Civil Service PPPs Pensions issues April 2006 Contents 2. Introduction 2. Civil service pension arrangements 3. Can employees continue as PCSPS active members following the PPP? 3. What will be the transferring employees membership rights? 4. The TUPE Regulations and pension scheme benefits 4. What happens to accrued rights? 6. New recruit rights 7. Contacts
Introduction This briefing paper examines the pensions issues likely to arise when the employment of civil servants transfers to a private sector classified entity through the Government entering into a public private partnership or similar project involving a private sector partner. It does not deal with projects where the Retention of Employment Model is used. A PPP is a partnership between the public and private sector for the purpose of delivering a project or service historically provided by the public sector. Many different legal structures may be used for a PPP, depending on the circumstances of the project and the objectives of the Government. The PPP will often take the form of a company limited by shares (either public or private) into which the assets and liabilities of the Government agency are vested. The majority of those shares will then be transferred to a private sector partner, with the Government retaining a minority shareholding for strategic purposes. But this is by no means the only structure that a PPP can adopt. The issues discussed in this note apply equally to projects carried out under the Private Finance Initiative ( PFIs ) and also to outsourcings, contracting outs and other commercialisation arrangements where an undertaking transfers to a new legal entity, whose ownership in whole or part then subsequently transfers to the private sector. For the purposes of this briefing paper, however, the new venture to which public sector staff are transferred will be referred to as a PPP. The employees in the organisation converting to a PPP will transfer to the new company under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (the TUPE Regulations ). Commonly this is at the same time as the private sector becomes involved; but it does not have to be. The sponsoring department could set up a limited company and transfer all the relevant employees to that company in advance of private sector investment. This note does not deal with PPPs where the Retention of Employment Model is used. This is the term used to describe the practice among public authorities who are outsourcing their functions into the private sector to second large numbers of their employees on a long-term basis to the contractor rather than transferring them under the TUPE Regulations. Where central Government oversees the transfer of employment of public sector employees, it is committed to protecting their ongoing pension rights under the Cabinet Office Statement of Practice, January 2000 ( COSP ). COSP was originally published in January 2000 and reissued as part of the HM Treasury updated guide Fair Deal for Staff Pensions in June 2004. Civil service pension arrangements Civil servants are entitled to join the Principal Civil Service Pension Scheme ( PCSPS ) which provides benefits in its Classic and Premium sections. Both Classic and Premium sections provide final salarybased defined benefits. Some civil servants may have partnership pension accounts in which they build up rights on a money purchase, or defined contribution basis. All are protected under COSP and partnership pension accounts are also protected under the TUPE Regulations. Civil servants can be members of PCSPS if employed by the Crown or a public funded body, such as Non- Departmental Public Bodies ( NDPBs ). NDPBs are often corporate bodies created by Act of Parliament but can, in exceptional cases, be limited companies. For the purposes of this briefing note we have split the pension rights which will concern the sponsoring department, the new employer company and the PPP employees into three categories: accrued rights: rights which current employees have already built up in PCSPS; membership rights: rights given to a current employee to accrue pension after transfer to the new employer; and new recruit rights: rights to accrue pension given to an employee recruited by 2
the new company after the PPP starts. Can employees continue as PCSPS active members following the PPP? No. PCSPS participation is restricted to civil servants and employees of organisations funded by grants from Parliament, the Consolidated Fund, the Scottish Consolidated Fund or a fund established by or under an Act of Parliament (see the Superannuation Act 1972, section 1 and schedule 1). This excludes PPPs where staff are not civil servants and funding of the organisation is partly from the private sector. It is, in theory, possible to create a PPP structure where staff remain civil servants. However, civil servant status is not normally appropriate for employees in a PPP because remuneration policy remains subject to public policy considerations for all civil servants. Some of the commercial freedom inherent in a PPP project would be lost. So, in a PPP, once the new employer is partly funded by the private sector it must provide access to its own scheme. If it does not have its own scheme, it will normally need to establish one. What will be the transferring employees membership rights? These will be set out in the documents establishing the PPP. There are minimum levels of accrual under COSP. The department responsible for the PPP needs to ensure that it complies with COSP when its public sector undertaking is transferred. The standard process is to ensure that the contract for the PPP provides specific protection of the employees rights to join a new pension scheme with a minimum level of benefit. However, it could be provided in a separate pensions agreement, or by reference to the governing documents of an existing pension scheme. Under COSP the new scheme must replicate PCSPS benefits at a broadly comparable level for transferring employees. Broad comparability is satisfied by the new employer showing the Government Actuary s Department ( GAD ) that the scheme benefit structure is, overall, materially at least as good as the PCSPS or, in exceptional cases, that employees receive higher pay as a result. Broad comparability is proved by a GAD certificate in respect of a particular transaction or, for the scheme of a company involved in a series