased these same schemes are pointing fingers at these same trapped charities for their inability to be able to continue to participate.

For many charities there is also a growing recognition that Councils have adeptly transferred historic past service liabilities in £millions to them, due to LGPS inability to segregate service between employers and without making employers aware of the impact. This has been hugely expensive for charities and DCLG and LGPS continue to try to ignore this issue and sweep it under the carpet. Indeed, LGPS continue to do this with unsuspecting Academies being a prime example.

A limited number of Funds and Local Authorities have sought to deal with the issues however, the response has been at best patchy and has lacked any level of standardised practice. Indeed these ore enlightened approaches attract a “nothing to do with me” response when raised with pension managers from Funds not employing them and for many admitted bodies they are completely unaware of the alternative options explored and implemented elsewhere. A lack of consistency of approach also means that each exercise needs to be looked at on an individual basis, adding complexity and professional adviser costs when helping charities through the maze.

The Shadow Scheme Advisory Board (SSAB), which was established to encourage best practice, increase transparency and coordinate technical and standards issues for LGPS as well as providing recommendations to Government for future regulation commissioned a report from PWC as part of its deficit management project kicked off in summer 2014.

The report was published in July 2015 and the key recommendations which will be of specific interest for admitted bodies are:

  • More flexibility on when exit debts are triggered. The proposals suggest that debts would not be automatically triggered by the exit of the last member. The paper recognises that some minor changes to regulation will be required.
  • Establishing a maximum level of prudence when calculating exit payments. Currently Schemes tend to use a gilts basis to calculate the exit cost despite schemes not investing assets in this way. This effectively means that employers paying a cessation debt are cross funding other employers who remain. This is recognised as inequitable and is also a discouraging factor for charities wishing to look at an exit. This proposal would effectively reduce cessation debts for those looking to exit the Scheme, for many to a point which may be affordable.
  • Flexible exit arrangements. These could include continuing to pay contributions on an on-going basis for a prescribed period and for employers to pay their cessation debts over a much longer period. This would be extremely welcome flexibility for many small employers and is a more consistent approach with that adopted in the private sector.
  • Employer exit on weaker terms. It is recognised that, in some circumstances, it could be in the interests of the Fund, the remaining employers and the admitted body to allow them to exit on weaker terms and small charities are cited specifically as an example.

These items certainly reflect much of the commentary supplied by charity representative bodies, charity advisers and charities themselves although at this stage they haven’t fully addressed issues around the transition of prior local government liabilities to charities but it is hugely helpful to charities’ positions and it has been a welcome addition to the debate, especially given that it comes from such a reputable source.

Unfortunately however, it has disappeared in to something of a black hole, possibly overtaken by other more pressing global events. The proposals however need to be addressed by the SSAB and implemented by Government and LGPS as quickly as possible. The issues faced have been created by local government, LGPS and the admitted bodies and there needs to be a commitment to co-operatively finding solutions, and a desire to do it soon. Charities need to be vocal with their Funds and local authorities about the issues they face and get them to look to address them positively. Charities should also be working collectively and in conjunction with their representative bodies to make sure their voices are heard.

David Davison

Playing the waiting game

In our fast paced society no one really likes waiting for anything, however for those financial directors of charities participating in local government pension schemes in England & Wales I’m sure they wouldn’t mind waiting a bit longer for their valuation results given everything else going on around them.

Read more »

David Davison

LGPS Discretions

An issue often over-looked by employers participating in a Local Government Pension Schemes is that each admitted body is required to have a Discretions Policy in place.  This Policy must be published, kept under regular review, and a copy must be sent to the administering authority. Read more »

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