The social housing sector has traditionally been a supporter of defined benefit pension provision, no doubt because of its strong links with the public sector. In contrast to the bulk of private sector employers, many RSLs still offer some kind of defined benefit pension; typically, this takes the form of either admitted body status within the LGPS and/or a defined benefit arrangement within the Social Housing Pension Scheme (SHPS). But with pension deficits and employer contributions rates soaring, RSLs who currently provide these benefits are having to explore ways in which these costs can be managed and contained.
Withdraw defined benefit provision altogether?
In private sector occupational pension arrangements, the most effective way of limiting pension liabilities is to end defined benefit accrual (offering instead a defined contribution pension, usually in the form of a contractbased group personal pension arrangement). The process of termination is not something which can be achieved overnight, as most employers have to undertake a mandatory 60-day consultation with affected staff and the change is understandably unpopular with employees and unions.
RSLs who participate in either LGPS or SHPS do not, in reality, have the option of terminating defined benefit accrual at present. This is because the effect of ending their current pension arrangements will be to crystallise the amount of any existing underfunding. For example, in relation to SHPS, the employer who ceases benefit accrual will become liable to pay a statutory debt equal to the full amount of any shortfall, calculated on the basis of what it would cost to buy annuities securing the rights its employees had already accrued.
Given that SHPS’s most recent actuarial valuation revealed an overall scheme deficit on an ongoing basis (usually much lower than buy-out costs) in the region of £663m, the buy-out deficit for most participating RSLs is likely to be prohibitive.
Against this background, a recent announcement from SHPS that it is to introduce a defined contribution option for employers from October 2010 is highly welcome. The statutory debt liability only arises if an employer ceases to employ any active members of the scheme (regardless of the type of benefits they are accruing). This means that an RSL will fairly soon have the ability to end defined benefit provision within SHPS and replace it instead with a defined contribution arrangement, and provided that it can persuade at least some employees to join that arrangement, no statutory debt will arise. Note, though, that employee engagement with defined contribution arrangements is notoriously poor, and it will therefore require good ‘marketing’ and an attractive level of employer contribution to ensure that take-up is and remains at a level which does not present a significant risk of a statutory debt arising by accident through normal staff attrition.
Unfortunately for RSLs who participate in LGPS, there is no similar proposal to make an equivalent change to that scheme (change may follow the next election, but is unlikely to be swift, if it happens at all).
Close to new entrants?
This is another favoured option amongst private sector employers with defined benefit schemes. Less draconian and so less unpopular than complete termination of accrual, it involves retaining ongoing accrual for existing staff, but offering new starters a different arrangement (again, usually on a defined contribution basis). Again, prior consultation will normally be required.
This option is already open to employers offering SHPS, and in most cases also to those offering LGPS. The obvious risk is that, over time, a closed scheme’s membership will dwindle until there are no active members left, at which point the statutory debt under SHPS or equivalent termination liability under LGPS will arise. It may be possible to manage such risk by retaining an employer discretion (for example, to offer defined benefit provision to senior hires), but active monitoring would be required, and there is the risk of discrimination liability attaching to the exercise of the discretion.
The introduction of SHPS’s defined contribution offering will provide a way out of this difficulty for SHPS employers; again, no such ready solution exists at present for LGPS. housing matters
Change the basis of defined benefit accrual?
RSLs offering SHPS who wish to maintain the principle of defined benefit accrual but reduce costs, could consider taking up some of the less costly benefit options currently provided, or shortly to be available via SHPS. These include final salary benefits with a lower accrual rate (1/70 or 1/80), and CARE (career average revalued earnings) benefits, with accrual rates ranging from 1/60 to 1/80. Such a change would still attract the statutory consultation obligation, but is likely to be considerably less unpopular than some of the more drastic options already considered.
Again, there are no current proposals to introduce such options to LGPS: the ‘new’ LGPS introduced in 2008 actually improved the accrual rate from 1/80 to 1/60.
Share pension costs with employees?
Another obvious option is to seek to pass some of the increased employer contribution costs on to the employee. This still leaves the risk of the pension provision with the employer, but at least the employee takes part of the burden.
For LGPS, even this change would not be particularly straightforward, since the member contribution rate is set out in statute, and individual employers have no discretion to make any changes to how the scheme operates. The employer and employee would therefore need to reach a separate agreement that the employee would reimburse part of the employer’s costs (by way of deduction from wages).
This would not be particularly tax-efficient for the employee, since the additional payment would not count as a member contribution and would not qualify for tax relief. Realistically, therefore, the employer may well have to hold up the threat of withdrawing the benefit altogether in order to get member agreement. Even then, a knowledgeable member (or union representative) who is aware of the potential cost to the employer of termination of the arrangement could well call the employer’s bluff on this point.
SHPS offers more flexibility on this point, since it may be possible for the employer (after due consultation) to increase the amount of the employee contribution formally. This at least would give the employee the benefit of tax relief on the additional contributions. It may be possible also to combine the change with a salary sacrifice arrangement, so that the employee (and employer) save on NI as well.
Other pensions news
The statutory debt legislation has also been causing considerable problems for any RSL group participating in SHPS which wishes to restructure, since the associated transfers of staff may result in a statutory debt being triggered inadvertently. On 12 November 2008, the Government announced it was considering making changes to the legislation to ease some of these difficulties.
Following an informal consultation with selected organisations on a range of options, the DWP is shortly expected to issue draft amendments for full public consultation, with a view to introducing the changes in October 2009. Options covered in the informal consultation included a default apportionment of any liabilities within the restructured group (so that no immediate debt would arise), and setting a “threshold” level of underfunding so that a debt cannot be claimed unless the scheme’s deficit exceeds a specified percentage of its overall liabilities.