Employees transferring from public bodies can now be more confident that their favourable pension terms will be maintained in the private sector, although there remain some uncertainties in respect of the detail of the new employer’s obligation and the enforceability of their rights. This is the result of the Government’s “Fair Deal” guidance being placed on a statutory footing with effect from 1 October 2007.

What is Fair Deal?

Since 1999, it has been Government policy that employees whose employment is compulsorily transferred within the public sector or from the public to the private sector (typically as part of an outsourcing arrangement) should be provided with “broadly comparable” pension benefits by their new employer. This policy is set out in an HM Treasury guidance note called “Fair Deal for Staff Pensions” having previously been an appendix to the Cabinet Office Statement of Practice “Staff Transfers in the Public Sector”. It does not apply directly to private sector employers, but requires public sector bodies to enter into contracts on terms that satisfy Fair Deal.

Under the Fair Deal principles, transferring employees must be provided with pension benefits for future service that are “broadly comparable” in value to their public sector pension entitlements immediately prior to the transfer. They must also be given an opportunity to transfer their past service benefits into their new employer’s scheme (thus maintaining a link with their current salary) on a day-for-day credit basis. These same protections must be afforded on a second or subsequent generation transfer, which makes it difficult for private sector employers to change the pension benefits during the life of the contract.

Whether or not the pension arrangements offered by the new service provider satisfied the requirement for broad comparability was determined by reference to and certification by the Government Actuary’s Department. (Note, however, the Government Actuary’s Department’s policy of withdrawing passports until a “broadly comparable” scheme is amended to reflect changes in the corresponding public sector scheme – the subject of a separate article in this edition of Insight.) With regard to the Local Government Pension Scheme, it is possible to satisfy the broad comparability requirement by the service provider effectively becoming a participating employer in the LGPS by means of an admission agreement. Such an arrangement is not possible in relation to the Principal Civil Service Pension Scheme or the NHS Pension Scheme where service providers must either use their own final salary scheme as the vehicle for future service benefit provision or, if they do not have one, establish a scheme satisfying the broad comparability test.

On a second generation transfer, where the relevant employees have transferred from the public to private sector and are now being transferred again, Fair Deal should again apply, with the second private sector employer required to provide benefits broadly comparable with the original public service pension scheme in which the employees participated.

So what changed in October 2007?

On 27 June 2007 the Secretary of State for Communities and Local Government issued the Best Value Authorities Staff Transfers (Pensions) Direction 2007 under powers contained in section 102 of the Local Government Act 2003. The Direction came into force on 1 October 2007 and places Fair Deal on a statutory footing. This has resulted, at least in part, from trade union lobbying.

What does the Direction do?

As mentioned above, Fair Deal is not legally binding guidance although in practice most public bodies, including local authorities, have followed its principles. In some instances (for example, where a very small number of employees were transferring) contracting bodies may have considered it appropriate to depart from the full requirements of Fair Deal, indeed this was specifically permitted by the policy. The 2007 Direction has enshrined the policy in legislation, making it harder for contracting bodies to enter into contracts that do not comply with the full requirements of Fair Deal.

The Direction applies to English “best value authorities” which includes local authorities and waste disposal authorities. The Direction does not apply to Scotland or Northern Ireland. Nor does it apply to Welsh local authorities.

New service contracts

The 2007 Direction applies where a best value authority enters into a new contract with a service provider for the provision of services currently undertaken by the authority. Where, as a result of the contract, an employee of the best value authority transfers employment under TUPE to a new employer, the contract between the authority and the contractor must provide for the contractor to secure “pension protection” for the transferring employees. This essentially means the right to acquire pension benefits which are the same as, or broadly comparable to, the rights which the employee had or had a right to acquire as an employee of the authority. This level of protection can be provided by, for example, participation by the new employer in the LGPS. The Direction does not address issues regarding accrued benefits which will continue to be dealt with under the Fair Deal guidance.

Re-tendering service contracts

The Direction also applies to provide protection to employees who transferred from employment with an authority as a result of an original service contract and who are now being transferred to a new employer a result of a re-tendering of the contract. The protection afforded by the Direction applies irrespective of when the original contract was put in place. However, the Fair Deal principles only apply to those contracts entered into after June 1999.

One important point to note is that the pension protection to be provided in such situations to transferring employees is by reference to the pension benefits to which they were entitled immediately prior to the transfer to their new employer rather than by reference to the benefits provided under the LGPS at the date of the original transfer. There is an inconsistency here with the original Fair Deal requirements on second generation transfers, which makes it hard for employers to know the appropriate benchmark for their comparable benefits.

Will the Direction make a difference in practice?

As mentioned above, under the Fair Deal policy an authority could insist on less than full broad comparability in circumstances where this was inappropriate or impossible, for example, where only a few transferring employees were involved. However, the new statutory basis does not have this flexibility. This could result in smaller contractors (particularly those without their own final salary schemes) being less willing to tender for contracts as a result of the increased pension costs they would incur if successful.

The Direction only imposes obligations on the authority: there are no obligations imposed on the contractor. That said, if an authority omits to comply with it, there could be unexpected implications for the contractor. For example, could it be argued that, in entering into the contract in breach of the Direction, an authority has exceeded its powers and the contract would potentially be void – not a position most contractors would want to find themselves in. And what of the transferred employees? The legislation has not given them any directly enforceable rights, for example, to damages in the event an authority concludes a contract without complying with the Direction. And were the contract to be void who would their employer be? Would TUPE mean they have rights against the contractor notwithstanding the voiding of the contract?

There are clearly a number of questions still to be answered. We understand that this uncertainty has not gone unnoticed by the same public service trades unions who were some of those lobbying Government to put the Fair Deal policy on a statutory footing. It may well only be a matter of time before a test case is taken which may provide some answers. In the meantime, in order to avoid those pitfalls and the possibility of becoming the test case, English “best value authorities” and those contracting with them should take particular care to ensure compliance with the Direction.