The Ministry of Housing, Communities and Local Government (MHCLG) and the Scheme Advisory Board of the Local Government Pension Scheme (SAB) have both issued new guidance that will assist employers in managing their ongoing LGPS liabilities and the costs triggered on exit.
Since September 2020, the legal framework has been in place to provide additional flexibilities in relation to payments due when LGPS employers leave the scheme or their circumstances change. But for the flexibilities to be used, funds must have appropriate policies in their funding strategy statements on how the debts of departing employers are dealt with and how ongoing contributions are assessed.
The March guidance will enable funds to update their statements and facilitate the implementation of the funding flexibilities.
Read the MHCLG March guidance and SAB guidance. Our Pensions team summarises the new guidance and what this means for LGPS employers below.
1. New guidance was issued in March 2021
The MHCLG and the SAB issued the new guidance to support administering authorities of LGPS funds (administering authorities) when updating their funding strategy statements to permit the practical application of the funding flexibilities on offer since September 2020 when employers depart the LGPS or their circumstances change.
2. Is a 'deferred debt agreement' now an option in the LGPS?
Yes, administering authorities can agree to a departing employer deferring an exit payment to the fund by using a 'deferred debt agreement'.
3. Can an employer leaving the LGPS spread the cost of an exit debt?
Yes, administering authorities now have the ability to recover a departing employer's exit payment over an agreed period of time, rather than as a single payment upon exit.
4. Can contributions to the LGPS be changed between valuations?
Yes, administering authorities can now revise the contribution rates payable by LGPS employers between valuations.
5. But do any of the above require appropriate policies to be in place?
Yes, administering authorities must set out their policies on these new flexibilities in their funding strategy statements before they can operate them in practice. The new guidance is meant to facilitate the updating of funding strategy statements and is therefore expected to be helpful in the implementation of the funding flexibilities.
Background to the flexibilities
In September 2020, regulations introduced new funding flexibilities into the LGPS expressly allowing administering authorities to review employer contributions, spread exit payments due from departing employers and establish deferred debt agreements. For more information on this, read our alert 'Can't pay.....right now! Flexibility for employer debts in the LGPS (24 September 2021)' However, before an administering authority can implement any of the flexibilities, their funding strategy statement must contain appropriate policies on the operation of those flexibilities so as to ensure consistency and transparency.
New guidance from MHCLG and LGPS SAB
On 2 March 2021, both MHCLG and the SAB issued their respective guidance notes (guidance) relating to:
- deferred debt agreements;
- spreading employer exit payments; and
- amending employer contributions between valuations.
Given the number and range of employers in the LGPS, it is inevitable that many of their financial circumstances will change between valuations and that a number of employers will leave in any given year. Consequently, the introduction of the funding flexibilities was welcomed by the majority of administering authorities and employers as a means of reacting to changing circumstances and of managing employer and pension risk.
However, it is the March guidance that will now enable administering authorities to update their funding strategy statements and to work with employers to put these flexibilities into practice. While it should be noted that there is no obligation on administering authorities to make use of the new powers, in its guidance the SAB 'actively encourages administering authorities to make use of these flexibilities where appropriate'.
Given the current economic backdrop and the financial pressures many employers are facing, it is to be hoped that the new flexibilities are utilised where it is in the interests of all affected parties to do so.
The deferred debt agreement
For many employers, the cost of leaving the LGPS, with the associated exit debt, has been prohibitive. This has left many in the invidious position of wishing to reduce their future service pension costs, but being unable to afford to do so.
The option of a deferred debt agreement (DDA) allows an administering authority to defer the triggering of an exit debt where the administering authority:
- deems this appropriate;
- has had regard to appropriate actuarial advice; and
- has set out its policy in its funding strategy statement.
While a DDA remains in place, the departing employer becomes a deferred employer in the relevant LGPS fund. A deferred employer will continue to pay past service deficit contributions to the fund, and such contributions can be revised (up or down) following subsequent actuarial valuations.
Agreeing a DDA will enable departing employers to terminate accrual for their employees (and so reduce future service costs) without the need to pay an immediate exit debt, which may be very attractive (and even business critical) from a cash-flow perspective.
However, departing employers must be aware that while they may be able to benefit from positive future investment performance, their liabilities will increase if investment performance is weak or actuarial assumptions become more prudent. It will be crucial for departing employers to frequently monitor such changes over the life of a DDA.
Deferred debt agreement - policy requirements
The guidance states that an administering authority's policy should include:
- any circumstances where the administering authority considers it would not be appropriate to enter into a DDA with a departing employer;
- the process the administering authority will adopt for consulting with the departing employer;
- the evidence an administering authority would require from a departing employer to consider a DDA;
- the matters which the administering authority will expect to include in the DDA, including:
- the responsibilities of the departing employer as and when it becomes a deferred employer under the DDA (deferred employer); and
- circumstances triggering a cessation of the DDA leading to an exit payment (or credit) becoming payable; and
- the administering authority's approach to monitoring a DDA, including frequency, and the circumstances in which the administering authority may consider:
- approaching the deferred employer to seek to agree a variation to the length of the agreement; and
- serving notice on the deferred employer that it is reasonably satisfied that the deferred employer's ability to meet the contributions payable under the DDA has weakened materially, or is likely to weaken materially in the next 12 months.
Even with the new funding flexibilities, the default position remains that a departing employer is liable for an immediate debt payment on exit. If an administering authority is to vary this position by allowing a DDA, it must be clear that doing so is not detrimental to the interests of the fund and its other employers. The fact that a DDA may be in the interests of the departing employer alone will not be sufficient.
