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The Actuary The magazine of the Institute & Faculty of Actuaries

Protecting staff pensions

For 20 years, the Transfer of Undertakings (Protection of Employment) Regulations 1981 (TUPE) have safeguarded most employment rights when employees are transferred from one employer to another. However, TUPE does not safeguard occupational pension rights, but governments of all colours have long sought to protect their own employees’ pension rights when they are transferred as part of a private finance initiative, or some other contracting exercise.
In 1999 the government formalised this intention into a clear statement of policy, making it a key plank of overall public sector pensions policy. The Treasury paper Staff transfers from central government: a fair deal for staff pensions and the government actuary’s statement of practice (both published in June 1999) set out the policy in detail.
Since its introduction, Fair Deal (as it is known colloquially) has proved to be a popular and widely understood policy which, in the world of pensions, is really saying something generally accepted by both employers and unions alike as affording a reasonable degree of pensions protection on transfer. It has also had some arguably beneficial side-effects.
There are two main elements to Fair Deal:
– A contracting employer must operate a pension scheme for transferring staff which has been certified by the Government Actuary’s Department (GAD) as being broadly comparable to the public sector pension scheme from which they are transferring, and staff must transfer to this scheme automatically (although transferees retain the right to opt out if they wish).
– Staff should have access to bulk transfer terms under which they can transfer their accrued public service pension benefits to the new pension scheme and achieve full continuity of benefits year for year, and adjusted for any differences in benefits.

Broad comparability
‘Broadly comparable’ does not mean ‘exactly the same’ or ‘always better under all circumstances’, but it does mean that no identifiable group of transferees should suffer a material reduction in the value of their accruing pension benefits. Generally speaking the assessment of broad comparability is a predetermined pass-or-fail test. It is not a negotiation.
In framing Fair Deal policy, it was deemed unduly restrictive to insist that the new employer should offer benefits identical to those of the relevant public sector scheme. However, new employers increasingly find that diverging from the public-sector design simply adds to the ongoing cost of their scheme, and that closely following a public-sector template is the cheapest option. This is because changing the balance of the benefit structure can result in a ‘levelling-up’ of benefits.
For example, some employers might seek to limit the full inflation-proofing offered by public-sector schemes, and to compensate for this in value terms by improving death benefits. However, while pension increases are more valuable to females than to males because females live for longer in retirement, death benefits are less valuable to females because of their lighter mortality. Hence the trade-off price between the two types of benefit may be greatly increased, to the benefit of male members, by the need to ensure that females are not materially disadvantaged.
But broad comparability is not only a test of pensions value it also covers various qualitative tests; for example, to ensure that the range of benefits available in the new scheme is adequate, and that members’ benefits are afforded some additional protection on a wind-up or onwards transfer.
Money purchase is not considered to be ‘broadly comparable’ to final salary. Across the UK, there has been a wave of closures among final salary schemes while, at the same time, we are constantly reminded of the poor value offered to members by some alternative money purchase schemes. (A recent survey showed that the ten worst large pension schemes were all money purchase.) In these circumstances, it is comforting that Fair Deal policy has resulted in the government’s becoming, in effect, a net exporter of good-quality final salary schemes to the private sector. The pensions world could learn a lesson from the example of good employer practice which stems from Fair Deal.
Indeed, one is often pleasantly surprised by contracting employers’ willingness to establish good-quality pension schemes to receive transferring staff. In many cases, employers accept the rationale for broad comparability and adhere to its requirements with genuine enthusiasm. Only in a few cases is any significant resistance shown. Perhaps this enthusiasm has more to do with the fact that compliance with Fair Deal policy is now a prerequisite for the acceptance of an employer’s bid for a contract, but one would like to think otherwise.

