Pension retention

The increase in public sector outsourcing has injected some vim into defined benefit pension schemes, which many had considered to be on their way out. By Martin McFall

In recent times actuarial consultants have painted a particularly downbeat forecast for the future of occupational defined benefit pension schemes. The combination of increased regulatory control over the schemes, people living longer and more stringent funding requirements are touted as signalling the beginning of the end for defined benefit arrangements.

However, expansion in public sector outsourcing has breathed new life into such schemes through the requirement to preserve employees’ future service pension entitlements upon a compulsory transfer from the public sector to the private sector. The improvement of primary care facilities under the NHS Local Improvement Finance Trust (Lift) model is a case in point, with the recent introduction of pension protection measures for transferred staff.

Protecting pension rights
Since the introduction of PFIs in 1992, some 780 PFI deals had been signed up to the end of 2005, with a further 200 deals on stream in 2006. By bringing on board private sector skills and services with the aim of delivering a value-for-money programme to modernise public sector institutions, the Government acknowledged that it would need to safeguard public sector pension rights of staff in order to push through PFI initiatives.

A balance between workers’ rights and patients’ interests is needed. To achieve this, HM Treasury introduced guidelines (June 1999) to protect pension benefits. Known as the ‘Fair Deal’, it was drafted from a central government perspective, but its application has been extended to local government and the health sector. Its core aims are to protect future service pension rights for transferring staff for the duration of the contract and provide for past service benefits to be transferred as part of a bulk transfer. For future service PFI contractors are required to provide staff, post-transfer, with a defined benefit scheme of broadly comparable value.

However, each new PFI deal does not translate into a new defined benefit scheme being set up and open to new members. A survey of PFI contractors found that, of the companies operating broadly comparable pension schemes, only two of those schemes were open to new joiners outside of staff transferring in as a result of a public sector outsourcing.

Fair transfer
The Fair Deal guidance, while setting out a practical code of practice governing future service, only sought to protect past service rights for transferring staff after their initial transfer from government employment. Subsequent transfers were a matter of private sector commercial negotiation. A prescriptive first stage bulk transfer required the contracting party to provide ‘day-for-day’ credits in their defined benefit scheme for transferees. While staff retained a past service link to future salary increases, subsequent transfer obligations watered down the protection offered in respect of bulk transfers.

A revised Fair Deal in 2004 addressed the issue of subsequent transfers by requiring bulk transfers to be on “no less favourable terms” to those provided through the initial agreement. However, the pendulum may have swung too far, with the onus for transfer risk being placed squarely on the contracting party at the bidding stage of the contract.

The very nature of a competitive tendering exercise can work to the disadvantage of contractors that thoroughly price in pensions risk and tender accordingly. In seeking to protect staff pension rights by setting out a best practice procurement model for bulk transfer agreements and controlling subsequent generation contract rounds by shifting responsibility on to the private sector, HM Treasury may have unwittingly pushed too far. Undoubtedly, some contractors may view such a lopsided approach to pension risk as sufficient disincentive to tender for new contracts. This may, in future, lead to fewer participants tendering for contracts, with broadly comparable defined benefit pension schemes being concentrated in the hands of a few large PFI contractors.

Local initiative
Local government outsourcing contracts are distinct from those of central government or the health sector in that contractors can opt to provide a broadly comparable pension scheme or become admitted to the Local Government Pension Scheme (LGPS). Transferring staff can then remain as scheme members and subsequent contractors can dispense with concerns about the transfer of liabilities between private contractors. Contractors who have opted for broadly comparable pension provisions have been averse to LGPS because of a perceived lack of control over costs, including indemnity bond costs or an ability to shape scheme deficit funding.

While this has led to more local government outsourcing contractors offering broadly comparable pensions, the Department for Communities and Local Government is mindful that contracting authorities’ attitudes to pensions risk when stipulating a requirement for admissions to the LGPS may ultimately result in poorer-quality services as contractors seeking to price the risk thoroughly are eliminated from tenders. To address this position and create a more level playing field for contractors, the Government has proposed the development of pass-through arrangements for sharing the pensions risk for contractors admitted to the LGPS.

Options under consideration are for the contractors’ contribution rate to be set for the duration of the contract, and for no past service liability or exit liability to be apportioned to contractors. Such pass-through arrangements are already influencing contract discussions on pathfinder projects such as the Building for Schools programme. The proposals may result in amendments to the LGPS regulations and a removal of some of the more volatile aspects of pensions risk. As a result a significant number of contractors could be swayed to LGPS admission and away from broadly comparable pension provision, and in so doing would diminish future defined benefit provision in the private sector.

Lift schemes
The pass-through arrangements being proposed are peculiar to local government contracts. Contractors cannot be admitted to the Principal Civil Service Pension Scheme, and in the health sector a variant of outsourcing – the Retention of Employment Model – is standard form. However, with £1bn being injected into primary care facilities and community hospital redevelopment, contractors entering into Lift-funded joint ventures with the Department of Health are being expected to protect the terms and conditions of service of hospital staff who work in community settings. To date Lift schemes have not encompassed staff transfers, but projects such as the Lift scheme in southwest Hampshire are set to apply Fair Deal requirements.

So will the requirement for broadly comparable pension schemes for transferring staff in Lift help to extend defined benefit pension provision in the private sector?Public sector outsourcing has the potential to help ensure the continuation of private sector-defined benefit pension provision in the future, but just how successful that will be is dependent on the approach that future government guidance and contracting authorities take relating to the tricky question of allocating pensions risk. nMartin McFall is head of pensions at ASB Law