As from 23 September 2020, Local Government Pension Scheme (LGPS) Funds can offer LGPS employers greater flexibility in how they manage the financial consequences of an exit from the scheme. For the first time, the LGPS Regulations will include an ability for employers:
- to enter into formal deferred debt arrangements; and
- to spread the payment of exit debts that are crystallised.
In May 2019, the Ministry of Housing, Communities & Local Government (MHCLG) consulted on various proposals to amend the LGPS, including various options to provide flexibility for employers in relation to exit payments. Last month (August 2020), in a partial response to an earlier consultation, MHCLG confirmed it was introducing new flexibilities. The required changes to the LGPS regulations have now been implemented.
Local Government Pension Scheme (England and Wales) Partial Government Response: review of employer contributions and flexibility on exit payments
2020/893, (The Local Government Pension Scheme (Amendment) (No2) Regulations 2020
Key points for LGPS funds and employers
1. Review of funding strategy statements
Whilst the required legislative changes have now been implemented, the new flexibilities can only be used in practice when the relevant LGPS Fund has set out its policy on deferred debt agreements and spreading exit payments in its funding strategy statement (FSS).
Those LGPS Funds that have not already done so must now consider the circumstances in which they will be willing to allow employers to benefit from the new flexibilities, and then clearly set out their policy in their FSS.
2. Employers should review their position on exit
Scheme employers who have an LGPS exit date in the coming months should consider if either of the new options will assist them in managing the financial impact of that exit.
The change to regulations reflects arrangements that have previously been reached through service contracts or admission arrangements. Where employers have previously reached commercial agreements in relation to managing exit payments in relation to an exit that will occur after 23 September, they should consider how those existing commercial arrangements compare to the alternative options for payment spreading or debt deferral. As noted above, key to either option being available will be the funding strategy of the particular LGPS Fund and its adoption of the required policies.
3. Changing employer contribution rates mid-valuation
Alongside introducing debt payment options, the amendments to the regulations also introduce a power for LGPS Funds to change employer contribution rates between Fund valuations.
There are very specific circumstances where the power to change contribution rates can be used, but in particular it might be used to address a significant weakening in the employer covenant. Given the uncertain economic backdrop created by COVID-19, LGPS Funds will welcome the ability to react more effectively should an employer's covenant begin to materially deteriorate.
How will employer exits be affected by the new flexibilities?
The updated LGPS regulations now set out:
- the requirements for a deferred debt arrangement and its legal effect; and
- the flexibility for LGPS Funds to offer a debt payment spreading facility.
As noted above, before either a deferred debt arrangement or the spreading the payment of an exit debt can be agreed, the LGPS Fund has to set out its policy on how it proposes to utilise these options in its FSS.
What are the requirements for a deferred debt arrangement?
LGPS Funds now have the power to allow an exiting employer with no active members to defer any exit payment. In return, the employer must continue to meet their responsibilities as a scheme employer; i.e. to continue to pay an appropriate level of contributions to the Fund, as determined by subsequent actuarial valuations.
This approach is similar to the deferred debt arrangement approach already adopted by multi-employer schemes in the private sector.
The key requirements for an LGPS deferred debt arrangement are:
- The employer must have not active members in the Fund.
- The arrangement must be made in writing and it must set out the period it applies for. The duration of the arrangement may be varied by agreement between the employer and the LGPS Fund.
- Before entering into a deferred debt agreement, the LGPS Fund must have consulted the exiting scheme employer and considered the views of its appointed actuary.
What happens when a deferred debt arrangement is in place?
Where an employer enters into a deferred debt agreement, it becomes a deferred employer. This means it remains a scheme employer and must continue to meet all the legal obligations of a scheme employer, but (importantly) it is only required to contribute at the rate advised by the actuary as specific to that employer.
Where a deferred debt agreement is in place, there are consequential changes to the requirements for actuarial certificates and revising the rates of contributions.
When the deferred debt agreement terminates, the employer will be treated as an exiting employer for the purpose of the regulations.
