David Davison, a director at Spence & Partners, discusses the recent section 75 debt arrangements and the consequences for pension schemes.
Posts by David
On Friday 25th May 2018 new LGPS (Scotland) Regulations 2018 were published and came into effect from 1 June 2018. The Regulations are a result of a long and in depth consultation process focused on trying to assist with the difficulties faced by community admitted bodies (‘CAB’s), mostly charities, participating in these schemes. Charities are often trapped in LGPS unable to afford the contributions to stay in or the cessation debt which would be imposed to exit. The current approach offers CAB’s with only a threatening cliff edge and is inflexible, inconsistent and does not reflect the approach adopted across stand-alone or segmented schemes.
The new Regulations do indeed add some flexibility in a couple of key areas:-
- The addition of the option for the administering authority (‘AA’) and the employer to agree a ‘suspension notice’ which would defer an employers requirement to pay a cessation debt. The employer would still be required to pay on-going contributions to the Fund as set by the AA. There is not really any specific guidance provided how such an agreement can be reached, which is a bit of a double edged sword. It does not therefore restrict the authority in terms of the approach it can take but as a result leaves the way open for a lot of interpretation. It is to be hoped that AA’s apply this flexibility pragmatically to arrive at reasonable outcomes for both parties.
- The recognition that if an employer is over-funded then on exit they should have the right to the repayment of that surplus in full. The Regulations have therefore added a definition for an ‘exit credit’ which for the small minority of employers in this position will be welcome news and prevent Funds from just pocketing their surplus on exit.
Unfortunately however even with these changes the revised Regulations are a bit of an opportunity lost. In January 2018 the Pension Committee at ICAS provided a response to the Scottish Public Pension Agency (‘SPPA’) suggesting some additional items which would make these changes more workable and balanced. These recommendations included:-
- a recognition that CAB’s should be able to make deficit contributions to Funds on a ‘closed on-going’ basis until the last member’s beneficiaries have ceased to receive payments.
- A consistent basis for the calculation of these payments.
- That CAB’s funding position be fully and consistently adjusted to recognise and reflect inherited liabilities from prior public sector employments. It is wholly unreasonable that CAB’s are expected to pay for benefits built up for staff who previously worked for public bodies.
- It should be compulsory for all LGPS funds to provide CAB’s with a note of their estimated cessation value annually to allow both to better manage their funding position.
Scottish Government is to be commended for at least leading the way in trying to find a resolution to the difficult issues faced. A review of 3rd Tier employers in England & Wales is currently underway and it is to be hoped that the findings of this exercise will lead to similar changes to those implemented in Scotland but hopefully even taking a step further. It will be hugely interesting to see how these new Regulations are enacted in practice.
Nearly three years ago I wrote an article praising Lothian Pension Fund in Edinburgh for an enlightened move they announced which protected organisations burdened with legacy LGPS debt. This is a huge problem, as outlined in a previous Bulletin, which unreasonable saddles admitted bodies with past Council liabilities without full compensation and usually without them even being aware. The process adopted is akin to someone buying a car but having to pay for the previous owners lease as well as your own!!
The logical and reasonable approach that Lothian Pension Fund took was to confirm that where participation in their Fund had effectively come about via an outsource from a local government entity that on exit from the Fund the exit debt would be calculated on an on-going basis rather than the much more penal cessation basis and I have been fortunate to witness a number of my 3rd sector clients benefit greatly from this wholly sensible change. Some of these issues are dealt with via transferee admission agreements but not all with many legacy arrangements still in place.
What however has surprised me is that other Funds have steadfastly refused to follow suit, a position highlight by four recent exercises I have been undertaking where all the organisations hold very significant amounts of legacy Council benefits under their membership.
How can it be reasonable for an individual to work for 35 years for the Council and then move to a small 3rd sector organisation with LGPS membership for a couple of years prior to retirement and for that small organisation to inherit the past liability in full. Patently it can’t be!
