Running down a final salary pension scheme - expert Q&A

Q Are employers obliged to give reasons for closing a final salary scheme?

A No, although the case for harmonious workplace relations would suggest that this is good practice. This is especially true where a trade union is recognised and becomes involved in the issue. In most cases, it will be apparent to members that financial considerations are driving the decision-making process.

Q How should staff be informed?

A Members must be informed in writing about changes affecting their schemes, and timescales for the changes must be laid down. There is also a requirement for two months’ consultation with employees when any significant change to a scheme is proposed. The Pensions Act 2004 requires that employers must consult if a prescribed decision is to be made regarding an occupational scheme. Also, The Occupational and Personal Pension Schemes (Consultation by Employers and Miscellaneous Amendment) Regulations 2006 set out a list of the changes including raising normal pension age, closing a scheme to new members, switching to a defined contribution scheme, or increasing members’ contributions.

Q Must there be a consultation period?

A A consultation period of at least 60 days must be allowed after affected members have received written notification of the proposed/intended changes. But, if a change is required as a result of statutory provisions, then consultation is not required. A further level of consultation applies where the scheme is contracted out. Wind-up of the scheme will necessarily result in the surrender of the contracting out certificate.

Q How should trustees be informed?

A The employer must give notice to trustees, members and recognised trade unions, three months prior to the surrender of the contracting out certificate.

Only one month’s notice is required if there is no recognised trade union or if it agrees to the changes.

Q Can incentives be offered to get members to transfer out of a DFB scheme?

A A recent trend has emerged for under-funded schemes to offer ‘incentives’ to members (deferred or otherwise) to transfer benefits away from the scheme. These incentives have taken the form of cash payments to transferring members – which will attract income tax/national insurance liabilities – or enhanced transfer values, where members are offered an enhancement to the cash equivalent value of the benefits they hold in the under-funded scheme.

Q What levels of closure can be considered?

A There are several levels of closure or alternatives to full closure of a scheme. These include:

Move to career average earnings
Change the scheme accrual rate
Close to future accrual
Close to new members
Increase retirement age
Ask the members to contribute more

The employer could even consider increasing its own contribution.

Q What continuing obligations will there be on employers once a scheme is closed?

A The Occupational Pension Schemes (winding up and deficiency on winding up etc. (Amendment)) Regulations 2004 requires members’ benefits to be bought out in full if the employer is not insolvent at the start of the wind up. Some schemes will close as a result of merger / acquisition activity. Members of schemes affected in this way have some statutory protection. Staff acquired as a result of TUPE have protection via the Transfer of Employment (Pension Protection) Regulations 2005 made under the Pensions Act 2004. They must be given pension benefits if they were:

Active members of a scheme to which the former employer contributed; or
Eligible to become active members of such a scheme; or
Would have become eligible members of such a scheme after a longer period of employment.

Q What particular issues must be confronted when closing a final salary pension scheme?

A The effect on employee relations should be considered. The closure of such a scheme could result in a significant level of disengagement and all the problems that could result. If the employer is a significant company, then brand issues could follow as the closure will undoubtedly be deemed newsworthy. This is unlikely to be an issue for most employers, however.

The biggest issue, in my view,is that of funding. Most schemes are in deficit. The recent turmoil in equity markets, fall in bond yields and increasing longevity among the UK population, means that the position for most schemes will be deteriorating rather than improving. A scheme may not wind up without being fully funded on a buy-out basis and for a scheme in deficit to reach such a point, it is likely to require a (relatively) massive financial commitment from the sponsoring employer. A financially robust employer might consider this commitment. However, most will want to consider alternatives to full closure as outlined above.

Q What legal recourse might members who are unhappy about a closure have in challenging it?

A Members who are unhappy may have recourse via the courts, but it is likely that robustly drafted contracts and terms and conditions of employment will offer the employer sufficient protection against this. The involvement of a trade union could help the employee in trying to negotiate a more satisfactory outcome. While many employers will undoubtedly be taking advantage of the current economic situation to investigate the closure of their scheme, so too will many be looking at ways in which they can continue to participate in their employees’ financial future, without jeopardising, their own.

Paul Rodgers is an employee benefits consultant in the Financial Services Division of The Wilson Organisation.