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Covid-19 – deferring employer contributions to the LGPS
Estimated reading time: 6 minutes
It is understandable that, in these challenging times, where we are all getting used to working and living differently, pension costs may not be at the top of the list of financial priorities. However, there have been a few concerns raised by employers in our funds.
These concerns relate to meeting employer contributions and deferring payment for a short period of time until business and income streams get back to something more stable. It is likely more employers will raise these concerns if lockdown continues for longer.
There are some important matters to consider about the impact that Covid-19 may have on the payment of employee and employer contributions to the Pension Fund. This blog sets out further considerations for Local Government Pension Scheme (LGPS) funds.
Deferring LGPS employer contributions
The LGPS Regulations state that total contributions due for the year, as set out in the rates and adjustments certificate, must be received by the appropriate year end. This means that if the administering authority agrees that an employer may defer contributions for a short time, then a higher amount of contributions will need to be paid each month, following the deferred period, to ensure the total certified amount is paid by 31 March. It is not a contribution holiday!
The default position for administering authorities should still be that employer contributions be made monthly, in line with the rates and adjustments certificate. However, Covid-19 will have caused employers financial difficulties in some cases. If an employer was late in paying contributions, the fund would usually report this as a breach and – depending on the severity of the breach – they may inform the Pensions Regulator (TPR).
However, TPR issued a statement on 20 March 2020 that it does not intend to use its regulatory powers in respect of either late reporting or failure to make contributions over the three months following the statement.
Therefore, there is likely to be an increase in requests from employers to defer their contribution payments.
Transaction costs are higher in most assets – especially credit assets – at the moment and so this will need to be considered.
Considering deferral requests
If the administering authority does receive a request then they should have a policy in place for considering these requests to ensure a consistent approach to employers and to protect the fund (and the other participating employers) against unnecessary financial risk.
We suggest that such a policy to these requests could include the following:
- Business case – request an evidence based business case from the employer to support how Covid-19 has impacted them and their sector
- Ongoing concern – assess the strength of covenant and whether they will be able to make higher contributions later in the year and how this deferment will help them
- Security – does the employer have a guarantee in place or some other form of security? If not, is it worth requesting alternative forms of security?
- Materiality – consider the materiality of any deferment. For mature, well-funded employers this is likely to be less material than immature, poorly funded employers
- Period – keep the deferred period as short as possible; i.e. a maximum of three months and then review again
- Timing – could the employer pay a lower amount now rather than nothing and have less of a step up later in the year? For example, could they pay the primary rate but not the secondary rate?
- Advice – refer to the fund actuary to get advice on any implications, as appropriate
- Communication – make sure any agreement has been documented and the employer is aware of future obligations and increased contributions
- Interest – should any delayed payments be subject to interest and at what rate
Together with employer contributions, there are some other considerations, as detailed below.
We understand that employee contributions must continue to be paid to the Fund and cannot be deferred, although potentially the level of contributions may reduce due to employees receiving lower pay as the pensionable pay definition includes all wages. This is set out in the Pensions Act 1995.
There is also some ambiguity over whether an employee’s contribution banding should reduce due to the reduction in pay. For example, if an employee is furloughed and receives 80% of pay so that pay reduces from, say, £25,000 to £20,000 then the contribution band would reduce from 6.5% to 5.8%. The Regulations are not clear as to whether furlough, where the employer and employee may have agreed a period of absence, would mean this reduction is applied. This is not surprising, given the current circumstances are unprecedented and the Regulations would certainly not have been written to cover this.
Given the member’s benefit will be based on lower pay, to ensure consistency and fairness, it would be reasonable to expect the employee’s contribution band would also reduce. This is certainly the view of the Local Government Association (LGA) and this is covered in their Q&A – see the link below.
Transaction costs are higher in most assets – especially credit assets – at the moment and so this will need to be considered.
If a number of employers choose to defer their contribution payments, this will start to affect the level of cashflows previously anticipated to be paid into the Fund. This could therefore lead to difficulties if a Fund relies on those cashflows to make pension payments, for example. If insufficient cash is paid into the Fund this may lead to cashflow problems and possibly the need to disinvest at an inopportune time.
The deadline to finalise the English and Welsh LGPS valuations was 31 March 2020, which was in the early days of the crisis in the UK. There was therefore not enough time to review employer contributions payable from 1 April 2020 which had all been agreed. Therefore, the 2019 valuations themselves were largely unaffected.
Going forwards, funds may expect the fund actuary to take into account the impact on the investment markets of Covid-19 and how this would affect the employer funding positions since 31 March 2019 and the resulting employer contributions, especially those employers who are approaching cessation from the Fund.
Fortunately, the strong investment performance over the first ten or eleven months since 31 March 2019 and the reduction in long-term inflation expectations means that funding levels may not have reduced materially over the twelve month period to 31 March 2020. So for many employers, contributions may be at similar levels to those certified, although this will vary by Fund and employer.
Our funding model is designed to withstand short term volatility, as a result of the built in smoothing mechanism. However, we will be reviewing the inputs for any funding updates as at 31 March 2020 to ensure they are still appropriate for the long-term funding objectives of each fund.
Further information
The LGA has produced a Q&A that will be regularly updated and which attempts to answer these and other questions arising at this unprecedented time.
We would encourage administering authorities to have a deferred employer contribution policy in place to deal with these requests in a fair and consistent manner.
If you would like any help preparing a communication to employers or have any questions, please get in touch with your usual Barnett Waddingham contact to find out how we can support you. Alternatively, please contact me below.
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