David Davison: Charities suffer from local government pension requirements

The current situation is anything but a 'fair deal', says the pensions consultant at actuarial firm Spence & Partners

David Davison
David Davison

When is a fair deal anything but a fair deal? Answer: when it involves arms-length charities picking up historic pension liabilities built up by local authorities. 

Over recent years we’ve seen countless organisations specifically established to provide services back to local councils or services brought in house by existing charities. These bodies are being given Hobson’s choice of maintaining their local government pension scheme (LGPS) provision to be able to compete for work, and being uncompetitive for the work through the rising costs of their pension provision - a situation highlighted particularly when contracts come up for review.

When they were created, these organisations, which could include the likes of a local meals-on wheels service or a sports and leisure provider, were required to remain within the LGPS or provide broadly comparable pension benefits under the slightly ironically named ‘fair deal’ requirement.

While providing their staff with a generous pension is perfectly reasonable, the LGPS, unlike most schemes, does not recognise multiple employers related to specific periods of service, and therefore all past liabilities are effectively re-allocated to the new employer. This means the new employer is responsible for 100 per cent of the pension liabilities and associated costs, even for those staff who may have spent several decades working in the local authority before transferring into the newly-created organisation. The new organisation is notionally deemed to be fully funded on a continuing basis, but this falls way short of the necessary funding on exit and does not take into account future cost variations and additional associated costs, such as on redundancy.

There is currently no mechanism open to employers to segregate these liabilities or indeed to leave them with the employer with whom they were built up. So organisations are forced to accept this transition inequity to compete for services, despite the additional risks they face and in the knowledge (or in many cases unaware) that they are saddling themselves with a burden from which there is no escape.

I was contacted by a charitable organisation which was established in 2008 to provide services to a local authority. Of this newly-formed charity’s £11m worth of pension liabilities, 85 per cent of these related to service carried out by its people when they were employed by the council, prior to the formation of the new organisation. Effectively this meant the charity had to fund 100 per cent of the increased contributions even though only 15 per cent of these liabilities related to staff service since it was established.

While the charity could have afforded the approximately £1m to pay the cessation debt for their service, they were saddled with an additional £6m related to the council benefits. This meant that they were forced to continue in the scheme accruing further liabilities and taking them to a point beyond which they could not afford to exit.

Because of their required commitment to this expensive defined benefit pension scheme with its rising costs, organisations now find themselves uncompetitive on price when tendering for work from the same local authorities they were created to service. It’s a perverse circle as the loss of these contracts can lead to the insolvency of the charity with their pension liabilities having to be picked up by the LPGS, with the main burden for this left with the local authority. There seems to be real lack of awareness that the potential savings made in service costs need to be offset by the increase in pension expenditure should one of their spin-out service operators fail.

The current LGPS position is totally inequitable, it restricts the flexibility for affected charities and it is, in my opinion, unsustainable. The ability to limit the growth of liabilities would make organisations more competitive in pricing work, more likely to retain it and therefore more likely to be able to continue funding pension contributions that would ultimately protect members' accrued benefits.

The LGPS should be required to segregate service periods on transfer and retain responsibility for contributions, ill-heath, strain-on-fund costs, and cessation debt for their period of service - as is the case in the majority of other schemes. This is a sensible means of addressing the problem and one that would not represent a significant burden for local authorities.

For the many local charities that were created out of local government to serve their former masters, reform of this pension anomaly would be welcomed and seen as a significant step towards a genuine fair deal.

David Davison is head of the public sector, charity and not-for-profit practice at Spence and Partners

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