The Lothian approach recognised this and provided a clear policy statement so that everyone knew exactly where they stood.
Unfortunately, while hugely welcome, even Lothian’s approach doesn’t go quite far enough. I struggle to see the difference between members who transferred across at outset (which the policy covers) and those who transfer across at a later date (who aren’t covered). The historic liability is the same. Indeed the policy also doesn’t reflect transitions from other public sector employers and schemes which results in a similar inequity.
Scottish Government missed a huge opportunity to resolve this issue when they introduced their new 2018 LGPS Regulations but unfortunately it was absent from the revisions. This is an area which could have benefited from some prescription and a clear policy statement that it is unreasonable for public bodies to expect other organisations to pick up their liabilities and that any such liabilities should be excluded in the calculation of contributions and in the settlement of any cessation liability.
With the findings of the Tier 3 review due shortly to the England & Wales Scheme Advisory Board it is to be hoped that they will deal with the issue. In the meantime Funds have the opportunity to behave fairly and responsibly and deal with their own liabilities in full.
The more I read about defined benefit (DB) consolidation, the more it appears to have a key parallel to Brexit, namely: everyone seems to have a different expectation of the outcome.
The DWP’s White Paper “Protecting Defined Benefit Schemes” was published in March and followed up last year’s Green Paper with further proposals on the benefits of consolidation.
There are multiple consolidation options. Each will have a different impact and will be complicated to achieve.
The suggestion is that bigger is better. Having larger schemes reduces cost and improves governance. Interestingly, however, the 2017 Purple Book suggests that smaller schemes (i.e. those with less than 100 members) are on average better funded than those with more members.
So, in considering consolidation, what options are possible, what are their potential benefits and what might be the associated considerations?
The potential to consolidate investments seems relatively simple, can reduce costs and provide schemes with access to a greater level of investment choice.
Access to investment platforms can provide cost and administrative benefits even without wholesale changes to underlying governance or administration.
Consolidating governance, for example, in the form of sole ‘professional’ trusteeship also seems to present schemes with a straight-forward path to governance improvements and can be achieved without upheaval to the schemes’ delivery services.
Going beyond the above there is further potential, but the benefit improvements are much less certain based upon the specific circumstances of each scheme and employer.
There may be operational opportunities to merge key scheme services such as administration and actuarial.
It’s far from clear cut, however, that such a move will result in cost savings.
There is little evidence that the provision of services within a DB Master Trust are provided at a materially lower cost unless some form of benefit consolidation can be achieved.
In addition, the likely scheme time horizon will have a huge bearing on the cost effectiveness of any move given the inevitable set-up costs of a service change. If, for example, the time horizon to buyout is within 5-10 years then annual savings may not outweigh initial transition costs.
Any move to a DB Master Trust must be reviewed in terms of flexibility. Such a move will require a scheme to fit within the DB Master Trust model where any pricing improvements which can be achieved are done so via some form of standardisation.
The timing of valuations or the approach to administration may not be something that suits all schemes or employers.
What is the Master Trust approach to employer covenant, member communication and benefit options and is any approach outside the norm likely to incur additional costs which may negate any savings?
This will be an important initial consideration as in my experience these schemes are much easier to join than they are to exit.
This is even more problematic.
Converting one scheme benefit basis to another has long been fraught with difficulty given that ultimately a guarantee will have to be provided that members will be no worse off.
This will undoubtedly result in up-front costs that again have to be considered against any savings which can be made in future.
There have been calls for Government to standardise benefits to make consolidation easier, but it remains to be seen how this can be achieved.
Ultimately a Scheme Actuary will have to sign-off any benefit conversion to confirm that the change does not detrimentally impact on members’ accrued benefits, which is far from an easy hurdle to get over.
It is also difficult to envisage how consolidation can happen for schemes with unequal funding levels, as trustees would surely seek a “levelling-up” of funding. This has been an issue which has undoubtedly slowed the pace of consolidation in Local Government Pension Schemes (LGPS).
