Escaping from the Local Government Pension Scheme
Charities which employ staff who participate in the Local Government Pension Scheme have in last few years found themselves saddled with significant and growing LGPS funding deficits. As a consequence, there has been an increasing recognition that to prevent these pension liabilities from creating a risk of insolvency/wrongful trading, employers would ideally cease future provision of the LGPS as a pensions vehicle for staff, in order to “turn off the taps and put a plug in the bath”.
Many charities are not legally obligated to continue providing the LGPS as the pension scheme of choice for staff, unless there is a specific ongoing contractual right for employees to ongoing membership (which may be varied in certain circumstances), or staff have transferred to the charity from the public sector with specific pension protection.
However, the practical barrier to stopping LGPS participation for many charities lies in the fact that, under current LGPS regulations, cessation of participation will lead to the triggering of an “exit liability”, where the LGPS actuary will calculate any underfunding (usually calculated on a conservative gilts basis) which is payable by the withdrawing charity.
This sum is called an “employer debt”, and under LGPS regulations, it is immediately payable by the charity to the LGPS Fund (or more specifically the “administering authority” which is looking after the fund). Although the stark reality is that many employers have historically been prevented from leaving the LGPS because of the size of their exit liabilities, the position is now changing for two reasons.
HOW SOME ADMINISTERING AUTHORITIES ARE ALREADY HELPING WITH LGPS EXIT LIABILITIES. Current LGPS regulations mean that when the last active member of an employer leaves the scheme, the employer is, on the face of it, obligated pay a lump sum exit liability calculated on a full buyout basis to the LGPS administering authority. It’s not necessarily common knowledge, but some administering authorities are prepared to help charities which are faced with LGPS funding deficits that potentially constitute an existential threat.
Wary of insolvency
The reason for this is not simply largesse by administering authorities, it’s because they understand that if less financially robust employers are pushed into insolvency owing the LGPS money (in the form of an exit liability or otherwise), it’s the other participating employers in the LGPS who will have to pick up any liabilities which can’t be recovered by the LGPS from the insolvent employer in its capacity as an unsecured creditor.
A far less worse outcome for the LGPS Fund could be to help keep a charity financially viable in the longer term, through an agreement that the charity will cease participation in the LGPS in short order, and that any exit liability generated will be amortised over a longer period of time (potentially many years) under a repayment plan which is realistically affordable for the charity.
It should be remembered that not all administering authorities have the same appetite to negotiate with charities to agree such an approach, and even those authorities which are prepared to cooperate in this way will not proactively advertise the fact. It’s likely they will need to be convinced by the charity that its financial circumstances mean the cessation of participation and an exit liability repayment plan is in fact the least worst option for the LGPS Fund.
In practice this process will need to begin with an initial approach by a charity and its advisers to the administering authority, explaining the charity’s current and future financial position and why the charity believes it does not have a legal obligation to continue to provide the LGPS to employees.
THE GOVERNMENT’S PROPOSALS TO CHANGE THE LGPS. Alongside this more helpful approach by LGPS administering authorities, the Ministry of Housing, Communities and Local Government has issued a formal consultation document setting out proposals which include two alternative options to help employers deal with underfunding risk:
- The introduction of a “deferred employer” status which would allow LGPS Funds to defer the triggering of an exit payment for certain employers with a sufficiently strong financial covenant - although the employer would continue to pay contributions on an ongoing basis. The consultation expressly acknowledges that this proposal should help charities and smaller employers in managing their obligation to make an exit payment when they cease to have active members in the LGPS.
Formally building into the LGPS regulations an option where an exit liability, which is calculated on a full buy-out basis, can be recovered over an extended period of time.
The rationale for this later approach is perhaps more to protect remaining scheme employers from having to pick up “orphan” liabilities from employers who have ceased to participate, rather than simply assist employers who are struggling with funding issues, because to agree to this approach the administering authority will need to be convinced that the charity has sufficient and appropriate assets to cover its liabilities in the longer term.
The essence of the proposal is that the Government intends to give administering authorities more flexibility by spreading exit payments over an extended period of time, or by allowing an employer with no active members to defer exit payments in return for an ongoing commitment to meet existing liabilities. In the consultation document the Government acknowledged that some administering authorities have already been attempting to achieve the same outcome through the repayment plans mentioned earlier in this article.
In addition to the above proposals, the LGPS Scheme Advisory Board has commissioned pension consultants Aon to review potential funding, legal and administrative issues presented by participating LGPS employers such as charities, and to identify options to “improve the situation”.
SUMMARY OF LGPS OPTIONS. If the Government’s proposals come to pass (perhaps in April 2020?), these are the three formal options which the LGPS will have to help deal with the acute funding issues now facing participating charities:
- Calculate and recover an immediate exit payment from the charity (as is the norm at the moment) i.e. a “clean break” approach.
- Agree a repayment schedule for an exit payment in order to spread the payment.
- Agree what is called a “deferred debt” arrangement, which will leave the charity paying deficit contributions without any active members if the administering authority is confident that the charity would be able to fully meet all of its funding obligations in the longer term.
Employers who participate in the LGPS are encouraged to read the consultation paper and to respond with their views to the Ministry of Housing Communities and Local Government by 31 July 2019. If you are reading this article after that deadline it should still serve as a good background briefing to assess any proposals and indeed any comments from Aon before these emerge.
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