Practical Law

David Gollancz, barrister, 11KBW:

In this post David Gollancz looks at:

• The government’s consultation on the future of the Fair Deal. 
• Its potential outcomes and their implications.

“Pensions are often an important element in the overall remuneration of staff, particularly within the public services where there are occupational pension schemes offering a high quality of benefits….If appropriate arrangements were not made for staff pensions as part of business transfers, the result could be disadvantageous to public service staff who were transferring to the new employer…It is not in the interests of the contracting authority, or the new employer, or the taxpayer, for staff to be alarmed about the prospects for their pensions in a business transfer which depends upon staff motivation for delivery of good quality public services.” (A Fair Deal for Staff Pensions, 1999, paragraphs 4 – 5)

The government is consulting on the future of the Fair Deal (FD).  The consultation canvasses three possibilities: abolition; reform; and no change. 

No change gets effectively dismissed pretty quickly: FD is said to be expensive, complicated and high-risk.  Consequently it deters new entrants to the outsourcing market, especially SMEs, and makes for a two-or-more tier workforce in public sector organisations when protected workforces move back in-house.

Reform is outlined, rather vaguely, in terms of reducing the level of benefits offered at each stage, or in respect of each component, of FD, so that it will more resemble the protection offered by the Pensions Act 2004. 

Abolition is briefly considered but not (unlike “no change”) dismissed.  The consultation observes that ending FD would significantly reduce the value of pension provision for future transferring employees.  Rather than concluding that that could amount to a breach of trust, the consultation observes that it would correspondingly reduce costs for independent providers (that is, private sector employers), thus opening up the market, while leaving in-house bid teams effectively condemned to uncompetitiveness.

What’s the problem with the Fair Deal? 

According to the consultation it boils down to cost, risk and complexity.   A slightly more detailed breakdown is as follows:

• Broadly comparable pensions are very expensive to provide, and the cost falls on the public purse through private sector contractors’ contract prices. By way of example, whereas a central government department “pays” around 19% of gross salary back to the Treasury to account for the cost of its employees’ pension entitlement, independent providers paying into GAD certified pension schemes may pay close to 45%. Moreover, exit costs can be swingeing and, according to the consultation, threaten employers with insolvency.
• The FD rules are difficult for independent providers to understand because they are different from standard private pension schemes. For example, broadly comparable pension schemes are required to give day for day credit for pre-transfer accrued reckonable service, which entails both receiving and, on re-transfer, paying a “bulk transfer payment” calculated on a different basis from the Cash Equivalent Transfer Value which is standard in ordinary pension schemes. Those LGPS exit charges are not only high – according to Hutton, many independent providers do not properly understand their exposure when they become admitted bodies, not least because the methods of assessing the value of accrued benefits can differ on entry and exit.
• The demographic risks of defined benefit schemes are exacerbated in the case of smaller workforces, because there can be little smoothing of the demographic risk.
• The public sector schemes themselves have changed since FD was introduced and are continuing to change. As a consequence, “broad comparability” will mean different things according to when the employees in question were outsourced. If and when those employees are insourced again and become entitled to re-join a public sector scheme, it is likely either that closed schemes will have to be reopened, or new schemes put in place, to honour their FD right. The result will be a “two (or more) tier workforce”, but in the public rather than private sector.

These assertions bear closer examination. 

• Cost. There is no question about this. To provide defined benefit pensions just is expensive, final salary pensions still more so, and the heightened demographic risk makes them even more so in smaller workforces. Devices like the retention of employment model  (RoE) or admitting the private sector employer as a member of the public sector pension scheme (as happens in the Local Government, Teachers’ and, to a limited extent, the NHS pension schemes) are problematic; RoE doesn’t achieve the government’s political goal of transferring employment and its attendant risks to the private sector, and the “admitted body” approach can be very expensive.
• Complexity. This really doesn’t wash. The Fair Deal has been around in broadly its present form since 1999 (and for longer than that in practice: the need to protect the pensions of exported workers was recognised by the Thatcher administration in the early 1980s). There are plenty of “passported” schemes around: those certified by the Government Actuary’s Department (GAD) as meeting the “broadly comparable” standard. GAD lists 73 currently-valid passports on its website and there is an indeterminate but substantial number of others. If a business of whatever size wants to bid for a public sector contract which requires the provision of a broadly comparable pension, it need only sign up to one of the passported schemes, and ensure that the cost is passed on to the public authority. As to the risk of exit charges, if businesses sign up to these without understanding them it suggests that they have failed to take proper advice – something which can easily be cured by ensuring that the bid documentation in public procurements draws bidders’ attention to the requirements and risks of FD at an early stage. Alternatively, it has been mooted quite often, in central government at least, that the government itself – presumably through Cabinet Office – could set up or at least certify a broadly comparable scheme or framework, specifically to support outsourcing to SMEs.
• Demographic risks are of course more acute but a similar consideration applies. There is no reason of principle why government should not facilitate the pooling of smaller schemes so as to create the benefits of risk smoothing. In the case of very small schemes, FD already provides for transferring employees not to be offered a broadly comparable scheme provided that they are compensated, for example by a salary enhancement.
• Changes in public sector schemes do create a more complex picture. To the extent that existing FD commitments are honoured (and the consultation makes it clear that they should be) that is inevitable. It is unlikely to be a problem on a grand scale however: it is not very often that services are insourced, and even where they are it is likely that during the period of outsourcing, employees will have left and private sector employers with a bit of nous will have bought transferring employees out of their rights (at a discount, naturally). The number of employees returning to public sector employment and hence pension entitlement is likely to be modest. Moreover, if Hutton’s recommendation of a broadly uniform reformed public sector pension is adopted and expeditiously implemented, the problem of the multi-tier public sector workforce will be effectively addressed.