There must also be a concern that close links to key personnel in a scheme sponsor who can provide valuable insight from an employer covenant and operational perspective could be lost through consolidation.
Are ‘Superfunds’ the answer?
There have been proposals that a middle way between own-scheme funding and buying-out with an insurer may be possible.
This would be via what have become known as ‘Superfunds’ which would consolidate scheme benefits from multiple schemes. The suggestion is that sponsors would benefit from lower costs than that required to fund a buyout.
Proponents have been quick to highlight that any transfer in to Superfunds would need to be fully assessed by Trustees as being in members’ interests and that any agreement is likely to result in accelerated employer contributions over those paid under a funding plan in order to gain access.
An initial entrant to the market has suggested that revised legislation is not required as their scheme is just the same as any other occupational pension scheme and could run under existing regulation.
This, however, differs from proposals put forward by the Pensions and Lifetime Savings Association (PLSA) where it was expected revisions to the regulatory framework would be required.
Clearly we are at a very early stage in terms of this potential solution and it is likely to evolve over the coming months. Undoubtedly questions remain over this approach, particularly around the break in the link to the sponsoring employer and therefore the strength of the employer debt security.
Industry unconvinced by consolidation
The Association of Consulting Actuaries’ Pensions Trends Survey 2017 suggested that only 16% of sponsors would consider consolidation and only 32% thought that potential cost savings were real.
That would seem to suggest there are real concerns about how successful any consolidation might be and a high level of scepticism that promised improvements can be achieved.
It is interesting that LGPS schemes where the benefit basis is the same have primarily gone for investment consolidation. This may well be a first step, but where funds have merged for delivery services the impact in the end-user experience has been patchy.
There are undoubtedly efficiencies and opportunities for improved investment and governance available through some form of consolidation, however, the extent will be very much based on individual circumstances and requirements.
Those in favour of much greater reform certainly have a lot of convincing to do.
This article originally appeared in CA Today on the ICAS website here – on the 19th May
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.
As the government announces changes to pensions regulations, David Davison explains what these mean for charities.
They say that good things come to those who wait but I suppose that depends on how long you have to wait. I’m certainly delighted after around 10 years of campaigning that it looks like finally the section 75 regulations relating to multi-employer defined benefit pension schemes (MEDBS), which have so negatively impacted on charities over many years, are to be revised.
The problem which many charities in these schemes faced was that the further build up of benefits could not be stopped without triggering an unaffordable cessation debt, therefore charities were trapped in schemes forced to continue to fund for ever rising liabilities as they couldn’t afford to exit. This was wholly inconsistent with the options available in other UK defined benefit pension schemes.
At the end of February, the Department for Work and Pensions (DWP) issued the The Occupational Pension Schemes (Employer Debt and Miscellaneous Amendments) Regulations 2018 with the expectation that these new regulations will be in place from 6 April 2018.
The regulations are a response to consultation carried out In April 2017 and the proposals comment on the findings of the consultation and how the government has chosen to respond.
The key proposal is the introduction of the Deferred Debt Arrangement (DDA). This will allow employers in MEDBS, whose only change is to cease to employ active members in a scheme, to retain an on-going commitment to the scheme rather than a cessation debt automatically being triggered.
It is envisaged that future contributions would be set on an on-going and not cessation basis similar to what would be the position in a standalone scheme or in the event that the scheme as a whole ceased accrual. This should offer charities really significant additional flexibility allowing them to control risk in an affordable way while focusing resource on paying down liabilities already built up rather than building further amounts.
In entering in to a DDA employers would continue to have all the same funding and administration obligations to the scheme as was the case prior to the agreement which will protect member benefits and indeed other employers.
‘The devil will be in the detail’
I don’t for a minute expect this to be the end of the story as we of course need to see how things play out in practice. As is ever the case, the devil will be in the detail, and we need to see how individual schemes react to the new flexibility and whether they seek to embrace it or look to put up barriers to implementing it.
