Employment law clinic: Closing a final salary pension scheme

The Challenge: A company needs to cut costs and the managing director thinks
the final salary pension scheme is a soft target. He recognises the legal
complications and industrial relations risks of winding up the scheme but
thinks there will be no problem in closing it to new members. Gareth Brahams,
partner in the employment department at Lewis Silkin considers whether he is

Final salary pension schemes typically cost 12 per cent of annual salary per
employee, whereas the figure for money purchase schemes is 6 per cent. For
employees, they are an excellent, but rarely appreciated, benefit. For
employers, the cost is high and unpredictable and the schemes carry a significant
administrative burden.

Unsurprisingly, the managing director is not alone in wishing to close the
scheme to new members. Of 970 schemes in the National Association of Pension
Funds’ Annual Survey (published in December 2002) 84 were closed to new members
in 2002.

Legal issues

For new recruits, the position under contract law is straightforward. An
employer is free (subject to constraints such as the National Minimum Wage Act
and the Working Time Regulations) to offer employment on any terms that a
prospective employee will accept.

However, employers may face claims under the Equal Pay Act as they may be
offering a benefit containing an apparently neutral requirement (to be eligible
for scheme membership, staff must be employed on a particular date) which has a
disparate impact on the sexes. This will most likely arise in occupations
traditionally dominated by one gender that are increasingly becoming more

In future years, questions will be raised under age discrimination laws
which must be implemented in the UK by December 2006. In almost any workforce,
newer hires will be younger than the longer-serving employees.

In either case, the determining question will be whether employers can
establish an objective justification defence. While it is possible to think up
justification arguments, the result of such litigation is far from predictable
– especially as the age discrimination laws have not yet been drafted.

Existing employees who have not yet joined the scheme but may wish to do so
pose a more difficult problem. In particular, trustees are obliged to notify
eligible staff of proposed changes to the scheme. Moreover, existing employees
are likely to regard the opportunity to join the pension scheme as a
contractual right (even though the true status of such an expectation varies
according to the circumstances and has not yet been fully legally tested). If
that opportunity is lost, they may claim for breach of contract or even resign
and claim constructive dismissal.

The primary defence would be that the option to join the scheme was not a
contractual right and/or the right was given up on notification of the change.

Employees would also be faced with a difficulty in quantifying their loss.
If an employee has not yet joined, the employer may argue that he or she would
never have joined and has therefore suffered no loss. This argument would be
particularly persuasive if the employee had been warned of closure but had
still failed to join. In any case, if a money purchase alternative is offered,
the true loss will only be determinable on the employee’s retirement. Depending
upon market performance there may be no loss at all.

What the HR manager should do

First, HR managers should highlight the risks identified above. If the
managing director has a change of heart, perhaps the company should launch a
campaign explaining just how generous it is being by offering scheme

If the MD resolves to proceed, HR managers should give as much advance
warning as possible, to protect the company from claims from non-member
employees. This should clearly state the rationale for the change, as the
document may need to be relied upon to defend future equal pay or age
discrimination claims. If future pensions provision is to be by way of group personal
pension schemes, HR managers should ensure that the advantages they have over
occupational schemes (such as. their portability and relative security in
insolvency) are emphasised.

To re-work the statistic used at the start of this article, the cost of
providing a final salary scheme could fund an expansion in the labour force by
an eighth. If the company is generous enough to continue funding such a scheme,
it should shout about it from the rooftops.

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