Pragmatic reform for past pension liabilities (BSA, public sector pensions)

15 March 2010

The BSA has been a long-time supporter of the concept behind Fair Deal but we believe that changes to social and economic circumstances have meant the policy is no longer protecting staff, not least because it saddles employers with debt. Mark Fox, the BSA's Chief Executive explains

That public spending needs to come down is not in question – or at least, not by anyone in the political mainstream. A debate may rage on the when, but not the whether. Timescales aside, it’s how costs are controlled without quality of services being affected that’s the big challenge.
Competition must be part of the answer, but there’s a major barrier to its effective use. This is the prohibitive cost of transferring public sector pensions to the private sector. This barrier must come down.
Put simply, private sector companies with solid track records in delivering highquality services while reducing costs are being frozen out of the market or being put off from bidding because of the huge pensions liabilities they are expected to take on.
These companies could – and often do – operate successfully across a range of areas including education, health, defence, food, housing and waste management. This means they transfer staff from the NHS, local government, civil service and increasingly the teachers’ pension schemes.
The Government requires contractors to provide ‘broadly equivalent’ defined benefit pension arrangements for transferred staff under the Treasury’s ‘Fair Deal’ policy. The BSA has been a long-time supporter of the concept behind Fair Deal but we believe that changes to social and economic circumstances have meant the policy is no longer protecting staff, not least because it saddles employers with debt.
The main problem for contractors is the requirement to price in past service pension risk for transferring staff. This is immediately unfair as the contractor has to fund the liability without having enjoyed the benefit of those people’s years of previous work. And no business would take on the financial unknown like this in any other circumstance. But more worryingly for government, value for money is reduced when contractors are forced to assume a worst case scenario and price in to contracts past service pension risk. This pushes up costs and can leave the taxpayer with a poor deal.
The BSA has calculated that on an average contract, a contractor is forced to price in as much as 12 percent of the contract value to cover the cost of pension risk. So for a contract worth £100m, the total cost to government is £112m. According to the Julius Review, the Government spent £80bn on outsourced services in 2008 – 12 percent of that is £9.6bn.This is clearly no insignificant amount of money.
The problem is compounded if the contract is not re-let to the same contractor. When this happens any deficit is turned into a debt that must be paid by the contractor. The deficit is calculated on a buy-out basis. For example, one contractor has a local government equivalent scheme currently fully funded on both the technical provisions (so pension scheme members are protected) and a FRS 17 accounting basis. However, should the contract not be re-let the contractor will be liable for a £30m debt based on an annuity buy-out cost. The company in question has a market capitalisation of £20m. If only one of its contracts comes to an end it will be forced to cease trading.
Clearly this is a desperate situation for the contractor, but it also has damaging consequences for the transferred staff and the sustainability of the public sector outsourcing programme.
The Government needs to take urgent action to tackle this growing problem. The BSA has suggested pragmatic reform including steps that could be implemented immediately.
First, the obligation for contractors to offer past service pension risk should be
removed. Second, the technical provisions for securing pension benefits on contract termination should be eased. Further details of these recommendations can
be found on our website http://www.bsa-org.com..
We believe that the scale and severity of the problem is now better understood by all parties. Yet we are still waiting for a plan of action. We need one, and fast. This is not a problem that can continue to be put off if public services are not to be threatened and costs increase. The BSA published a Discussion Paper February entitled Changing pensions transfer terms for better outsourcing, which is available to read from www.bse-org.com