In an earlier bulletin entitled ‘The Cessation Plot thickens’ I highlighted something of an anomaly in LGPS practice around security which I’d like to explore a bit further.
Firstly, I will consider an example of an admitted body looking to close off to accrual to better manage risk. Prior to doing this let’s assume that the organisation has £1m of accrued liabilities and £800,000 of assets covering them so a deficit of £200,000. The organisation is building further liabilities of £50,000 a year. Contributions for these new liabilities are £20,000 a year so each year the net position is worsening by £30,000 (excluding any investment return).
As an active employer the Fund has not taken any security so the Fund and therefore other participating employers are exposed to additional risk as liabilities continue to build.
If the admitted body was permitted to close to future accrual of benefits the accrued benefits are no worse pre and post the change (they will likely be lower afterwards if the link to salary on past benefits is removed), so why should security be required when none was previously in place. In addition a proportion of the contributions which were being used to build additional benefits in the Fund could be used to pay down the existing benefits rather than build up new ones. Let’s assume some of the £20,000 is needed to buy replacement benefits in another scheme so only £15,000 is available as a contribution. This will therefore reduce the deficit over time thereby reducing the risk to the Fund. This can only be good for all concerned and further supportive of the view that no security is needed.
So, why is there an obsession for Funds to get access to security on scheme change? It’s probably because they’re using it as an excuse to do so! A bit of a reality check is needed.
It’s potentially reasonable for Funds to look for security if some additional flexibility is being offered, such as access to a higher risk investment fund where the deficit risk could increase but without this the default position should be that additional security should not be necessary.
So if you’re being pushed for security by a Fund you may need to ask a few more questions, especially as any arrangement of this type is likely to be time consuming and expensive to arrange.
In my view there should be clear and consistent guidelines which Funds employ in relation to the provision of security. Some Funds are adopting a more pragmatic and indeed enlightened approach to the issue of security and it can only be hoped that others will begin to follow suit, especially if admitted bodies ask the right questions.