Exit credits in the Local Government Pension Scheme - Key points to note

28 June 2021

The High Court has considered an important case relating to retrospective amendments to the statutory exit credit mechanism in the Local Government Pension Scheme (LGPS),see R on the application of Enterprise Managed Service Ltd & Amey PLC and the Secretary of State for the Ministry of Housing, Communities and Local Government and others [2021] EWHC 1426 (27 May 2021, Queen's Bench division, Administrative Court).

The retrospective amendment was found by the High Court to be justified for reasons of public interest. The decision also provides helpful commentary on how the discretion to award an exit credit should be approached.

In this article, our pensions experts take a look at the case and discuss what employers exiting the LGPS need to know.



Key points to note for employers exiting the LGPS

1. Exit credits to exiting employers are not an automatic entitlement

A departing employer is not automatically entitled to a share of any scheme surplus on its exit from an LGPS fund in the form of an 'exit credit'.

Since 2018 the LGPS regulations provided for an automatic exit credit for employers leaving an LGPS fund where that fund was in surplus. These regulations were amended in 2020 with retrospective effect (to 2018) such that the exit credit was to be awarded at the discretion of the relevant administering authority rather than as an automatic entitlement.

The High Court has now established this retrospective removal of the right to an exit credit was permissible for reasons of public interest. In particular that, in some cases, the exit credit amounted to a windfall for certain departing employers who had in effect carried no pension risk during their period of admission to the LGPS.

2. Administering authorities still have discretion to pay an exit credit

An exit credit may still be payable on a discretionary basis.

The High Court decision provides helpful commentary on the considerations for the administering authority decision maker when exercising its discretion over the potential award of an exit credit. It will also be helpful to departing employers in clarifying the proper process that should be gone through when exit credits are under consideration.

Background

This decision relates to the introduction in 2018 of new regulations under which exit credits were automatically payable to exiting employers where the notional section of the LGPS fund attributable to the departing employer was in surplus. This resulted in administering authorities having to make exit payments to admission bodies on their exit from the LGPS, even where there had been no assumption of pension risk by the admission body; i.e. where the admission body had entered into a pension risk-sharing arrangement, or pass-through arrangement with the relevant contracting local authority.

This was recognised to result in a windfall for admission bodies in some cases, with the cost of this windfall being met from the assets of the LGPS fund.

As a result, legal changes were made in 2020 revoking the right to an automatic payment of an exit credit with retrospective effect to 2018.

Facts of the case

The claimants in the case, EMS and Amey, (EMS is a subsidiary of Amey) provided services to two local authorities. Alongside a commercial contract for services agreed between EMS and the relevant local authority, EMS had entered into an admission agreement to allow its participation in the relevant LGPS fund.

Under the terms of the admission agreement EMS carried a significant level of pension risk (in terms of fluctuating ongoing contributions and liability for any exit deficit). However, much of this risk was passed back to the relevant local authority via a pass-through arrangement contained in the provisions of the commercial contract for services. Such pass-through arrangements are common in such contractual relationships.

When the service contract and admission agreement simultaneously ended, the relevant LGPS administering authority declined to pay the automatic exit credit which then apparently arose under the relevant LGPS regulations in force at that time.

The administering authority's position was that to make the exit payment would amount to an unfair windfall for EMS, and would reduce the value of assets in the fund.

Whilst several legal claims for payment of the exit credits were being brought (including by EMS) LGPS regulations were introduced removing the right to an automatic exit payment, with retrospective effect. The claimants brought various claims including alleged infringement of property rights and infringement of the right to a fair trial to sue for the exit payments.

In this case, the High Court had to consider whether the 2020 regulations retrospectively amending the 2018 regulations were lawful. The Court also took the opportunity to offer some guidance on the application of the discretion which remains to pay exit credits under the LGPS regulations.

Court upholds the retrospective changes

The High Court has decided that the retrospective amendment to the exit credit mechanism was justified for reasons of public interest.

What the judge said

The judge acknowledged that the exit credit provision in the LGPS regulations had resulted in some unintended consequences. The exit credit had been introduced in 2018 as a counter-balance: an exiting employer would be liable to make an exit payment to cover a deficit, and as such it was considered reasonable that it would (in the alternative) receive an exit credit in the event of a surplus. But in reality, the LGPS regulations did not anticipate that this might result in illogical results, including a potential windfall for a departing admission body which had carried no or minimal pension risk over the life of the admission agreement.

The judge then considered whether there was a sufficiently compelling public interest ground for retrospectively amending the LGPS regulations to deal with this unintended consequence (even if part of the reason for the retrospective change was to defeat claims, including the EMS claim). Whilst the answer was not straightforward, he concluded that such a public interest ground did exist. In some cases the exit credits could reasonably be characterised as a windfall, which would benefit commercial companies. Meanwhile, the impact on LGPS funds would be to diminish their ability to provide pension benefits and created a risk of future deficits; the cost of which would ultimately fall on local taxpayers.

Can an exit credit still be made?

Yes. The decision makes clear that the retrospective change did not extinguish admission bodies' rights to an exit credit payment; only that the change extinguishes such a right being automatic. Departing employers can still claim for a discretionary exit credit, and the relevant administering authority can then consider the specific circumstances of each individual case. The judge concluded "That is a more proportionate measure than a simple removal of any claim to an exit credit."

The court also provided some helpful guidance around how the discretion should be exercised. The decision maker must make a rational and fair application of the relevant legislation when deciding whether an exit credit is payable, and that a multi-factorial approach should be taken - i.e. taking into account all relevant facts available to the administering authority decision-maker.

Importantly, the case held that the fact that an admission body benefited from a pass-through arrangement over the life of the admission agreement does not necessarily preclude an exit credit being paid to that admission body. The presence of the pass-through arrangement is an important and relevant factor for an administering authority to consider, but it is not necessarily the conclusive factor.

Commentary

While the retrospective nature of the changes to the LGPS exit credit mechanism has clearly had a detrimental effect on several admission bodies, the rationale for the changes is clear and was supported by the judge in this case. The decision also provides clarity to an issue that has caused considerable uncertainty for a number of administering authorities and admission bodies over a significant period of time.

The commentary in the decision as to how an administering authority should exercise its discretion in respect of the potential payment of an exit credit is to be welcomed. However, given the very broad nature of the discretion afforded to administering authorities on this issue it is inevitable that (i) there will be some inconsistencies in approach between LGPS funds and (ii) there will be protracted discussions and even disputes between LGPS funds and departing admission bodies in certain cases.

As LGPS funds also continue to roll-out their policies on deferred debt arrangements and the circumstances when exit debts can be spread, it is clear that the circumstances in which an admission body can depart the LGPS will become increasingly varied and the issues administering authorities and admission bodies will have to consider look set to become increasingly complex.

If you have any questions about this article, or about pensions in general, please contact Paul Carberry or Liz Wood.


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