Bulk transfers
Again, the agreement to bulk transfer terms is a prerequisite for the acceptance of a contractor’s bid. This usually involves a discussion between GAD and the bidding employer’s advisers concerning how much money is to be transferred from the relevant public sector scheme to the new scheme in respect of those who opt to transfer their accrued public service benefits.
The amount of money transferred can be a sizeable proportion (or even a multiple) of the overall contract value. Determining the right basis is therefore an important but fine balancing act between achieving good value for taxpayers’ money and ensuring that enough money is transferred for the benefit of transferees.
In setting out a transfer basis, GAD’s underlying philosophy is to transfer money which in its opinion is expected to be sufficient, in the normal course of events, to meet the accrued going-concern benefit expectations of transferring staff. As an added measure of caution it assumes the transferred moneys can be largely benchmarked against a portfolio of index-linked gilts bearing in mind that the money is coming from pension schemes which are unfunded.
In practice, GAD knows that receiving schemes are likely to take a more bullish approach to investments although this has not always paid off, as we have seen in recent years. Certainly in the current investment environment, GAD’s approach to determining bulk transfers could be viewed in some quarters as being rather attractive.
As part of the bulk transfer, GAD would normally expect staff to be offered year-for-year service credits. Nevertheless, if the new scheme’s benefit structure is materially different from that of the transferring public-sector scheme, this can affect the equation of value. Where the balance of value is shifted from accruing benefits to non-accruing benefits, then service credits of greater than year for year might be required. This might happen, for example, if in achieving broad comparability, a scheme offered a package of improved death benefits in exchange for limiting future pension increases.

Appropriate compensation
Fair Deal recognises that in some exceptional circumstances the requirement to establish a broadly comparable scheme might need to be waived. If there are perhaps only a few transferees and the bidding employer does not already offer, or have access to, a final salary scheme, it would arguably not be reasonable to expect the employer to bear the cost and administrative burden of establishing and maintaining a broadly comparable scheme solely for the benefit of a few members. In these circumstances, GAD would then advise the appropriate compensation for transferring staff. This would normally take the form of individually calculated contribution rates into a money purchase arrangement, together with additional protection benefits.
In deciding whether the circumstances are exceptional, account would need to be taken not only of the contract in question, but any other contracts which the employer has bid for, or is likely to bid for in the future. While a transfer of a few staff might not make a viable group for a new final salary scheme, a series of such transfers over a period of time might well, when combined, result in a viable group.
An increasingly common problem is that of the transfer of staff into pension schemes with a deficit. Broad comparability does not, in the normal course of events, involve the consideration of funding. Nevertheless, government bodies letting contracts are advised to obtain details of the funded status of the bidding employer’s pension scheme. They can then form a view of this in the light of the strength of the employer’s financial covenant, the strength of covenant itself being an important bid-assessment criterion.
For bulk transfers, however, the matter is slightly trickier. It would not be appropriate to pay taxpayers’ money into a poorly funded scheme if that money is simply going to bolster the finances of the scheme, rather than be used for the benefit of transferees. In such circumstances the transfer value might be paid in stages, in line with the scheme’s progress back to normal financial health (which would in any event be expected to be accelerated as part of the deal), or the money could be appropriately ring-fenced.

The new civil service pension arrangements
In October 2002, the Cabinet Office ushered in a new era for the pension arrangements of civil servants. New civil servants now have the choice between a traditional final salary arrangement known as ‘premium’, and a flexible, top-quality money purchase arrangement known as ‘partnership’. Existing civil servants can retain their membership of the principal civil service pension scheme (now known as ‘classic’), and were also given the option of transferring to ‘premium’ for future service only (‘classic plus’) or for all service.
This range of choices has created some interesting challenges in the context of Fair Deal. Broad comparability for the civil service arrangements now involves a requirement to mirror the choices currently available to civil servants. In short, through Fair Deal, the government is able to export its pensions choice agenda to the wider pensions world. From the limited experience to date, it seems that employers have, not for the first time, risen to the challenge of compliance in an enthusiastic and proactive way.

A fair deal?
The protection of staff pensions on transfer is a key plank of the government’s public sector pensions policy. In the three years since its implementation, Fair Deal has proved itself to be a landmark document and a beacon of good employer practice.