Spreading an exit payment
Administering authorities now also have a clear statutory power to recover a departing employer's exit payment over an agreed period of time, rather than as single payment upon exit.
This option will be particularly attractive to employers who wish to exit an LGPS fund, but also wish to do so with a certainty of cost and with a desire to preserve liquidity over the short to medium term. Unlike with a DDA, if the spreading an exit payment route is followed, the departing employer does not continue to participate in the LGPS fund. Once its final staggered payment is made, its liabilities to the fund will be fully discharged.
Spreading an exit payment will aid those administering authorities who wish to provide a departing employer with flexibility, but where the granting of deferred employer status may not be in the interests of a fund and/or other fund employers.
Spreading an exit payment - policy requirements
The guidance states an administering authority's policy should include:
- the key factors that the administering authority will use to consider whether a departing employer's exit payment should be spread;
- any circumstances in which the administering authority considers it would not be appropriate to spread an exit payment;
- how the administering authority will consider the appropriate length of time for an exit payment to be spread, including its view on the maximum length of any spreading period;
- the process the administering authority will adopt for consulting the departing employer in question;
- the evidence the administering authority would expect from a departing employer to consider the spreading of an exit payment;
- how the administering authority will inform a departing employer of its decision and the details to be included in the decision; and
- the administering authority's approach to monitoring an exit payment that has been spread, how it will engage with the departing employer, and any circumstances in which the spreading of the exit payment for a departing employer may be reviewed again (for example, as a result of a change in a departing employer's covenant).
Clearly, for an administering authority to agree to this option it will need to have significant confidence in the ability of the departing employer to meet its obligations over the length of the spreading period. This will require detailed analysis of the departing employer's covenant at the point of exit and robust ongoing arrangements to monitor that covenant over the spreading period.
It is anticipated that in certain cases, administering authorities will require contingent assets or other forms of security to be put in place to mitigate any exposure to the fund over the period the debt is to be spread.
Changing contributions between valuations
The contribution rates payable by employers participating in the fund are normally determined at fund valuations every three years.
Pension schemes involve long term liabilities and therefore a long term approach to the funding of those liabilities. However, the circumstances of a particular employer may change so materially during the three year valuation cycle as to warrant a change in contributions (either an increase or a reduction).
The flexibilities introduced in 2020 provide that an administering authority may revise an employer's contribution rate:
- where it appears likely to the administering authority that the employer's liabilities have changed significantly since the previous valuation;
- where it appears likely to the administering authority that there has been a significant change in the employer's ability to meet their contribution obligations; or
- where the employer has requested a review of its contributions.
Changing contributions between valuations - policy requirements
The guidance states an administering authority's policy should include:
- the key factors that the administering authority will use to consider whether a contribution review for an employer should take place;
- what factors the administering authority will take into account when assessing the risk or impact of an employer contribution review on other employers;
- how an employer will be involved in a contribution review and the circumstances in which the administering authority would consider it appropriate to consult other employers - for example, where they have provided a guarantee to the employer in question;
- the periods in the triennial valuation cycle during which the administering authority considers it may be inappropriate to conduct a review;
- the matters on which the administering authority will take actuarial advice in setting an employer's revised contribution rate; and
- the process required for an employer to apply for a review, the evidence they may be required to submit, and how the cost to the employer will be calculated.
It is clear from the guidance that employers and administering authorities should not expect to use this option with the primary objective of simply reducing or increasing contribution levels. Rather, this option should be used where an employer's circumstances have materially changed so as to necessitate a revision of contributions e.g.
- a material change in the employer's covenant that affects its ability to meet its obligations to the fund, possibly through the provision of contingent assets or a business or debt restructuring; or
- a significant change in the employer's liabilities in the fund, possibly following a transfer of staff or a significant number of redundancies.
While it will be open to employers to request a review of their contribution rates, employers will need to carefully analyse the administering authority's requirements and policy before doing so. It will only be in an employer's interests to request a review if it is confident it can present a robust business case to the administering authority to support any such request.
What's next?
The 2020 changes stipulate that an administering authority can only use the new powers where it has set out its policy in relation to them in its funding strategy statement. This requirement is intended to ensure administering authorities utilise the flexibilities transparently and consistently - and this should be welcomed.
As with any material change to a funding strategy statement, an administering authority will need to consult with "such persons as it considers appropriate" before finalising its policies in respect of the funding flexibilities. Given the potential impact the new funding flexibilities can have on employers, it is expected that administering authorities will consult with all the employers participating in their fund.
Such wide-ranging engagement should ensure that the circumstances and needs of the breadth of all employers in the LGPS are recognised, understood and comprehensively addressed in the revised funding strategy statements.
Indeed the SAB notes in its guidance that 'effective communication and engagement with scheme members will be vital to ensuring outcomes which enhance the ability of those employers to meet their duties under the scheme.' An open and proactive engagement between funds and employers as funding strategy statements are updated and the new policies defined will be a vital first step in this process.
Longer term, it is worth noting that the SAB guidance goes on to state "it is intended that these funding flexibilities provide a formal basis for discussions between employers and their Fund on these issues so employers should feel able to approach their Fund should they wish to investigate how they may apply in their case."
Together the funding flexibilities and the guidance supporting them are looking to refresh the relationship between administering authorities and employers and to allow for more tailored funding arrangements where appropriate.
There will clearly be a settling in period while funding strategy statements are updated and policies around the funding flexibilities are implemented. However, once the new 'rules of the game' are clearer, the funding flexibilities will provide administering authorities with greater options in supporting their employers while maintaining the security of their funds. They will also provide employers with additional tools to manage and mitigate their pension risk.
If you have any questions about the new guidance, or about pensions more generally, please contact Paul Carberry or Hannah Beacham.