In its response to the DCLG consultation, LCP proposed that the new Fair Deal should ensure that employers with outsourcing contracts involving employees in the LGPS take on the same level of pensions risk as they face on similar contracts when employees are in other public sector schemes (eg the NHS Pension Scheme).
In particular LCP highlighted that:
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Under the consultation, DCLG is proposing minimal changes to the current LGPS admission body regime. However, this does not meet the stated policy aim of encouraging more SMEs to bid for outsourcing contracts, as they will continue to have large pension risks which could threaten the contract’s profitability and in some cases the SME’s viability. In contrast, it is expected that larger companies would continue to have sufficient negotiating power to pass this risk back to the local authority.
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The main source of pensions risk for the contractor is because the contractor has to make good any shortfall in funding at the end of the contract. The funding position depends on the investment performance of the fund, in particular the market value of the assets on the contract termination date. Short term market volatility can significantly affect the outcome. In fact, a contractor could successfully run a contract for nearly the full term, only to find that a sharp drop in the stock market in the last week of the contract has wiped out all the profit and then more.
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The regulations should be revised so that the normal route is for the investment risk to remain with the contracting authority, who is the party carrying the risk in the first place before the contract is outsourced. The contractor’s contribution rate would be determined at the beginning of the contract and would not be expected to change over the contract term. This would be similar to the way in which admission bodies now work in the NHS and Civil Service Pension Schemes.
Tim Sharples, partner at LCP, said “Contractors have no control over the LGPS pension fund’s investment policy, and yet are expected to underwrite the risk. Pension Fund investment policy is designed around the main employers in the Fund who can take a long term view of investment performance. It is not appropriate for the contractor, who has a much shorter time horizon - the Pension Fund investment policy is much too risky for this shorter period, particularly for smaller companies.
“The issue of pensions risk causes a lot of friction in outsourcing contract negotiations, particularly when the local authority staff who negotiate the contract do not have ready access to specialist pensions knowledge and sometimes feel that the contractors are using pensions to “pull a fast one”. By imposing a standard risk sharing approach through the regulations, the DCLG could reduce contracting costs considerably whilst levelling the playing field and encouraging more SMEs to bid for these contracts.”
The consultation closed on 20 August. Results will be published “soon” according to the DCLG website.
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