Local Government Pensions Article - To Credit or Not to Credit

To credit or not to credit? 

Introduction

Outsourcing is a common practice in Local Government, as is setting up joint ventures and local authority trading companies. This practice often involves a transfer of staff to deliver the outsourced services, which brings about key considerations. The obvious consideration, and quite rightly so, is protecting employment rights in line with TUPE (Transfer of Undertakings Protection of Employment) regulations. There are, however, crucial considerations around pensions, which are not captured by TUPE regulations, that can be overlooked.

Pension Protection under the Best Value Direction

Employees’ pension rights in Local Government are protected under the Best Value Direction. This means that transferring employees must be provided with continued access to the Local Government Pension Scheme (“LGPS”) (or a broadly comparable scheme) when outsourced. Access to the LGPS necessitates an initial transfer of pension assets and liabilities at the contract start date, followed by further accrual  during the employees’ service period under the outsourced contract.

Pension Risk Sharing and Contractual Considerations

Thought must be given to the treatment of pensions in the commercial outsourcing contract and in the LGPS “admission agreement” (the agreement giving the contractor access to the LGPS). Decisions around pension risk sharing between the letting authority and contractor, including details of any guarantee to be provided by the letting authority, and the contractor’s obligations on pension contributions, need to be made at the outset. It is possible to set up outsourcing contracts so full risk sharing is in place (via a “pass through” arrangement), which provides cost certainty for the contractor and also has the advantage of putting contractors on an equal footing during the bid process.

There are outsourcing contracts, particularly historic ones, where no risk sharing is in place. This can often result in ambiguity when the contract ends. This can lead to uncertainties regarding onward pension transfers and the treatment of shortfalls or surpluses when employees move to a new contractor or back to the local authority. Additionally, the pension liabilities of employees who retired or left during term of the contract need to be addressed.

Impact of Legislative Changes

This complexity has been further compounded by changes to pensions legislation, which means that historic contracts may not be compatible with current regulations. A significant change in the LGPS regulations in May 2018, allowed surplus (an “exit credit”) to be paid to an exiting employer.

When a contract comes to an end, the contractor becomes an exiting employer and may stake a claim on any surplus. Whilst the Local Government Pension Scheme (Amendment) Regulations 2020 (2020 Regulations) removed automatic entitlement to exit credits to an exiting employer, it transfers the discretion to the administering authority to determine the amount of the exit credit (which could be zero) that an exiting employer can receive.  The 2020 Regulations also set out considerations that an administering authority must take into account when determining the amount of exit credit.  This can become a critical point of contention when the contractual documentation is unclear or silent on the treatment of surpluses.  As well as the usual public law requirements, attention also needs to be given to the LGPS Fund’s own policy documentation, alongside the legal documentation governing the commercial contract.    

Importance of Professional Advice

Why is this so important now? Market conditions from a pension perspective are much improved. This is primarily due to the rise in real gilt yields which has substantially reduced the value of liabilities and led to the emergence of very high surpluses in the LGPS. There will therefore be outsourced contracts, with very high pension surpluses, that are due to cease imminently (either to be renewed or insourced).

It is therefore advisable that local authorities undertake a review of their outsourced arrangements to help protect the public purse and prevent leakage of public sector monies to the private sector. When renewing or letting new contracts, it is necessary to specifically set out how exit credits are to be dealt with on the termination of a contract.

Seeking independent actuarial advice, alongside legal and procurement advice, is paramount for a comprehensive understanding of the pension implications of outsourced contracts, rather than relying on the LGPS Fund and its advisors.

Alongside preparation for the 2025 LGPS valuation, gaining clarity on the pension implications of their outsourced contracts should be a priority area for all Section 151 officers.

Authors

Urrffa Rafiq is a Director and Head of Public Service Pensions at KPMG

Lukman Patel is a solicitor and the Chief Executive of Burnley Borough Council