Estimated reading time: 5 minutes
In response to the ‘Local government pension scheme: changes to the local valuation cycle and management of employer risk’ consultation, the Government has issued a partial response in relation to the proposals for flexibility on exit payments.
In this response, the Government has set out amendment regulations which will provide administering authorities with more control over exit credits and, importantly, with the ability to restrict the payment of exit credits where, due to risk sharing arrangements, the exit credit would not be appropriate.
Here is our five minute guide to the proposed changes and what administering authorities ought to consider.
What are exit credits and why have they caused concern?
Exit credits were first introduced to the LGPS in the Local Government Pension Scheme (LGPS) (Amendment) Regulations 2018 and came into effect from 14 May 2018. This brought about the ability for LGPS Funds to pay money to an employer exiting the LGPS where a surplus was revealed on cessation. Although this gave Funds more flexibility in dealing with employers’ participation in the Fund, one of the key issues in practice was that it also gave rise to the potential for employers to receive an exit credit without having taken on any pensions risk (i.e. the financial risk remained the responsibility of another employer). We previously set out some of the potential issues in our earlier briefing note here.
We were amongst many to raise concerns about these unintended consequences and these were addressed as part of the Government’s Local government pension scheme: changes to the local valuation cycle and management of employer risk consultation which was published on 8 May 2019 and closed on 31 July 2019.
Among other topics, this consultation noted specific concerns with exit credits where a ‘pass through’ approach has been adopted. Under this approach, the pass through employer doesn’t take on any pensions risk and rather it remains with the original letting authority. At the end of the contract, the pass through employer wouldn’t be required to make an exit payment if there was a deficit identified at cessation, and so it would be inconsistent to suggest that they would be entitled to benefit if a surplus was identified. The consultation therefore asked for comments on whether the Regulations should be amended to enable administering authorities to factor in an employer’s exposure to risk in the Fund when determining any exit credit.
Although the consultation covered a range of issues, on 27 February 2020 the Government issued a partial response to the consultation to address specifically the exit credit issue only. As summarised in the response document, most respondents agreed with the proposed amendments, noting however that there are a wide variety of risk sharing arrangements adopted in the LGPS (not only pass through) and therefore flexibility would be welcomed.
The Local Government Pension Scheme (Amendment) Regulations 2020 were laid before parliament and, although they came into force on 20 March 2020, took effect from 14 May 2018 when exit credits were first introduced by earlier amendment regulations.
What do the new amendments for exit credits include?
- Administering authorities will be able to determine, at their discretion, the amount of any exit credit due, having regard to any relevant considerations. We expect this will allow administering authorities to factor in any risk sharing arrangements as appropriate (without the onus of setting out the details of the risk sharing arrangement falling on the administering authority), and also consider the exit credit relative to the contributions the employer has paid in. This will provide administering authorities with more flexibility in managing the exit process for employers.
- The period in which an exit credit (when due) is payable will be extended from three to six months. This will be helpful to offer administering authorities a more appropriate length of time for managing the cessation process and arranging any payment.
Action for administering authorities
The next step is for the administering authority to set out their formal exit credit policy in their Funding Strategy Statement.
What might be included in an exit credit policy?
First and foremost, the policy should seek to protect the interests of the Fund, its members and its participating employers, and it should be clear and transparent. This may of course be difficult to achieve because of underlying differences in existing admissions, and the potential differences between admissions already in place and future admissions.
Given the range of factors to consider in managing an employer’s exit from the Fund, the policy should also enable the administering authority to retain some of the flexibility that has been provided by the amendment regulations.
Administering authorities may want to consider the following key points when setting policy.
- The level of pensions risk borne by an exiting employer in its participation in the Fund should be taken into account when determining the level of any exit credit.
- Our view: Typically this applies to pass through arrangements but there are other risk sharing arrangements which may need to be considered.
- The responsibility falls with the exiting employer to evidence the level of risk taken, as typically risk sharing arrangements can be made without the administering authority’s involvement.
- Our view: Often the administering authority is informed of any outsourcing after the contractual agreement has been made so measures could be taken to detail exit payments in these arrangements.
- The administering authority may also take into account the level of contributions paid into the Fund by the exiting employer.
- Our view: The policy could cap any exit credit with consideration of the actual primary and secondary employer contributions paid into the Fund.
- The administering authority will aim to pay any exit credit within six months of the employer’s exit date.
- Our view: The administering authority may want to retain some flexibility so that this may differ if agreed with the exiting employer and will be subject to prompt provision of the required exit information from the exiting employer.
- Any other relevant factors will be taken into account by the administering authority and legal advice will be sought where appropriate.
- Our view: we would suggest that, although policy needs to be clear, you may also want to retain some discretion to deal with bespoke cases.
It is also worth considering how any policy sits with the existing cessation policies as set out in your Funding Strategy Statement (FSS).
If you would like any help preparing your exit credit policy or have any questions in general, please get in touch with your usual Barnett Waddingham contact to find out how we can support you. Alternatively, please contact us below.
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