Partnerships between the public and the private sectors often involve a TUPE transfer of employees from the public body to the contractor. The Fair Deal principles govern the transferred employees' pension provision.
Under Fair Deal, a contractor may either provide a pension scheme which is "broadly comparable" to the Local Government Pension Scheme (LGPS) or become a participating employer (known as an "admitted body") in the LGPS.
The Department for Communities and Local Government (CLG) is concerned that local authorities are not operating the admitted body status provisions consistently. CLG have issued an informal consultation document on admitted body status. This is the second consultation document on admitted body status in the last two years.
The consultation does not affect community admission bodies within the LGPS or arrangements applying to broadly comparable pension schemes. Consultation on the current document closes on 10 April 2008.
Find out more about the potential implications for both contractors and outsourcing local authorities from Wragge & Co's pensions team.
Admitted body status: background
Admitted body status (ABS) was introduced in 1999 to facilitate public sector outsourcing. The current ABS regime has applied since 2003.
ABS allows local authority employees to continue to be members of the Local Government Pension Scheme (LGPS) when their contracts of employment are transferred to a contractor as part of an outsourcing exercise.
ABS: the current requirements
The ABS requirements are set out in the LGPS Regulations. These regulations provide that the admitted body:
- Is treated as a scheme employer.
- Has to comply with the standard employer requirements.
- Has to comply with additional provisions which arise from their different status, including:
- The requirement for a valuation on termination and the payment of an exit charge to meet any capitalised deficit.
- Risk assessment often leading to the requirement for a bond or guarantee to be given to protect the relevant LGPS fund in the event of the admitted body failing.
Why are CLG consulting?
CLG is aware of a number of perceived problems with the ABS framework. Since 2006, CLG has been working closely with key stakeholders to resolve the problems with the ABS provisions resulting in this latest informal consultation document which:
- Develops some of the themes from the 2006 discussion paper.
- Considers the next steps in the light of the responses received to the 2006 paper.
- Seeks comments on the next steps from a national range of interested parties.
Unlike the previous round of consultation this consultation paper does not express a preferred way forward, nor does it provide a commitment from CLG to develop any of the approaches outlined. Instead the review aims to ensure that ABS provisions meet the needs of contractors and authorities, while remaining committed to the following fundamental principles:
- Delivery of Government policy on "Best Value" outsourcing and transfer of undertakings.
- Compliance with Fair Deal and the Staff Transfers (Pensions) Direction 2007.
- Ensuring any proposals are affordable, sustainable and continue to have no adverse affect on taxpayers.
What are the perceived problems with the current ABS provisions?
The consultation paper notes that CLG believes that the ABS concept does not require fundamental change. Indeed, it provides pension stability throughout the contracting-out process when contracts and workforce may pass to different contractors. However, CLG recognises that concerns have arisen in relation to ABS as a result of changes to business experience, sector changes and changes in service delivery.
Examples of concerns about the implementation of ABS are:
- Volatility and lack of control by contractors over pension risk. This can lead to contractors paying large termination payments or being required to pay higher contributions than originally expected.
- Contractors are therefore either not bidding for certain contracts or are "inflating" bids in recognition of this risk; consequentially, "best value" is not always being delivered.
- Authorities stipulating ABS as a contractual condition rather than being a matter of contractor choice.
What are the "possible approaches" raised by CLG ?
CLG is committed to ensuring that appropriate pension protection is provided as part of an outsourcing exercise either through a broadly comparable pension scheme or by continued access to the LGPS through ABS. Responses to the earlier informal consultation show that there is no one single approach which would command universal support. CLG, therefore, is inviting stakeholders to now raise any approaches they wish to be considered as part of the consultation exercise. However, in the consultation paper CLG have set out three possible approaches:
- Provision of revised guidance re-emphasising the original intentions.
- In addition to updating the guidance, consider making minor regulatory modifications to make the existing framework operate better.
- Introduce some broader regulatory changes which enhance the options available but which avoid any conflict with the key policy basis of ABS.
Possible Approach 1 - Provision of revised guidance re-emphasising the original intentions
CLG seeks comments on whether the current guidance should be updated to clarify:
- The purpose of the current legislation.
- To make clear the statutory and non-statutory roles of all key stakeholders.
- To set out all the key steps involved for protecting pension rights for transferring staff.
In addition, CLG suggests that the guidance could also:
- Ensure that relevant information is available to key stakeholders at the tender stage to address uncertainty over pension costs.
- Clarify the policy that authorities should not require ABS as a contractual condition.
- Set out how pension risks should be identified, addressed and managed.
Possible Approach 2 – In addition to updating the current guidance making minor regulatory modifications
CLG considers that there is general agreement that the intentions behind the existing framework are sound. However, it could operate better by making specific regulatory changes as well as improving the guidance as suggested above.
Proposed regulatory changes are:
- Specific provision to refund any pension surplus at the end of a contract to enable contractors to benefit from fund performance and actuarial assumptions.
- Requiring annual actuarial monitoring of contracts to check for employee-related or other changes that could have an impact on the pension position.
- Requiring an annual review of indemnity cover.
- Requiring the prepared risk assessment to be published locally.
- Requiring contracting/letting authorities to provide a statement, as part of the bidding process, about the actuarial aspects of ABS.
