Pensions for those Stepping Out of the Public Sector

Pensions are on my mind at the moment. Partly because mine is worth only marginally more than what I have paid into it these last fifteen years - but also because I am working with a number of potential social enterprises which are about to `step out' of the public sector.

For some of these pensions are a big headache. There are several public sector schemes and all work a bit differently but all have three things in common. One is that they are `defined benefit' - meaning what you get is a proportion of your final salary linked to inflation. The second is that the employer (the state) contributes up to 20% of the employees' salary - much more than is normal in other sectors now (0-6% is fairly common). The third is that most schemes are in deficit - meaning that the payouts are not covered by those paying in. The bill for this is picked up by HM Treasury and total unfunded liabilities were, on 31st March 2008, estimated at 770 billion pounds.

So what's the relevance of all this for the divestment of public services to social enterprises and the third sector? Well, if the Government insists, as HM Treasury's `Fair Deal' Guidance states now, that former public sector workers are offered a `broadly comparable' pension, we have a potential show-stopper on our hands. To take on these commitments, at minimum, creates a huge current and future obligation the third sector.

Indeed I spoke recently to one third sector CEO who had recently been presented with a bill from the LA Pension Scheme for 360k for FOUR employees the charity had taken on from the public sector a few years earlier under arrangements that allowed them to remain in their original pension scheme. The bill reflected a deficit in those four employees' pension built up over the whole of their employment with the LA, not just the three or so years with their new employer. The deficit had, in effect, been dumped on the charity. Just imagine the damage this causes to, say a medium-sized charity. And this is aside from the resentment felt by those employees without deals like this which are often worth, in effect, 40% of salary.

So put yourself in the shoes of a charity today looking at taking on state services faced with a local authority insisting you took on responsibility for funding staff pensions. You'd effectively be taking on employees on terms and conditions, and with accrued liabilities that the LA itself didn't have to fund (because HM Treasury picked up the tab) so probably didn't even have on its books. Successfully obtaining `Full Cost Recovery' in those sort of situations is hard to envisage.

Which is why the third sector and new social enterprise have to read the small print on pension deals, even if the public sector is offering enhanced payments as part of the deal, as they are with many of the new health spin-outs. These are fine - as long as the money keeps coming. Should the taps ever turn off, one is, as an organisation, left with the job of funding the scheme. And what the deal says about long-term liabilities is absolutely critical.

The white-knight in the case of all of this is, we all hope, Lord John Hutton. His forthcoming review of pensions is a one-off opportunity to deal with the imbalance between public section pensions and the rest. Most observers are confident that Hutton will raise the employee contribution as a minimum. But it is still unclear whether he will recommend the abolition of `Fair Deal' which would liberate social enterprises and third sector orgs to take new employees out of the public sector scheme and put them in a money-purchase scheme immediately - for pensions are not covered by TUPE rules.

Neither is it clear whether Hutton will reduce the contribution from employers or insist that new public sector employees cannot join defined-benefit schemes. Or that all public sector pensions are brought back into some semblance of fiscal balance by reducing the overall benefits paid. This might require legislation and it is unclear at the moment whether the Government will want to go this far.

The minimum, I believe, is that `Fair Deal' should go. This will allow social enterprise and third sector organisations to pay pensions to new public sector employees at their existing charity levels (normally about 6% compared to the forthcoming 2012 legal minimum of 3%) and without generating future liabilities. It will also mean that all employees are on a similar deal, which is better for workforce morale. Former public sector employees will still be on a slighly better deal than existing staff - as TUPE means that more favourable conditions around sick pay and so on will automatically transfer. But the really OTT differences created by the pensions gap will be eliminated.

There will be people reading this who have reached understandings with public sector bodies for staff coming out to stay in the old pension scheme under `approved provider' arrangements. This will often be underpinned by a short to medium term committment from commissioners to meet the costs of the pension scheme current and future. But this is only useful for as long as commissioners can afford to pay. Once this ceases to become the case, whatever the legalities, it automatically becomes your problem too. Better, I believe, we avoid that by seeking to get people coming out of the public sector onto money-purchase schemes as soon as they leave state employment.

Let's hope Hutton's review allows this to happen.