Originally published in Insight - Human Capital (Pensions), Spring 2008
For some time there have been calls within the private sector for a review of Admitted Body Status (ABS) for transferee bodies in the Local Government Pension Scheme (LGPS). In 2006, the Department for Communities and Local Government (CLG) issued an informal consultation on changes to ABS but it is the most recent informal consultation issued on 18 January 2007 which could herald changes to the ABS process.
The ABS Route
Under ABS, a prospective contractor applies to become an admission body in a Fund of the LGPS. This is achieved by entering into an admission agreement with the administering authority to the Fund and, if different, the authority letting the contract. This is very much like becoming a participating employer in a private sector scheme and enables the transferred employees to continue to accrue benefits under the LGPS. On admission, contractors are actuarially allocated assets in the relevant Fund equal to the members' accrued liabilities at the start of the contract. These assets are then calculated in line with investment returns and contributions over the contract period.
It is not a statutory requirement for contractors to offer ABS when contracting with local government. The decision to offer ABS or a broadly comparable scheme boils down to contractor choice, although the contracting authority may take the arrangement offered into account when assessing otherwise equal bids. (A broadly comparable scheme requires a passport issued by the Government Actuary's Department – a topic which features in a separate article in this edition of Insight.)
Ideally any contractor who takes on ABS will start a contract on the basis of a level playing field i.e. it does not inherit any past service liabilities and will be able to competitively price the contract at the tendering stage along with rival contractors. Subject to the actuarial assumptions used being reasonable, any Fund should have sufficient assets to ensure that past service liabilities are fully funded. In theory this should ensure that the contractor is only liable for the liabilities accruing during the duration of the contract. However, there are other risks associated with the ABS route which have deterred potential contractors from proceeding with the contract. The key concern is one of a lack of control. Contractors are entirely dependent on the administering authority to control costs. For the duration of the contract they are potentially exposed to volatility in respect of increases in contribution rates and have no input in the Fund's investment strategy, actuarial assumptions or deficit spreading and have no prospect of the return of surplus.
There are also additional costs, which arise throughout the duration of the contract. From the outset the contractor will bear the costs of negotiating the agreement to achieve ABS. The contractor may be liable to meet the valuation costs every time there is a valuation by the Fund Actuary. The cost of obtaining and maintaining any bond (if one is required by the letting authority) also falls solely on the contractor. If a contractor bidding for a contract is unaware of the potential pitfalls associated with ABS, the benefits of taking on the contract can become significantly outweighed by the costs risks. From the point of view of local authorities, the transfer of pensions risk to the contractor which the ABS route involves is something which contractors will take into account in pricing their bids so there are costs issues for the authorities themselves.
The Need For Change
For some time there have been concerns that the actual implementation of ABS does not always reflect the way in which the current practice is supposed to work. The statutory framework is very bare. Many of the principles which are supposed to regulate the use of ABS are contained in guidance not law. Contractors have complained of wide variations in the way the policy is implemented across the country. Some have reported practices which are actually contrary to the principles set out in policy e.g. a back door compulsion to offer ABS where the letting authority has stipulated ABS as a requirement for obtaining the contract or a requirement to offer open admission agreements whereby new recruits are granted the same terms and conditions as those employees being outsourced. The treatment of contractors on the re-letting of contracts has also caused some concern.
CLG is seeking views on how best to address the concerns about the current arrangements, particularly the costs issue and lack of consistency while still ensuring compliance with the principle of a fair deal for staff and working towards the elimination of a two tier workforce in public sector contracts. It has put forward three possible approaches for discussion:
If this approach is selected, there would be no fundamental changes made to the existing ABS procedure or to the regulatory framework. Instead, CLG would re-state the original intentions of ABS i.e. contractors should pay contributions based on future service cost and would not inherit past service liabilities. Only in exceptional circumstances would a contractor be asked to find a portion of an accrued deficiency and this would be made clear during the contracting process. CLG envisages that this approach could be achieved by clarifying the current guidance as well as setting out in detail how risks should be assessed and dealt with.
Revised Guidance And Regulatory Modifications
This approach would be similar to the first approach but its aim would be to introduce greater certainty on risk for contractors. It would involve issuing specific regulatory changes such as a provision to refund any surplus at the end of the contract to enable contractors to benefit from the Fund's performance and actuarial assumptions. Requirements may also be introduced for an annual review of any indemnity cover and an annual actuarial monitoring to check for changes which may impact on pensions provision.
Broader Regulatory Changes To Support Management Of Pension Risks
This approach would involve the introduction of measures designed to address the cost implications inherent in the ABS route. Those measures considered in the consultation paper include:
- allowing for pass through of pension costs in the contracting process i.e. contractors would contribute only for membership of the LGPS during the contract and would have no past service liabilities. The letting authority would retain and meet the actual cost of all investment risk.
- introducing a requirement for mandatory open admission agreements. This type of arrangement would mean that all new employees on a contract would become members of the LGPS.
- cap and collar arrangements. This arrangement would ensure contracts specify an upper and lower limit on the employer's contribution rate (they are already inserted by some letting authorities in ABS contracts). Such an approach would work on the basis that the contractor pays the contribution rate certified by the Fund actuary. Where the actuary specifies a contribution rate outside the range between the upper and lower limits, an adjustment in the contract price would be negotiated.
The consultation paper demonstrates CLG's commitment to ensuring that parties to the ABS process should effectively manage the risks in proceeding down the ABS route. It is fundamental to the process of any revised ABS route that contractors should have a better understanding of the possible risks associated with ABS in order that they can focus on the services to be provided to the letting authority. Responses to the consultation are required by 10 April 2008. Hammonds will be contributing a submission towards the consultation process.
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