of government procurement projects, a passport valid for two years which pre-approves the scheme separately from any particular transaction. For Classic and Premium PCSPS members, broad comparability will normally mean that benefits will be awarded on a final salary (not money purchase) basis. In a two-stage PPP, employees employment transfers prior to private partownership of the new company. In this model, the employees can stay in PCSPS between stages one and two. However, if a two-stage model is preferred, it will normally be advantageous for the company to set up its broadly comparable scheme while under public ownership. That way, pensions can become a minor issue at the stage at which the private investors step in. Note that if a transaction involves members of a local government pension scheme, but is managed by central Government, the COSP must be followed. Where a local government body is transferring services to the private or part-private sector as a best-value arrangement, it must comply with the Local Government Act 2003, sections 101-102, which replaced the two-tier workforce non-legislative guidance. A crucial difference in local government is that the Local Government Pension Scheme Regulations 1997 (as amended in December 2003) permit private sector companies to participate in that funded scheme so that benefits can be replicated. PCSPS, which is unfunded, does not allow private sector participation. Some PPPs have the features of an outsourcing contract in that at a future point the 3
Government department may replace the current private sector partner with a new one. In such contracts, the Government department should provide that at that future change of partner, the new partner will provide a broadly comparable scheme. The TUPE Regulations and pension scheme benefits The TUPE Regulations provide that when a business or similar operation is transferred from one organisation (the old employer) to another (the new employer), the employees in the business have protected employment rights. Rights and obligations of the old employer become rights and obligations of the new employer. There is a pensions exception to the TUPE Regulations but it is limited to benefits payable in old age, for incapacity or following death. The European Court of Justice has set a test for deciding whether a benefit is payable in old age: it is only benefits paid from the time when an employee reaches the end of his normal working life as laid down by the general structure of the pension scheme in question and not benefits such as those [payable on] dismissal for redundancy that can be classified as old-age benefits. Applying that test, the Court ruled that the new employer must replicate most rights to any immediate lump sum and pension on early retirement. It is probably only where early retirement is on the grounds of invalidity (ill health early retirement) that the new employer is not bound. The new employer s obligations will also include additional costs for any enhanced rate of pension on early retirement. The cases heard by the Court concerned employee benefit arrangements in the NHS. In the main civil service, both PCSPS and the Civil Service Compensation Scheme benefits are likely to transfer under the TUPE Regulations. The overall effect will often be materially the same for PPP employees: if the benefit is under the TUPE Regulations then the law requires that it is replicated by the new employer; if the benefit is not under the TUPE Regulations, then COSP requires that it is matched at a broadly comparable level. GAD will normally take the effect of the TUPE Regulations into account and leave such benefits out of the broad comparability analysis. What happens to accrued rights? Accrued rights would not be an issue if the employees were allowed to remain in the PCSPS for the purposes of future pension accrual. However, as has been outlined above, that is not a realistic alternative in a PPP and the new employer will need to establish a new pension scheme for the benefit of the transferring staff. It is therefore necessary to consider what will happen to accrued rights when transferring employees become members of their new employer s pension scheme. Accrued rights are protected at a statutory minimum level, based on the pension earned to the date of the employee leaving the PCSPS. When members leave the PCSPS, including where they must leave when their employer moves outside the civil service, they have a statutory right to a cash lump sum valuation equivalent to their future pension rights. They can take this transfer value into their new employer s scheme or an arrangement with an insurer. PCSPS benefits are based on final salary and a statutory transfer value will almost always buy members less than they would get at retirement for that period of service which they have already completed. There are a number of reasons for this, but the two most obvious are that: the transfer value is based on salary on the date of leaving the scheme instead of the date when the member eventually retires; and the receiving scheme often converts the transfer value into a future pension at a different mathematical basis than that used by PCSPS. To preserve accrued rights more fairly than statutory transfer values, the sponsoring department needs to provide a mechanism in the PPP contract for transferring accrued rights. This should provide for: calculating the value of the bulk transfer out of 4