There undoubtedly seems to be widespread consensus that change in this area is long overdue and along with these changes we’ll shortly witness similar changes to Local Government Pension Scheme (LGPS) regulation in Scotland and a review of Tier 3 employers in LGPS in England and Wales which will hopefully result in increased flexibility in these schemes as well.
Undoubtedly however this is a huge step forward and one can only hope the opportunity will be embraced by scheme trustees and employers alike.
This article was original publish on Civil Society website. You can read the original article here.
The LGPS Scheme Advisory Board (SAB) is seeking the input of charities at a meeting in Birmingham on 28th February 2018. The SAB was established to encourage best practice, increase transparency and coordinate technical and standards issues.
It is currently undertaking a review of Tier 3 employers in the LGPS – details of the project can be viewed here. Tier 3 employers are all those with no tax-payer backing (i.e. colleges, universities, housing associations, charities and any admission bodies with no guarantee from a Council, academy or other tax-payer backed employer).
The aims of the exercise are to identify:
- the duties, benefits, issues and challenges for LGPS funds, Tier 3 employers and their scheme members with regard to their participation in the LGPS.
- options for change that would improve the funding, administration, participation and member experience with regard to Tier 3 employers.
As part of this exercise it’s vital that charities get their voices heard. A key element of this project therefore is to gather information and to facilitate this a listening meeting has been set up at 2pm on Wednesday 28th February 2018 at Colmore Gate, 2 Colmore Row, Birmingham, B3 2QD. The meeting will be an informal discussion and provide you with the opportunity to ensure your views are heard and taken into consideration as part of this review of the LGPS.
If you are interested in attending please contact Chris Darby as soon as possible at email@example.com.
This is a unique opportunity to have your voice heard and facilitate the change that is needed within LGPS. Hopefully the content I have provided in previous Bulletins from ICAS will help everyone with content.
It’s coming up to that time of year when participants in LGPS will be preparing for their year end accounting disclosures under FRS 102. The norm is that the Fund advisers provide an indicative set of assumptions, these receive a cursory glance, you await the results of your report at some time around May and then have this incorporated in your accounts.
Did you realise that it is the Directors /Charity Trustees who have responsibility for these disclosure assumptions and not the Fund actuary? You can therefore chose to use a different set of assumptions if those are more suitable for you and bearing in mind that one set of global assumptions issued by the Fund actuary can’t be specific to each employer, this is probably something worth considering, especially if your balance sheet position is important.
You may well be surprised by just how much of a difference small changes in the assumptions can make to your liabilities and therefore your deficit and balance sheet position.
I would therefore encourage employers already disclosing an LGPS pension liability to consider the assumptions used and whether or not they are appropriate.
The table below shows the potential impact of varying the assumptions used to calculate the FRS 102 liability. Please note this will vary for each scheme and the figures below are provided as an example only.
|Change in assumption||Change in liability|
|+0.1% p.a. discount rate||-2%|
|-0.1% p.a. inflation||-2%|
|-0.5% p.a. salary increases||-1%|
Indicative results showing the impact on deficit and balance sheet position are shown below.
|Organisation specific assumptions
So a small change of 2% in liabilities as in this case could reduce the deficit by 15% and improve the balance sheet position by £159,000.
As you can see therefore, for organisations participating in LGPS, it is well worth considering the use of bespoke assumptions, particularly if you are looking to manage your balance sheet. If you would like an indication of how changes could have impacted your 2017 disclosures we would be happy to provide these.
If you are considering a change, you need to consider this now as Funds usually require some advance notice that a different process will be used. We provide this service for many of our clients so don’t hesitate to contact us if you need more information.
In past bulletins I have highlighted the lunacy of organisations in LGPS Funds being forced to continue to build pension liabilities beyond the point where they are affordable. Organisations are stuck, continuing to build more and more benefits for their staff, focussing contributions on new benefits rather than looking to pay down the legacy liabilities they’ve already built up.
Organisations have the Hobson’s choice of an unaffordable exit debt or continuing accrual driven by LGPS Regulations which are patently not fit for purpose.
