The government has slashed public sector spending, including the budget of local authorities. At risk of oversimplifying matters, local authorities have responded by outsourcing some of their services to charities and the private sector. Many charities have gone into public sector outsourcing blind; which in time could prove horrifically costly. Specifically, I am referring to the pension risk that can conveniently transfer to the contract-winning charity.
If staff from a local authority are transferred to a charity under the Transfer of Undertakings (Tupe) regulations, the charity is required to offer them a broadly comparable pension arrangement. In real terms, this translates to a lot of money (and risk) which charities are not considering; let alone pricing into their bids.
I understand that "profit" is a dirty word within some charities, but public sector outsourcing should be self-sufficient. The cost of running public sector services should be covered by the contract price, with a little surplus (profit) to cover administration costs. Third sector employees do not work for free.
Worse still, pension risk can threaten the very existence of a charity. One organisation to feel the pensions bullet is People Can, which inherited significant pension risk after "winning" various public sector contracts. The charity ended up with a pension liability of around £17m that it could not afford to repay, and was driven into insolvency in 2012.
Pension risk relating to Tupe is huge, and must not be underestimated. There are ways and means of mitigating pension risk. Again, in danger of over-simplification, Local authorities should be asked to retain all risk related to pension liabilities, and this should be reflected in the commercial contract. In practice, however, local authorities are less than willing to oblige.
Each tender should be for the delivery of a particular service, not as an opportunity for local authorities to offload their pension risk to the charitable sector. Many local authorities find it perfectly acceptable to discharge pension risk as part and parcel of the deal, despite attempts to persuade councils that the practice is absurd. In fact, it would seem that local authorities openly ignore their own guidance, which states that:
"It is, therefore, recommended that the letting authority and contractor discuss with the relevant administering authority and its actuary, the best way to manage potential risks".
A cynic might say that the local authorities are offloading pension liabilities as part of a rather grandiose attempt to de-risk. However, I suspect the real reason is far more simplistic: the local authorities themselves don’t understand pension risk.
It is important that charities gain pension and legal advice before committing to a particular contract, and they should be prepared to walk away if necessary. Some charities seem to loathe this approach due to "reputational risk," which is nonsense. You are only as good as your next tender – all previous dealings are forgotten.
Until the third sector collectively refuses to take on pension risk, local authorities will continue to pass on these liabilities as business as usual. Charities need to make a stand.
Trustees have a legal obligation to act in the best interests of their beneficiaries, and to safeguard the assets of the trust. I suspect the Charity Commission would take a dim view on how some charities are exposing their organisation to huge pension risk. One may even argue it is illegal.
Gareth Hopkins is an independent pensions consultant
This article was originally published on the Third Sector blog