A couple of years ago, the rules on what happened to any surplus in the Local Government Pension Scheme (LGPS) were changed.
If an employer is admitted to the LGPS, it runs the risk at the end of that admission of having to pay an exit debt. If the assets of its admission are less than the cost of providing pension benefits when it ends its admission to the Scheme, this becomes a debt that the employer must pay immediately.
But what happens if the admission is in surplus when it ends?
Unlike in most private pension schemes, the LGPS fund was entitled to retain any surplus for its own use. So admitted employers ran the risk of having to pay off any deficit, but did not stand to benefit from any surplus.
In 2018, the regulations governing LGPS were changed so that if there was a surplus, then the employer received it as an ‘exit credit’. This seemed perfectly fair – after all, if the employer had to pay any debt on exit, why shouldn’t it benefit from a surplus?
The problem was that in most cases, the employer wasn’t running that risk. It has become standard practice in outsourcings and similar projects for the employer for another party, often a public sector body, to agree that it will pay off any debt. That’s fine too – it meant contractors had certainty as to their risks, and could price their contracts at a lower rate because they weren’t having to factor in paying an exit debt.
As a result, it meant that with the 2018 change, employers stood to gain from any credit without carrying the risk of paying an exit debt at all. And that wasn’t fair either. The public body who carried the risk could not benefit from any surplus, unless there was a separate agreement requiring the contractor to pay over any credit. And these were rare – the change wasn’t expected much in advance of it coming into force, and most commercial agreement assumed that the old rules on surplus would apply, without the chance the contractor could benefit.
Because of the response to the 2018 changes, early last year, the Government consulted on a change to the exit credit process. It’s now just responded, confirming that it will make changes.
The exit credit will still exist, and that seems sensible. There are clearly going to be cases where it is fair and right that a contractor should receive a payment. After all, it has paid into the LGPS over in some cases many years.
The big difference is that it will not be automatic. From 20 March 2020, each LGPS fund will have the discretion to pay an exit credit to an employer. But if it thinks it is fair not to do so, it can withhold that payment.
This gives the ability to prevent an employer from benefitting when someone else would have had to have paid any exit debt. This seems to us to be a sensible approach.
We still recommend that where any public sector body is offering support to a commercial entity in respect of LGPS admission and exit risk, you still include a provision requiring the employer to pay any exit credit they receive to the public sector body. That means that if the LGPS fund does decide to pay a credit (and such a mechanism might encourage it to do so), then the public sector body still benefits in proportion to the risk it has borne.
LGPS funds’ use of the discretion could still be challenged, so we’ll need to see if any guidance, or lessons from experience, develops.