How is it best to manage the cost of the TPS?

All education providers who are members of the Teachers Pension Scheme (TPS) have good cause to be concerned about the increasing costs of the employer contribution, particularly as it is likely to increase further in 2024.

For many education providers it is unavoidable. Independent schools, however, are “accepted schools” under the TPS regulations and therefore can choose to leave the TPS is they wish to – and many have.

Such is the Government’s concern of the impact a mass exodus of independent schools from the TPS might have on the financial strain of the TPS and on teachers within the independent school sector, that it is currently consulting on draft regulations that will allow the phased withdrawal of independent schools from the TPS. Under the draft regulations existing teacher members of the TPS in an independent school could remain in the TPS whilst teachers not in the TPS at the time that the school changed its status would not be enrolled.

For more information see: Government response to initial consultation and consultation of the draft regulations.

Many independent schools have sought to leave the TPS while there are no exit charges applied by the TPS on doing. Reassuringly, the Government’s response to the initial consultation confirms that should the implementation of exit charges be considered in the future, all interested parties, including independent schools, would be consulted. So any change to introduce such charges shouldn’t be immediate. Nonetheless, the strong possibility of further increases to the employer contribution in 2024 looms large over the sector, and most governing bodies are reviewing their options.

One option is to leave the TPS. This will require extensive consultation with employees to satisfy both employment and pension law. The fallout in terms of industrial action and possibly unfair dismissal claims should not be underestimated, particularly their impact in terms of cost, disruption and management time. The implications leaving the TPS may have on the school’s ability to attract and retain staff should also be considered.

Option two, would be to wait for the introduction of the proposed draft TPS regulations. However, this may be sometime away and the savings that they may provide, certainly in the short term, may be insufficient against the impact a rise in employer contributions in 2024 may have on the school’s employment costs.

Option three is to consider the hybrid approach, whereby the school remains in the TPS and all teachers can continue to be members but with the cost of any future rises in the employer contribution being shouldered, in part or entirely, by the teacher. To provide further information about this option we have invited Peter Norman of First Actuarial to provide his insight on the hybrid approach.

The hybrid approach – a ‘best of both’ pension strategy for schools?

Given the challenging economic backdrop, it appears TPS costs are likely to rise again in 2024. Whilst independent schools reluctantly absorbed the contribution increase from 16.48% to 23.68% in 2019, a further increase is likely to be unsustainable for many schools.

Over 200 independent schools have already exited the TPS, forcing their teachers into a defined contribution (DC) scheme. Whilst well-funded DC schemes can provide decent retirement outcomes, we are seeing increased interest from schools in a ‘third way’ that doesn’t force teachers out of the TPS – the hybrid approach.

What is a hybrid approach?

A hybrid approach is all about choice for teachers and cost control for schools. A hybrid solution typically gives teachers two or more options, such as:

• staying in the TPS, but with the school capping its cost (typically achieved through reducing teacher salaries); or
• moving to a DC scheme – with either the same or increased teacher salary in return for a given level of pension contributions from the school.

Under a hybrid approach, a school would typically decide a target level of cost (for example, a pension contribution of 20% of payroll) then design a pension strategy where each option resulted in the same overall cost of employing that teacher to the school For example, a teacher willing to give up pay could receive a higher level of pension contribution (and vice versa).

If designed properly, a school should be indifferent as to what pension option the teacher chooses – the cost to the school is fully under control and always the same. A solution that gives cost control to schools and flexibility to teachers may sound too good to be true. So what’s the catch? We suggest there are 3Cs to consider.

Contracts

It’s likely your teachers’ contracts allow them to take part in the TPS indefinitely. The problem for schools is your liability is effectively uncapped – schools are told what to pay into TPS and, no surprises, school contributions have been on the rise for some time.

To adopt a hybrid approach, teachers will likely need to sign contract variations which cap the cost to the school. This is more complicated than meets the eye as a contract variation would need to:

• set out the pension options, calibrated to a target cost today; and
• allow a school to ‘pass through’ any future contribution rises to teachers who wish to remain in the TPS, typically via a salary reduction.

Consultation

Any proposed change to contracts requires consultation under employment law. And whilst a hybrid strategy has many desirable features, it’s more complicated to explain to teachers.

For this reason, a well-designed consultation program is critical. Schools need to put together a well-expressed business case for change, to win the hearts and minds of its teachers. And many schools will want to support its teachers in making a complex pensions choice, for example – through pension education and modelling sessions.

Cost

A hybrid strategy is likely to require more legal and consultancy advice upfront, which may result in higher installation costs. However, once implemented, a hybrid strategy should thereafter largely look after itself.

When should I consider my options?

One school of thought (pardon the pun) is to wait until the next contribution adjustments are announced, expected to be in late 2023 (for early 2024 implementation).

However, experience has shown that pension change exercises take time; there is likely to be insufficient react time to install a new pension strategy during the window between announcement of contribution changes and the first increase date.

Schools can instead review and decide their pension strategy now – either provisionally or definitively. If a hybrid approach is preferred, consultation and contract changes could happen before the next round of TPS contribution increases are announced. A hybrid approach is about agreeing a framework for fixing the school’s cost – so that if and when contribution increases are announced, the pension options available to teachers change in a pre-determined way. In our view, the 2021/22 academic year would be an ideal time to consult on a hybrid strategy, to insulate a school against likely future increases in cost.

What should I do next?

A school requires expert legal and consultancy advice to review, consult upon and implement any pension strategy.

First Actuarial has significant experience of advising independent schools on pension matters, and in particular, recently helped a large independent school implement a hybrid strategy on which we worked with Tom Sharpe, Legal Director at Birketts who advised on and assisted the school with the employment law aspects of the proposal, in terms of the contractual changes proposed and the necessary employment consultation.

The content of this article is for general information only and you should seek specific advice before taking any steps to change your current pension arrangements.

If you would like to speak to First Actuarial to discuss the hybrid approach further please get in touch with Peter Norman, or if you would like to speak to a member of the Birketts’ Education Team please contact Tom Sharpe.