Over the last few months, there has been much commentary that some employers could leave the Local Government Pension Scheme (LGPS) to take advantage of a lower cessation debt.
What’s the issue?
Cessation is where an employer ceases to be a scheme employer, which can happen in situations where, an admission agreement terminates (for example, as a result of reaching the end of a fixed term linked to an outsourcing contract) or otherwise when an employer ceases to have “active” members contributing to the fund.
It occurs most frequently in the case of admission bodies, such as charities and private contractors. Under the regulations, the administering authority (AA) is required to obtain an actuarial valuation of the liabilities of current and former employees of the admission body as at the termination date.
The values placed on an employer's liabilities and share of assets at cessation are typically calculated using assumptions based on market conditions at that particular date. This can lead to significant cessation debts, where adverse market conditions at the cessation date can mean that a high value is placed on the liabilities and/or a low value of assets.
Whereas the value placed on assets will normally take into account fund returns since the last valuation, the value of the liabilities is typically driven by gilt yields. When gilt yields are low, this increases the value placed on liabilities and when gilt yields are high, the converse is true. Given the rise in gilt yields following the September 2022 “fiscal statement”, debts owed by employers exiting the LGPS are likely to be lower than they have been previously.
Opportunity vs risk
There are clearly opportunities for those employers who are in a position to choose when they exit and have taken a pro-active approach to cessation valuations. Those who have regularly monitored the estimated cessation debt are likely to find themselves well placed. That is, if (and it’s a big if) they can afford to pay the debt to end their obligations to the fund.
For employers, the current situation highlights the importance of formulating an exit strategy well in advance of any decisions. By continuous monitoring of the cessation position, employers will be able to make informed decisions when market conditions are most favourable.
It may also be important for employers to consider, and take advice on, covenant issues, which may have an impact on settlement terms agreed with the AA.
Since September 2020, the regulations governing the LGPS have given funds the power to offer some flexibility to employers in making exit payments. AAs can agree to a departing employer deferring the date an exit payment to the fund is crystallised (using a ‘deferred debt agreement’) or to recover an exit payment over a period of time agreed with the AA. It will be interesting to see if more employers consider these alternative options to manage exit payments.
However, as an article from Professional Pensions points out, there are potentially risks for LGPS funds. If the amount of an employer’s debt is lower, the fund will ultimately receive less money to pay benefits. As a result of this risk and because there is no prescribed method for determining the assumptions to be used for a cessation, AAs (on the advice of the fund’s actuary) are likely to consider their approach to the assumptions for setting cessation funding targets and make changes where appropriate.
This highlights the impact of market conditions on the level of cessation debt and given the volatility of the current political and economic situation, further developments in this area are likely to unfold as more valuation results filter through.
Due Diligence and Communication
Employers who are considering an exit should also undertake appropriate due diligence, and where possible, ensure there is a positive channel of communication with the relevant AA.
Due diligence is important because an employer may be participating in an LGPS fund for a specific reason – for example, due to a previous TUPE transfer from a public body. In those situations, the employer should carefully consider whether there are any continuing obligations to provide for LGPS participation (whether due to a contractual obligation or otherwise).
Employers should also ensure there is an appropriate consultation with staff about any proposed changes. Even where the pension consultation regulations do not apply, employers should think through the best way to engage and consult with affected members (considering previous statements given to members and the terms of their employment contracts).
Finally, we consider it would be an unusual case for an employer to engage on an exit process without speaking with the relevant AA. The AA will want to ensure that it is comfortable the legalities of any exit are satisfied. The employer will almost certainly need to understand its potential exposure to a cessation debt (it would be beneficial for the employer and the AA to be able to agree the approach to the liabilities to be settled), and where a deficit exists, the AA will need to agree to any alternative to settling the liability immediately on exit.
This blog was written by Hannah Taylor and Michael Hayles
Higher gilt yields are expected to result in an uptick in employers looking to leave the Local Government Pension Scheme (LGPS), which would create both opportunities and risks to funds, according to experts.