Ending a deferred debt arrangement
A deferred debt agreement will terminate if:
- The deferred employer enrols new active members.
- The deferred debt agreement reaches its end date.
- The deferred employer becomes insolvent or is subject to a take-over or amalgamation (unless the LGPS Fund is satisfied that this does not significantly weaken the deferred employer's ability to meet its deferred debt contributions in the next 12 months).
- The LGPS Fund notifies the deferred employer that its ability to meet its contributions under the agreement has materially weakened or is likely to be materially weakened in the next 12 months.
What are the requirements to spread an exit payment?
In practice, some LGPS Funds and exiting employers have been agreeing arrangements to spread the payment of exit debts for some time now. However, to have a clearly stated ability to do so under the LGPS Regulations is a welcome clarification.
To implement an arrangement to spread the payment of an exit debt, the LGPS Fund must issue a revised schedule of contributions for the exiting employer to show the proportion of the exit debt to be paid in each year following the employer's exit date. The period over which payment of the exit debt can be spread must be reasonable in the view of the LGPS Fund.
As with the deferred debt arrangement the LGPS Fund must have consulted the exiting scheme employer and considered the views of its appointed actuary before issuing any revised schedule of employer contributions.
LGPS Funds and employers may see the debt spreading option as a helpful tool in managing exit debts particularly in light of the financial challenges facing certain employers as a result of COVID-19.
Changing employer contribution rates mid-valuation
While LGPS Funds regularly monitor the covenant strength of their employers and seek additional security where appropriate, the ability for LGPS Funds to react decisively between actuarial valuations should an employer's covenant weaken has historically been limited.
Alternatively, the circumstances of certain employers and their LGPS members may materially alter between valuations, such that a reduction in employer contributions is appropriate.
Both employers and LGPS Funds should therefore welcome the ability to respond to a change in circumstances between valuations that warrants a change in contributions.
The power to change contribution rates will allow LGPS Funds to respond to certain changes affecting funding between valuations. An inter-valuation change to contributions can only be made if:
- in the view of the LGPS Fund it appears likely that the liabilities arising or likely to arise have changed significantly since the last valuation; or
- there has been a significant change to the ability of employers to meet their contribution obligations; or
- there has been a request by an employer for a cost review funded by the requesting employer.
In those circumstances, contribution rates can be changed (upwards or downwards) by an LGPS Fund where:
- it has adopted a policy on amending contribution rates between valuations; and
- it has consulted the affected scheme employer(s) and the Fund actuary on the proposed revised contribution schedule.
Employers will therefore need to be mindful of the potential for increases to contribution rates outside the usual valuation cycle that may be triggered by the actions or financial standing of other fund employers and to engage with consultations in relation to the FSS and contribution reviews. They should also be aware of the potential to themselves trigger a contribution review if they are willing to fund the costs of that review.
What happens next?
The new debt payment mechanisms put on to a regulated footing arrangements that may have been reached in the past through contractual agreement. In order to put in place a deferral arrangement or to spread exit debt payments, LGPS Funds must ensure that they have in place, as part of their FSS, policies on spreading employer debt payments and deferred debt agreements. LGPS Funds will also need to update their FSS in relation to a policy for inter-valuation contribution changes.
The MCHLG's partial consultation response demonstrated there was a very strong level of support for the changes to exit arrangements and contributions. The increased flexibilities will therefore be welcomed by a large majority of both LGPS Funds and employers. It will be interesting to see how quickly and in what numbers the flexibilities are implemented in practice.
It is inevitable that there will be some variation in approach between the various LGPS Funds as they respond to their own particular circumstances. However, from an employer perspective it is to be hoped there is a high degree of consistency between LGPS Funds and that appropriate guidance is provided to support LGPS Funds as they shape their policies and revise their FSS.
As LGPS Funds and employers respond to the current economic challenges and uncertainties, the new flexibilities represent a welcome broadening of the options for the funding of the LGPS and the management of employer exits.