If a contractor for a local authority becomes insolvent, what happens to the pensions of outsourced staff? Gary Delderfield gives some advice
In times of economic difficulty, hardly a day seems to go by without the insolvency of some company or another hitting the news.
And while there is undoubtedly the human cost to these insolvencies, particular legal issues arise where the insolvent company has contracted with a local authority to take on outsourced services for a defined period of time.
One knotty legal problem relates to the pensions for outsourced staff, where the contractor has put in place a ‘broadly comparable scheme’.
Since 1 October 2007, English local authorities have been required by tahe Best Value Authorities Staff Transfers (Pensions) Direction 2007 (the Pensions Direction) to include pension protection for staff in their outsourcing agreements.
Before that date, the same protections for future service benefits were set out in the non-statutory Fair Deal guidance, which had applied to public sector outsourcings from 1999.
Protection on the initial transfer from the public sector includes the requirement to ensure that pension benefits are provided which are the same as or broadly comparable with the original public sector scheme.
There are two ways in which a contractor can fulfil the requirement to protect future pension accrual in relation to local authority outsourcings. The contractor may either become an ‘admission body’ in the Local Government Pension Scheme (LGPS), or provide its own ‘broadly-comparable scheme’, which has been certified as such by the government actuary’s department.
In terms of service provision, the service contract will provide for what happens to the contract services on insolvency. In practice, this means that either another provider will take over the services or the services will return in-house to the local authority. However, real issues can arise in relation to pension benefits the employees have accrued under the insolvent contractor.
Where the insolvent contractor was an admission body in the LGPS, the employees’ full benefits are guaranteed by the LGPS as a statutory pension scheme, irrespective of the company’s solvency. Funding deficits may revert back to the letting authority, but benefits will be fully protected. Employees will also be able to aggregate their membership with future membership, if they remain in the LGPS under their new employer.
However, where an insolvent contractor provided its own broadly-comparable scheme, the employees’ benefits are dependant on the scheme having sufficient assets to pay the pensions in full.
The insolvent employer will not be in a position to top up these assets where they are insufficient. However, the Government’s Pension Protection Fund may give the employees some degree of protection.
The Pension Protection Fund (PPF) was established in April 2005 to provide compensation for members of eligible underfunded pension schemes whose sponsoring employers had become insolvent. Broadly speaking, all private sector defined benefit pension schemes – including broadly-comparable schemes – are eligible to be transferred into the PPF, where they are underfunded on the PPF basis.
A scheme is transferred into the PPF after an assessment period, during which the PPF considers whether or not the scheme is sufficiently funded on the PPF basis. The assessment period is triggered by the employer’s insolvency.
During this period, no benefits accrue, no contributions are paid and no benefits may be transferred out. In addition, the PPF looks at whether or not there have been any rule amendments over the three years before assessment, and any resultant benefit increases are disregarded.
If the scheme is accepted by the PPF, it will transfer into the PPF and its members will receive PPF compensation in place of the benefits which had been provided by the scheme. In summary, the compensation which the PPF provides is:
90% of a member’s pension for all other members – subject to the compensation cap. The compensation cap is adjusted for the member’s age – 90% of the 2009/10 cap is broadly £28,7000.
If the PPF decides that the scheme is sufficiently funded on the PPF basis, then it will be left to wind up on its own and secure benefits somewhere between the PPF compensation level and the full benefits.
It is clear that the principles of the Pensions Direction which require pension protection for employees when outsourced by a local authority will not necessarily apply, should the contractor become insolvent.
The position between employees who remain in the LGPS under an admission agreement and employees who join a broadly-comparable scheme can be very different in an insolvency situation.
Employees in a broadly-comparable scheme may not end up with ‘broadly-comparable benefits’ on insolvency, although the PPF will ensure such employees do have some level of compensation, should the worst happen.
Unfortunately, in the current climate, this is an issue we are likely to be seeing more and more of in the future.
100% of the member’s pension where the member had reached normal pension age at the start of the assessment period
Gary Delderfield is a partner at Eversheds
