Legal Q&A: Pension scheme closures

In recent years, many companies have closed their final salary/defined benefit pension schemes either to new members, or altogether. It’s likely this trend will accelerate during the current economic downturn. So what are the legal issues for employers to consider?

Q If an employer is considering closing its final salary pension scheme to current employees, where should its thinking start on legal issues?

A The first question is: how will the change be implemented from the legal perspective? Employers should review affected employees’ contracts of employment to ascertain what, if any, changes need to be made. Where contracts make clear that pension terms can be changed by the employer, this will make the planned closure easier to implement. However, a route to change terms and conditions will need to be developed if contracts refer to membership of the current scheme.

Q What about the rules of the pension scheme – where do they come into play?

A The rules of the scheme are likely to need amending in order to close it to current active members. So the employer will need to check who has the power to make changes. It is very common for the scheme’s trustees to have joint control with the employer of the scheme’s amendment power. It will, therefore, be critical to focus on how the employer will obtain the agreement of the trustees to implementing the change. But some schemes’ rules are written in a way that prohibits the trustees from agreeing to changes to future service benefits. It may be possible to work around this, however, by implementing the closure by amending affected employees’ employment contracts or requiring employees to opt out of the scheme.

Q What should employers consider to get the pension scheme trustees on board for a proposed closure?

A Generally, it is for employers to decide what pension provision they offer (or don’t offer) their employees. However, if the trustees’ agreement is needed to exercise the scheme’s amendment power, they will need to be convinced of a reason why they should give it. The employer will need to articulate a sound business reason why it is looking to close the scheme to existing members. But employers can draw comfort from the fact that the trustees’ primary duty is to protect the interests of benefits that have already accrued – rather than to negotiate the continued provision of final salary benefits. The scheme’s trustees are also likely to focus on the long-term funding of the scheme when implementing a closure. With no active members, the scheme will be left with just deferred and pensioner members.

Q Does the employer need to consult with affected employees?

A There are pension-specific consultation obligations for employers closing a pension scheme to future accrual. These apply to all employers with more than 50 employees. The employer must consult with affected employees, or their representatives, for a period of at least 60 days. The consultation process is started by the employer who has to provide written information about the change and its effect, indicating the timescales for implementation. There is no statutory definition of what consultation actually involves. In practice, the employer should consider the responses received before making its decision about the closure – though this will not prevent the employer from pushing its plans through.

Q Do all affected staff need to be consulted?

A The parties to be consulted will vary depending on the employer’s organisation. Where arrangements for consultation already exist, such as with information and consultation representatives or trade unions, the employer should use those arrangements to carry out the pension-specific consultation. Even if the employer does not have any pre-existing arrangements, the pensions legislation allows for the election of representatives. The employer should ensure that the consultation process covers the interests of all affected staff.

Q Are there any other pension hazards?

A There are many potentially knotty issues out there. But the main one is to ensure that closing the scheme does not trigger an immediate cash call on the employer. This can happen if the closure triggers the winding up of the scheme. It could also happen if the scheme has a number of employers participating in it, but the closure does not happen at exactly the same time for all of their employees. The immediate cash call can be huge – the full cost of securing all of the scheme’s liabilities with an insurance company, known as the ‘buy-out’ debt.

Robin Simmons, partner at pensions specialist law firm, Sackers

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