The pensions industry is still waiting for the government to close a loophole allowing outsourcers to claw back surplus from the Local Government Pension Scheme even when they have not paid into the plan.
In 2018, the government made changes to LGPS regulations to allow employers to reclaim money from the scheme, if they can show they have overpaid against the cost of buying out their portion of liabilities with an insurer.
Known as exit credits and introduced in May last year, the payments were introduced to reconcile an imbalance where employers would be liable for any exit payment if they were in deficit and wanted to leave the scheme, but could not retrieve any overpayments. As a result, many employers proved reluctant to fully fund their obligations.
However, the new rules created problems where local authorities had outsourced functions to private contractors but protected them from having to pay contributions above an agreed level, repair deficits or pay exit fees in exchange for a better price – known as 'pass-through' arrangements.
This means some companies can now claim payouts from the LGPS, despite having borne none of the risk associated with funding the scheme.
Where the council bears the risk of higher costs, it also seems appropriate for the council to get the benefit of any surplus at the end of the contract
Kirsty Bartlett, Squire Patton Boggs
Catherine McFadyen, head of public sector actuarial, benefits and governance at Hymans Robertson, explained: “This caused an issue because when employers were entering the LGPS, they entered into legal arrangements on the understanding that there was no ability to get any surplus refunded, so that was priced into the contracts.
“And quite often councils entered into side agreements with these employers, which stated that they wouldn’t be charged a deficit – the repayment at the end would be covered by the council.”
Contractors receiving surplus without bearing risk
Ms McFadyen noted that during 2019 a few such situations arose, allowing employers at the end of their contracts to claim surplus driven by investment gains rather than any participation in the risk of the scheme.
There were also cases where the employer could extend its current contract with the local authority but preferred to take the surplus instead, she noted.
The Ministry of Housing, Communities and Local Government is aware of the situation, and in a policy consultation launched in May 2019 proposed a solution for the issue.
“This situation would clearly not have been what was intended when the contract was agreed,” the document stated.
“It would be unfair for a service provider to receive an exit credit in such a situation and it is our intention to make changes that would mean that service providers cannot receive the benefit of exit credits in such cases,” it added.
Government proposed new rules
The government proposed to amend the LGPS regulations allowing councils to take into account a scheme employer’s exposure to risk when calculating an exit credit.
“If the administering authority is satisfied that the service provider has not borne any risk, the exit credit may be calculated as nil,” it stated. The changes would be applied retrospectively from May 2018, closing the loophole.
However, the government has not yet published its response to the consultation, which closed in July 2019. A Ministry of Housing, Communities and Local Government spokesperson said: "We are considering responses to the consultation and intend to publish a government response in the coming months."
Bart Huby, partner at LCP, estimated that this situation occurred in a small number of cases, but it was “enough for the government to feel that it is important that the credibility of the LGPS legislation is maintained, and also to avoid further ones happening”.
Kirsty Bartlett, partner at law firm Squire Patton Boggs, agreed with the amendments proposed by the government.
She explained that it is common for councils and contractors to agree ‘pass through’ arrangements, with contractors paying a fixed contribution and the council bearing the risk.
“Where the council bears the risk of higher costs, it also seems appropriate for the council to get the benefit of any surplus at the end of the contract," she said, adding that surplus would now benefit members.
Exit payments are still appropriate
On the other hand, if contractors have not been protected from funding risks, an exit payment in case of a surplus is appropriate, Ms Bartlett noted.
She said: “The original change to the LGPS regulations to introduce exit credits is therefore fair in some circumstances, but it would be helpful to make a further amendments so that they are not mandatory and LGPS funds can take into account the wider commercial circumstances.”
LGPS pension bill to rise 1% with McCloud case
Fears that a legal case over discriminatory pensions could dent the funding of the Local Government Pension Scheme have been partially allayed, after preparations for the plan’s valuation found that liability increases will be limited.
Mr Huby said: “A lot of pensions legislation is taking longer than originally envisioned – there have been delays.
“With all of the legislation on Brexit taking precedent, this is quite a complicated one which actually has relatively low level of financial risk. Unless there is an easy solution, it could take a long time.”