Possible Approach 3 - Broader regulatory changes
CLG suggests the following steps which may address the cost implications inherent in providing continued access to the LGPS, while at the same time ensuring that the provisions continue to meet the needs of authorities, contractors and taxpayers:
- Allowing for pass-through of pension costs in the contracting process.
- Introducing a requirement for mandatory open admission agreements.
- Cap and collar arrangements.
Broader regulatory changes: pass-through of pension costs
Under pass-through, the contractor would pay contributions at the rate specified at the start of the contracting process. This contribution rate would only be varied in relation to common factors, such as mortality assumptions. It will also be varied in relation to matters in the contractor's control, such as abnormal pay increases. Contractors would not be responsible for funding of accrued benefits.
The intention behind this approach is that the authority would effectively meet the actual cost of pension provision rather than the cost which has been inflated by over-cautious assumptions etc. CLG notes that if much or all of the pension risks were retained by authorities, the result might be greater competition, realistic prices and better value for money to the public sector. At the same time CLG comments that full pass-through arrangements would represent a significant change from current arrangements and would be inconsistent with the "transfer of risk" principle that is inherent in the spirit of outsourcing exercises.
Broader regulatory changes: mandatory open admission agreements
In contrast with closed agreements, where only employees who originally transferred with the contract can be LGPS members, CLG asks whether contractors and authorities should enter open admission agreements where both transferring and all new employees can become LGPS members.
CLG comments that mandatory open admission agreements would address multi-tier workforce issues and ensure that contractors could not bid for contracts on the basis of an ability to spend less on pension provision for new hires. However, additional costs would almost certainly be borne by an authority or a contractor (or both) if this approach is adopted.
Broader regulatory changes: cap and collar arrangements
Cap and collar arrangements (which set both the lower and upper limits on pension contributions) are set out in the contract between the authority and the contractor and not in the admission agreement. The arrangement requires the contractor to pay the contribution rate specified by the actuary. However, where the specified rate is outside the range set out in the contract, there is an adjustment to the contract price. The authority meets costs in excess of the agreed maximum but the contractor does not get the benefit of contributions falling below the lower limit.
CLG comments that cap and collar arrangements are normally specified at the preferred bidder stage. However, in order to ensure a level playing field for all bidding contractors involved in any outsourcing exercise, CLG suggests that the availability of cap and collar arrangements should be set out in the invitation to tender.
CLG states that while cap and collar arrangements may provide certainty there are potential disadvantages. In particular, the contractor might always price near the cap so that the authorities never benefit from the collar. In addition such arrangements would require separate negotiation for each contract.
The transfer of pension risk is a material part of many public/private sector transactions. Reaction from stakeholders suggests there is now a general consensus that the current ABS regime requires some degree of revision. It is in this context that CLG has been reviewing and consulting on the ABS framework for over 18 months now. That CLG have concluded a second round of informal consultation (which has a significantly broader remit than the first round of consultation) is required is indicative of the wide range of opinions that the current ABS framework generates.
The consultation exercise offers the opportunity for all relevant stakeholders to participate in a root and branch review of the current regime. It is worth noting that only 20 responses were received to CLG's previous informal consultation paper in July 2006. If contractors and authorities wish to create an improved ABS framework that facilitates outsourcing exercises and delivers "best value", it is important that they respond to the consultation paper. This is particularly the case for contractors since CLG have indicated that its objective is to make ABS sufficiently attractive for it to be the route of "contractor choice", rather than providing a broadly comparable scheme.
It would appear that no imminent changes are likely as a result of the consultation paper. Nevertheless, the paper provides helpful clarification and guidance in relation to the current ABS regime:
- CLG have clearly stated that the decision as to whether ABS is obtained or a broadly comparable scheme is provided is a matter of contractor choice. Over the years this position has not be universally implemented.
- Fair Deal 2004 provides that pension discussions should form part of the mainstream competitive procurement selection process. CLG are clear that regardless of how any future ABS process is developed it will be imperative that full and accurate information on pension costs must be made available at the outset of the tendering process. This is so that contractors can take them into account when preparing their bids.
- The proposed pass-through arrangements are in practice already increasingly being negotiated by contractors and authorities. Pass-through mechanisms do not require legislative change if contractors and local authorities are willing to agree them in the context of their own commercial negotiations. The pass-through section of the consultation paper will hopefully provide stakeholders with greater insight into how such arrangements may work in practice. It will also aid negotiations going forward.
In the private sector, many defined benefit schemes are being closed to new entrants and future accruals or are being wound-up. With this backdrop and recognising the fact that defined benefit schemes are expensive to run, it is arguable that mandatory open admission agreements as proposed are not consistent with the overriding principle of delivering "best value". If new recruits are admitted to the LGPS, the cost of that will have to be met by either the contactor or the local authority.
Taking a step back, it should be remembered that in April 2008 the new LGPS comes into effect. Contractors who have already obtained admitted body status and those contractors who are intending to obtain admitted body status in the near future should consider what the implications are for their business of participating in the new scheme For example, contractors should consider if their level of employer contributions will be affected or if they will be required to revise any of their discretionary policies.
This analysis is based on the Local Government Pensions Scheme Regulations 1997 and the Review of admitted body status provisions in the Local Government Pension Scheme published January 2008 by the Department for Communities and Local Government. Consultation on the review closes on 10 April 2008.