Defined benefits schemes: closing them to future accruals

Defined benefit pension schemes have been hitting the headlines again. A survey of employers published by the National Association of Pension Funds in October 2008 found that:

  • 21% are considering a switch to defined contribution
  • 10% may take steps to reduce costs or risks;
  • one in five is likely to level benefits down.

A number of issues will have influenced these decisions, but cost, increased risk and volatility are the usual primary factors. Falls in the stock market and reduced returns on assets have contributed to increased scheme deficits. Faced with the need to maintain a strong business and the pension scheme at a time when resources are limited, employers are considering whether to reduce the level of benefits provided, or to close schemes to future benefit accrual. How can these changes be achieved?

Scheme documents and section 67 of the Pensions Act 1995

The starting point is to check the scheme rules. Terms will vary and some employers may find that they can make changes unilaterally using powers set out in the rules. For others, it may be necessary to make amendments. Amendment powers are worded in a number of different ways, but the key points to check are:

  • Do the trustees have a role to play? Is the amendment power in their hands or are they required to consent?
  • Are there any other conditions that must be complied with? For example, do changes need to be made by deed, or can they be made by resolution or announcement? Satisfying requirements of this sort is important as failure to do so is likely to mean that amendments will not be valid.
  • Is the power of amendment wide or limited? Some protect existing entitlements and benefit terms – which in some cases extends to future terms.

Section 67 protects the benefits members have earned up until the amendment date. The legislation ensures that active members are no worse off after the date of the change than they would have been had they left service and become deferred members at that date. In practice, this means that benefits will need to be revalued in line with statutory and scheme requirements when schemes are closed to future accrual.

An alternative route is to think about making the changes in accordance with or by varying the members’ contractual employment terms. This approach can be particularly useful where the amendment power is restrictive or difficult to operate, or where the trustees are unlikely to agree to amend the rules. If the change is achieved contractually, there is case law that supports the view that trustees are obliged to amend the rules to align the scheme documents with the new terms of employment.

Employers will also need to decide what the pension benefits for future service are to be. A number of factors will be relevant here, including your goals in terms of cost and risk management and maintaining a competitive benefits package that will enable staff to be retained and recruited.

Closing schemes to future accrual and other “listed changes” will trigger the statutory consultation requirements, unless you have fewer than 50 staff. This means that you will need to:

  • Tell members about the proposed changes
  • Provide opportunities for them to ask questions
  • Respond to points that are raised.

At the end of the consultation process, the employer must tell members whether the proposal is to be implemented in the form that they have been told about, or in a modified form. The consultation period must be at least 60 days.

Consultation

At present, there are no penalties for failing to consult. However, not doing so, or a flawed consultation process, could mean that the trustees will not be able to sign a deed of amendment documenting the changes. In addition, it has been proposed that the Pensions Regulator be given the power to impose fines if consultation is not effected properly.

Employers will also need to ensure all of the implications of plans are understood. It is always worth checking the winding-up rule to ensure that closure to future accrual will not trigger winding-up and result in an immediate call on the employer to fund the scheme to buy-out level. Winding-up may be on the cards in the longer term, but employers are likely to prefer to plan ahead for this. Funding and investment strategy should also be considered, as benefit changes – and in particular, closure to future accrual – could lead the trustees to change their approach. Employers may wish to include points relating to funding and investment in their proposals.

Practical points

Addressing the practical issues when changing a pension scheme goes hand in hand with dealing with the legal points and both should be factored into employers’ plans.

Work out why change is needed. Is it driven by cost, risk, volatility, or all three? This is key to deciding what to change and to explaining your case to members, unions and trustees.

Ensure that the business need for change is understood. If you are concerned about making sensitive information available, you may wish to put confidentiality agreements in place.

Carry out a due diligence exercise on members’ contracts and documents. If members’ contracts state that they are entitled to specific pension benefits, their contractual terms will need to be changed.

Work to a realistic timetable that allows time to review options, take advice, consult, communicate changes and implement new arrangements. The timetable should also allow the trustees and unions time to consider the proposals and take advice.

Be prepared to listen. Consultation can provide valuable feedback and may help to improve proposals.

Helen Baker, associate, Sacker & Partners

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