At last there seems to be a glimmer of hope that the problem has finally been recognised and an acceptance that these Regulations need to be changed to better protect scheme employers as a whole, and indeed the Funds themselves.
In a previous Bulletin, I highlighted the work ICAS in Scotland had undertaken to encourage Scottish Government to review the Regulations and, as a result of this the Scottish Public Pension Agency communicated a commitment to review the Regulations and issue a consultation with their proposals. True to their word a consultation was issued on 6 November 2017 with a closing date of 15 January 2018.
The consultation proposes material changes to Regulation 62 (equivalent to Regulation 64 in England & Wales) which would allow ‘exiting employers’ to cease building up future benefits but without the imposition of a gilts based cessation debt, something which is unaffordable for most. This would be via the use of a ‘suspension notice’ where Funds could agree to let employers continue to participate, effectively on an ‘on-going’ basis, with a continuing contribution commitment to the Fund. Such an approach would assist in dealing with this ‘Hobson’s choice.’
I greatly welcome the SPPA’s approach although the detail still, in my view, needs some refinement.
ICAS has provided a response to the consultation which highlights some issues and makes further practical proposals how these may be resolved.
I can only hope that the proposals are implemented (with some pragmatic amendments) and that England, Wales and Northern Ireland look to follow suit. It can only be in everyone’s interests.
I was reading through an LGPS annual report for 2017 this week (I know, I get all the fun jobs I hear you cry!) and was struck by a comment about the scheme membership continuing to grow and linking that to the health of the scheme and it’s relative attractiveness. This ‘positive spin’ wasn’t wholly in line with my experience so I decided to do a bit of digging to see if the statements actually held water.
Trawling through some old scheme records I identified that the scheme membership had indeed grown by about 50% over the 10 years to 2017. However, when you looked a bit more closely the increases were driven more by rising numbers of deferred members, which had more than doubled. The active membership had only increased by about 29% over the period.
So this meant that the active members, i.e. those actually contributing to the scheme, had fallen as a percentage of overall membership from over 52% in 2007 to less than 46% by 2017.
Over approximately the same period the pensionable salary roll for active members had increased by about 26% with deferred pensions increasing by around 80% and pensions in payment by over 88%.
This led me to look at a few other LGPS reports and the position is broadly consistent, demonstrating something of a trend.
So what this means is that the salary increase and active membership numbers have increased by a relatively consistent amount so the future accruing liabilities are broadly consistent. However it does mean that proportionately there’s a smaller number of those funding any deficit contributions related to deferred and pensioner members and paying for the costs of running the scheme.
So the picture isn’t quite a rosy as the statement would lead you to believe. It’s also a position that’s not wholly surprising.
Given that public sector pay rises were frozen for two years from 2010 and then 1% until this year the average annual salary rise in the public sector over the last seven years has been around 1.5%.
However, CPI over the same period has been 2.3% a year. So active member benefits (linked to salary have been going up at a significantly lower rate over the period than the increases on deferred benefits and for pensioners.
However, this isn’t the whole story. In 2014 in England, Wales & Northern Ireland and 2015 in Scotland the LGPS Scheme moved from a final salary basis to a CARE basis so this means that active participants are likely to have benefitted from higher increases on their pension benefits accrued after this date than they have their salaries, and this on a higher accruing figure (i.e. 1/49th per annum vs the previous 1/60th). So while salary benefits may have been losing value in real terms that’s not wholly the position in relation to pension benefits. A ‘healthy’ position for individuals but possibly not quite so healthy for the Funds! If we are to see salaries begin to rise in the public sector over the next few years then this will be something of a ‘double whammy’ for funds.
So, the claim of materially reduced costs as a result of the 2014/15 changes has proven to be something of a con, and indeed something that many admitted bodies will have witnessed first hand.
You may therefore not want to take the healthiness of your LGPS scheme funding from Fund comments about the growth of the membership as things are far from as simple, or indeed as positive, as suggested.