PCSPS on the Past Service Reserve basis which takes account of future pay rises; and obtaining agreement from the new employer that the receiving scheme will provide like-for-like benefits. If the schemes have the same pension formula (e.g. the PCSPS Classic Section has n/80 x final salary where n is the number of years service) this will be year-for-year, so ten years pre-transfer service is credited as ten years service in the new scheme. Securing that both these two points are covered will be consistent with COSP and GAD s practice when granting a certificate or passport. The normal way to address these transfers is for each party to instruct an actuary to negotiate the assumptions used for calculating the conversion of a future pension into an immediate cash lump sum for transfer out of PCSPS. It should be agreed that the same assumptions will then be used for conversion of that lump sum into pension rights in the receiving scheme so that employees do not lose out. If a two-stage PPP model is used, the actuarial basis for transfers in and the rules for granting service credit can be settled and all the transfers can be effected while the central government department remains in control of the new employer. In an outsourcing-style project where the Government department may be awarding a new future contract to a new partner, the current agreement needs to provide for a bulk transfer agreement when staff leave the current provider for the new one. However, as has been outlined above, that is not a realistic alternative in a PPP and the new employer will need to establish a new pension scheme for the benefit of the transferring staff. It is therefore necessary to consider what will happen to accrued rights when transferring employees become members of their new employer s pension scheme. Accrued rights are protected at a statutory minimum level, based on the pension earned to the date of the employee leaving the PCSPS. When members leave the PCSPS, including where they must leave when their employer moves outside the civil service, they have a statutory right to a cash lump sum valuation equivalent to their future pension rights. They can take this transfer value into their new employer s scheme or an arrangement with an insurer. PCSPS benefits are based on final salary and a statutory transfer value will almost always buy members less than they would get at retirement for that period of service which they have already completed. There are a number of reasons for this, but the two most obvious are that: the transfer value is based on salary on the date of leaving the scheme instead of the date when the member eventually retires; and the receiving scheme often converts the transfer value into a future pension at a different mathematical basis than that used by PCSPS. To preserve accrued rights more fairly than statutory transfer values, the sponsoring department needs to provide a mechanism in the PPP contract for transferring accrued rights. This should provide for: calculating the value of the bulk transfer out of PCSPS on the Past Service Reserve basis which takes account of future pay rises; and obtaining agreement from the new employer that the receiving scheme will provide like-for-like benefits. If the schemes have the same pension formula (e.g. the PCSPS Classic Section has n/80 x final salary where n is the number of years service) this will be year-for-year, so ten years pre-transfer service is credited as ten years service in the new scheme. Securing that both these two points are covered will be consistent with COSP and GAD s practice when granting a certificate or passport. The normal way to address these transfers is for each party to instruct an actuary to negotiate the assumptions used for calculating the conversion of a future pension into an immediate cash lump sum for transfer out of PCSPS. It should be agreed that the same assumptions will then be used for conversion of that lump sum into pension rights in the receiving scheme so that employees do not lose out. If a two-stage PPP model is used, the actuarial basis for transfers in and the rules for 5
granting service credit can be settled and all the transfers can be effected while the central government department remains in control of the new employer. In an outsourcing-style project where the Government department may be awarding a new future contract to a new partner, the current agreement needs to provide for a bulk transfer agreement when staff leave the current provider for the new one. This is often called a second generation transfer. New recruit rights Neither the TUPE Regulations nor government policy provides a benchmark for new recruit rights. In local government outsourcing the public authority can impose a requirement that new recruits are provided with a minimum level of pension. For contracts awarded by central government, the Code of Practice on Workforce Matters requires that the PPP will provide that level of pension for new recruits who work alongside the transferred employees. This minimum can be money purchase with employer contributions of 6% of pay. This level means that new recruits can be on a lower tier of pension accrual than pretransfer recruits, although guidance refers to avoiding a two-tier workforce. The sponsoring department can, if made clear in the tendering exercise, set a higher level for new recruit rightsthere may be commercial difficulties with setting a high minimum level in some PPPs. Additional problems may arise where there is scope for future recruits to be employed in new areas of business which were not possible or feasible while the organisation was under public sector control. Contact Further advice on these issues and any other pensions law questions can be provided by our specialist pensions team, headed by partners Belinda Benney and David Gallagher. The pensions team advises both the public and private sectors on a wide range of pensions law issues. Clients advised by the team include the Cabinet Office, Home Office, Transport for London, Luton Borough Council, HM Treasury, the Metropolitan Police Authority, the Department for Education and Skills and the Foreign and Commonwealth Office and ODPM. Through advice given to Government departments and public bodies, the team is familiar with the types of scheme operated by public sector employers and have a good working relationship with the Government Actuary s Department. 6
Contacts Belinda Benney t: 020 7861 4190 e: belinda.benney@ffw.com David Gallagher t: 020 7861 4349 e: david.gallagher@ffw.com 7
Field Fisher Waterhouse LLP 35 Vine Street London EC3N 2AA t. +44 (0)20 7861 4000 f. +44 (0)20 7488 0084 info@ffw.com www.ffw.com This publication is not a substitute for detailed advice on specific transactions and should not be taken as providing legal advice on any of the topics discussed. Copyright Field Fisher Waterhouse LLP 2007. All rights reserved. Field Fisher Waterhouse LLP is a limited liability partnership registered in England and Wales with registered number OC318472, which is regulated by the Law Society. A list of members and their professional qualifications is available for inspection at its registered office, 35 Vine Street London EC3N 2AA. We use the word partner to refer to a member of Field Fisher Waterhouse LLP, or an employee or consultant with equivalent standing and qualifications.