closing
pension schemes – some hazards
by
Roderick Ramage, solicitor, www.law-office.co.uk
first
distributed to professional associates by letter 27 December 2002, revised 3
July 2003 and 3 February 2006
published
(with minor alterations) in New Law Journal 1 August 2003
DISCLAIMER
This article is not advice to any
person and may not be taken as a definitive statement of the law in general or
in any particular case. The author does not accept any responsibility for
anything that any person does or does not do as a result of reading it.
Closing a final salary pension
scheme may result in employers facing greater expense than they had
expected. Although this has been so
since the minimum funding requirement (MFR) was introduced, the issue became
acute only more recently with increasing funding problems affecting final
salary schemes. The draft regulations
laid before Parliament on 11 June 2003, while intended to improve the lot of
members (particularly those not yet in receipt of pension), has made the
position even worse for employers with final salary schemes. This note deals first with the general issues
of closing scheme and closes with a post script about the impact of the new
regulations.
There are commonly two forms of
closure, closing a scheme to new members and closing a scheme for the accrual
of future benefits. This note discusses
the latter, is no more than a simplified outline and must not be taken as
advice in any individual case.
What the employer might hope for is
that at a fixed date both it and the employees cease to pay contributions to
the scheme and no period after that date is taken into account in calculating
benefits. At the same time both start to
pay contributions to a stakeholder or some other money purchase pension scheme
and sometime soon something will be done to deal with the members’ accrued
rights, such as transferring them to the new scheme, so that the old scheme can
be brought to an end with no further expense.
It might happen like this, but a combination of poor funding and typical
trust deeds and rules generally results in something rather more complex with a
financial sting in the tail.
It is rare that an employer has the
power to close its pension scheme without triggering a winding-up. Typically it can close a scheme only by
giving notice to the trustees to discontinue its contributions, and, again
typically, the consequence of that notice is to pass effective control of the
scheme to the trustees, who, to the exclusion of the employer, will then have
the power to decide whether to wind-up the scheme immediately or to defer its
winding-up. It is in the winding-up that
there can be traps for the unwary, and so the planning of a scheme’s closure
needs to start with a review of the likely outcome of the winding-up process,
the main elements of which are:
1
the members in active service become
deferred members, in the same class as those who had left previously without
becoming pensioners;
2
the trustees realise (and maximise)
the scheme’s assets; and
3
to the extent that the assets are
sufficient and members do not transfer to other schemes, the trustees secure
members’ benefits by the purchase of annuities, immediate for pensioners and
deferred for the other members.
In addition, apart from any financial considerations, there are two other key consequences of the start of the winding-up of a pension scheme:
4
in the absence of an express
provision, the scheme’s deed and rules cannot be altered; and
5
if there is an MFR shortfall, which
while a scheme is ongoing can be discharged over a number of years in
accordance with a schedule of contributions, that shortfall becomes a debt on
the employer payable as a lump sum on demand.
The risk of creating a debt on the
employer may of itself affect the employer’s decision to close the scheme, but
the timing of the establishment of the debt may exacerbate the problem by
either increasing the amount of the debt or creating a debt where none existed
previously. Under s75 of the Pensions
Act 1995, the debt on the employer for an MFR shortfall is ascertained at the
first to occur of three possible times (the 1st preceding the
winding-up of the scheme and the 2nd and 3rd being the
“applicable time” after the start of the winding-up of the scheme):
1
immediately before the employer goes
into liquidation or, if an individual, bankruptcy (an “insolvency event”);
2
immediately before an insolvency
event in relation to the employer; or
3
if there is no such insolvency
event, any time, which may be determined by the trustees.
It is in the third case that the
determination of the applicable time can be crucial. If at an early stage in the winding-up the
trustees fix the applicable time and ascertain either the amount of the debt on
the employer or that there is no MFR shortfall and no such debt, they would
then recover the debt, if any, realise the scheme’s assets and secure the
members’ benefits as far as the funds permit.
If the scheme’s assets are insufficient to secure members’ benefits in
full, the order of priority in which they are secured is set out under the
Pension Act 1995, overriding any priorities in the trust deed and rules. The priority clause or rules normally
states expressly that, benefits may be reduced or abated, but this does not
necessarily limit members’ benefits to the available assets or release the employer
from further liability to contribute to the scheme if the following alternative
is applicable.
There is an alternative timetable,
which the trustees may be required to follow in order to maximise the funds
they can obtain to secure members’ benefits.
They should consider first securing members’ benefits as far as possible
by applying all the available funds in the purchase of annuities and deferred
annuities and only then fixing the applicable time and instructing the actuary
to prepare an MRF valuation. The scheme
would then have no assets but would have members whose benefits have been only
partly secured, and it is almost certain that there will be an MFR shortfall
and a debt on the employer, even if at the start of the winding up there had
been no such shortfall. If there had
been an MFR shortfall at the start, the amount of it is likely to be increased
at this stage.
The trustees, some or all of whom
may have conflicts of interest as directors or senior employees of the
employer, risk personal liability, if they fail to consider and if appropriate
take the alternative course of action and if, as a result, an aggrieved member,
whose benefits are less than they might have been, makes a successful complaint
to the Pensions Ombudsman against the trustees alleging maladministration on
their part.
This set of problems has been
altered by Occupational Pension Schemes (Winding Up and Deficiency on Winding
Up etc) (Amendment) Regulations 2004, SI 2004/403 (which were in draft when
this article was written). The draft
with proposals for other measures were published by the Government on 11 June
2003 (and may be regarded as the UK pensions 6/11). These regulations came into force and apply
to all schemes which begin to wind-up on or after 11 June 2003. The main effect is that, where the employer
is not insolvent and for the purpose of calculating the debt on the employer,
the liability for members not in receipt of pension is to be calculated on the
basis of the cost of buying deferred annuity contracts instead of the old and
relatively weak MFR basis.
The cost of purchasing annuities is
very much higher than the cost of satisfying the MFR on the pre-6/11
basis. The cost of satisfying the MFR
has caused the insolvency of some employers and it may be expected that more
businesses will be at risk of insolvency as a result of this measure. Three likely consequences flow from the new
regulations. The first is that it may
become crucial to establish when the wind up starts: ie whether of not the winding-up started before 11 June 2003. The second is that employers considering
winding-up their final salary schemes may, if they are able to do so, choose
instead to continue the scheme on a closed basis. The third is that, if the cost of annuity
basis applies, the date for fixing the debt on the employer may be less
important than under the pre-6/11 rules.
Whether an employer will be able to
continue the scheme on a closed basis.
will depend in on both the terms of the trust deed and rules and
regulation 2 of the Occupational Pension Schemes (Winding Up) Regulations (SI
1996/3126). Where (a) the Regulations do
not fix the date of the start of the winding up and (b), as is common, closing
the scheme for future pension accrual passes effective control of the scheme to
the trustees, any proposal to run the scheme on a closed basis may necessitate
a negotiation with the trustees and possible some enhancement of members’
rights and a consideration for trustees agreeing to a change in the deed and
rules or a postponement of the winding up.
Solutions or partial solutions may
be available in individual cases, but in all cases careful planning and
anticipation of the risks are necessary to avoid unbudgeted costs and unwanted
conflicts between employers and trustees.
PS (03/02/06)
The perceived loophole, through
which companies participating in multi-employer scheme could “escape” with no
more liability than the MFR debt, has been closed: see my article on this site about
multi-employer schemes.
copyright Roderick Ramage
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