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Offloading the baggage - is there escape from pensions liability?

Offloading the baggage - is there escape from pensions liability?
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Offloading the baggage - is there escape from pensions liability?

Finance | David Davison | 17 Apr 2012

The Royal Mail has offloaded its pensions liability onto the government. Can some charities do the same? David Davison investigates.

At the end of March the EU approved plans to allow the UK government to provide the Royal Mail Group (“RMG”) with financial support relating to ‘excessive pension costs’ and to provide restructuring aid consisting of a debt reduction amounting to around £1.1bn in total.

RMG, 100 per cent state-owned through the Royal Mail Holdings, had a monopoly over certain letter services until the end of 2005 at which point the postal market was opened up to competition. The government effectively accepted that the pensions accrued prior to this date were the responsibility of the state and represented an unreasonable burden on RMG which would impact on their future competitive position and limit their privatisation options.

The government therefore intends to transfer around £37.5bn of liabilities from the Royal Mail Pension Plan (“RMPP”) to a newly established unfunded public pension scheme. The move will result in a windfall to the Treasury with around £28bn of assets also being transferred.

However the RMG scenario is not unique and very similar circumstances affect numerous leading UK charities. As the drive for the public sector to out-source the provision of many of its core services gathered pace over the last decade or so, many charities in the education, leisure and housing sectors, to name but a few, were established to assume responsibility for these services. As part of that process these organisations assumed responsibility for the pension provision of their staff frequently unaware of the wide-ranging and potentially devastating implications of such a move.

An organisation I recently looked at which was established in 2007 had around £20m of pension liabilities of which around £15m related to benefits accrued prior to their formation!

Within local government pension schemes (“LGPS”) the schemes are unable, or possibly unwilling, to split the liabilities between relevant employers and therefore just recognise the last employer as having responsibility for all of the pension liabilities. Frequently on transfer of pension rights the LGPS will make the assumption that the associated pension liabilities are 100 per cent funded on an on-going basis. Such an approach has serious cost implications for many of the organisations affected.

This approach leaves the organisations completely exposed to market movements and changes in future actuarial assumptions. Where asset values have fallen, or not kept pace with assumptions, or the value of liabilities has increased, such as to take account of increasing longevity, this will result in increased deficits and increased contributions for the organisation which assumes the liabilities. The new employer will be responsible for all of these increased costs, including for pensionable service which predates their existence, and such an increase in costs is unlikely to be reflected in a commensurate increase in their council funding forcing such organisations to absorb the increases within current budgets. Ultimately an increasing proportion of funding will be directed to funding historic benefit promises and less will be available for actually carrying out the work of the organisation.

Should the organisation wish to consider exiting the scheme it will find itself responsible for all inherited liabilities and the costs will be calculated on a much more conservative, that is to say expensive, basis than will have been used at outset of any contract. In the case highlighted above the exit cost relating to the organisation’s period in existence was around £3m which was within the realms of the possible in terms of affordability, however the total exit cost was around £12m which was not. In addition organisations are forced to pay this increased cost even though the ultimate benefits will not actually be secured with a third party insurer, as would usually be the case in the private sector, so the local authority can subsidise its costs.

Additional costs

The transfer of previous pension rights on these terms has also left organisations exposed to substantial ancillary costs. Should individuals be forced to retire on ill-health or on grounds of ‘operational efficiency’ (such as redundancy) this will result on a ‘strain on fund’ charge payable by the employer which would again be based upon the total period of service. These amounts can be very significant and it is not uncommon to witness amounts of £100k+ being demanded in these circumstances. Again organisations have responsibility for all of this payment with the local authorities escaping any liability for their share.

As part of some transfers of pension rights some local authorities provided supporting guarantees however these seldom, if ever, have any value as usually they do not deal with any of the issues identified above and would purely provide the option for liabilities to revert to council ownership in the event that the new body became insolvent, which clearly provides little comfort.

It is also becoming apparent that we have the ridiculous situation where some organisations specifically formed to provide these services, and forced to provide access to LGPS, are being disadvantaged on re-tendering often losing out to other organisations with lower pension costs!

Local authorities have effectively (very effectively) ‘dumped’ millions of pounds of their pension liabilities and a huge level of associated risk on some unfortunate and unsuspecting charities.

I believe that there is now a pressing need for these schemes to clearly identify the responsibility for periods of service as attaching to specific employments and employers, and to apportion costs accordingly. It would also be interesting to see if a number of these affected organisations could pursue a legal case (on a similar basis as RMG) to ensure that the historic position was dealt with equitably. There also needs to be a fundamental review of the existing legislation to provide a mechanism to allow organisations to exit schemes on a more viable basis, whilst protecting the accrued rights of members.

In the case of new organisations being established to provide similar services they need to be very clear about their pension liabilities and take independent professional advice to understand and limit their risk exposure.  

Ultimately the acceptance of a responsibility for prior pension debt is not just an issue affecting the Royal Mail.  

 

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David  Davison

David Davison is head of public sector, charities and not-for-profit at Spence & Partners, director of Dalriada Trustees and Civil Society Media's dedicated pensions blogger.

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