The consultation’s look at the options

No change

The consultation is light on detail when it comes to options.  “No change” is characterised as failing to “tackle the current barriers to plurality of public service provision” (paragraph 3.4). Enabling more employers to become admitted bodies (or equivalent) to public sector schemes and thereby relieving them of many of the identified challenges of providing a broadly comparable scheme, is dismissed as leaving the taxpayer holding the risk of paying final salary pensions on salaries which it does not control.

Both these assertions need to be tested. 

First, does pension provision really act as a significant disincentive to potential outsourced service providers?  Of course employers will say so: the potential for skimming a little extra profit off the “pension” element of the contract price probably doesn’t adequately compensate for the hassle of compliance with the policy.  That will be particularly the case in those rare instances where contracting authorities actually follow the 2004 FD supplementary guidance, which necessitates some speculative expenditure by bidders.  But the facts demonstrate that SMEs are not deterred, under the existing dispensation, from providing a very substantial proportion of outsourced public services, particularly in areas such as health, social care and education. Moreover, if the number of transferring employees, or other demographic elements such as their age, makes it disproportionately expensive to provide a broadly comparable scheme, FD provides for an exception.  Otherwise, the cost can simply be passed on through the contract price, or indeed by way of an indemnity (the author is keen on indemnities in this particular regard; unfortunately the words “let’s indemnify the contractor” tend to make most public bodies go all pale and needing a little lie down). 

Secondly, how much of a risk is really posed by pay inflation?  It is standard practice in outsourcing contracts to impose various constraints on changes in pay and conditions, for example in the run-up to a re-let, so as to avoid the “poisoned chalice” workforce; there is no reason why such safeguards should not be used to control pension risk.

Reform

Reform too is dealt with briskly.  The consultation says that “a range of options exist” but they seem to come down to just two:

• reducing the requirements for future accrual (that is, not requiring private sector employers to contribute on a like for like basis post-transfer, perhaps simply requiring them to provide something like a stakeholder pension); and/or
• reducing the requirements concerning credit in the transferee scheme for accrued service in the transferor scheme (that is, changing from day-for-day to CETV, or similar).

This really is not reform, at least in the sense of making FD work better.  The express basis of FD was and remains as set out in the words quoted from the policy at the top of this blog.  The Acquired Rights Directive/TUPE excluded occupational pensions from its protection.  Recognising the political and legal risks of embarking on a programme of privatisation and outsourcing of public services without protecting pensions, first the Thatcher and latterly the Blair administrations adopted the policy underlying FD.   By implication at least, FD is supposed to extend TUPE-equivalent protection to public sector pension rights.  Just as TUPE does not allow a transferee employer unilaterally to derogate even a little bit from employees’ terms and conditions, so if the spirit and policy of FD is to be honoured, it ought not to be open to transferee employers to derogate from the standard of broad comparability; nor ought it to be described as “reform” if that standard is to be reduced…even a little bit. 

Abolition

The consultation deals in equally short order with abolition, remarking only that “this could have a significant impact on the value of future pension arrangements for transferring public sector employees”.  This must be in the nominations for understatement of the year.  “Could” have?  It would, without question, have an impact, and “calamitous” might have been a more appropriate word than “significant”.  The consultation comments in positive terms that abolition would make it possible for more varied independent providers to enter the public service outsourcing market.  As to that, if the public sector trade unions and their members suddenly remember where their spines are, abolition of FD might very well bring the outsourcing of public services to a shuddering halt, just as the Thatcher government feared in 1983.

What is the outlook for existing staff with FD protection?

The final chapter of the consultation, before the summaries and glossaries, considers the question of second and subsequent transfers (including re-transfers to the public sector).   The consultation asks, if FD is reformed or abolished, how should staff be treated where they originally transferred out under FD?  Should their pension provision continue to be protected by the terms of FD as it was at the time of the original transfer?  Or should they be subject only to the terms stipulated by any new policy?  The consultation notes that where FD requirements have been embodied in contracts, they will not be overridden by policy changes; “those involved” would have to “resolve any contractual issues as appropriate.” 

Will it all end up in the courts?

Reference to the contractual basis for the FD obligations reminds us of the legal implications of changes in or abolition of FD.  The government of the time does not appear to have considered judicial review risk.  Normally of course employment matters are governed by private law but in the case of a change of policy of such significance it may be that the courts would think that principles of public law were engaged.

Besides the employment and public administrative law questions raised by this part of the consultation, public procurement law issues are likely to arise.  If a company has won a contract on the basis that, upon its expiry, there will be an onward transfer on the FD basis, any relief from that obligation might amount to an unlawful change in the contract terms, favourable to the contractor and hence possibly in breach of the principles set out in pressetext. 

In conclusion, it is clear that the pension landscape in which FD takes its place is itself unwieldy, complex and quite possibly economically unsustainable.  Public sector pensions – indeed pensions generally – need sorting out.  But it is difficult to see how it is either morally just or legally sound to single out employees who are subject to involuntary transfer out of the public sector for what amounts to unfavourable treatment.