Unrest
is rife in the pensions market as company pots run dry and contributors are
left with less than they expected. Communication with pensioners is the key if
changes to schemes are planned. Â Christopher
Mordue and Susan Thomas-Green report
Reports
of employers changing or withdrawing from final salary schemes have become
commonplace, provoking controversy and industrial relations unrest.
At
a time of increasing scrutiny of executive pay, stock market volatility and
concern about adequate pension prevision, employees and unions are increasingly
hostile in their opposition to the withdrawal of such valuable benefits.
Many
compelling forces are driving employers away from final salary schemes:
significant pensions deficits, higher ongoing costs, changes to accounting
requirements and changing employment patterns. While the impetus for change
is strong, the process of amending or terminating final salary schemes
demands the careful navigation of a range of difficult legal issues.
The
employer’s options
Many
employers initially consider simply closing the scheme to new entrants. This
seems an easy option as existing employees are not affected and the legal
issues are straightforward. However, this is rarely enough to solve any
funding problems. Any deficit in the scheme will relate to the benefits
members have already earned – these cannot be taken away without individual
member consent.
Further,
unless there is a high level of employee turnover, the effect of future cost
savings can be slow to show as contributions will continue for all existing
employees. Unions oppose scheme closures as the thin end of the wedge and
because over time, they create a two-tier workforce. In many cases, employers
do not reap the expected benefits and a few years later are forced to take more
drastic action.
Winding-up
the scheme is the most extreme step. This is usually to be avoided for
schemes in deficit since, on winding-up, any deficit has to be made good by the
employer. Before 12 June 2002, this deficit was calculated on a basis laid
down by the Government that did not provide enough money for schemes to secure
all the benefits in full – even though, with the falls in equity markets over
the past few years, many employers found themselves in deficit on this basis.
On
11 June the Government announced immediate changes so that any solvent employer
winding-up its scheme has to put in enough money to provide all benefits by
buying annuities and insurance policies to guarantee payment.
The
sums involved are immense. In practice, winding-up a pension scheme is no
longer an option except for a company on the brink of insolvency. In this
situation, the pension scheme trustees may be able to accept an amount that is
less than they are owed but is more than they would get if the company became
insolvent – this is known as a Bradstock compromise after the first company
that publicly announced it had done this.
The
practical options facing employers are to freeze the scheme – no more benefits
are earned, but it is not wound-up – or to make changes to the benefits and
member contributions to reduce the company’s funding burden.
Changing
the pension scheme
Advance
planning is key to making a success of these options. Employers must not
just look at the contractual relationship with employees (see below) but
also at the terms of the pension scheme trust deeds and rules.
This
will set out what powers the employer has under the scheme and whether the
trustees’ consent is needed or even, in rare cases, that of the individual
employees.
Working
with the trustees can be very important. The terms of the scheme may
prevent them from agreeing the employer’s initial proposals or the trustees may
be unwilling or reluctant to agree.
It
is important to remember that trustees, unlike company directors, have personal
liability to the pension scheme members and their actions are often excluded
from the company’s directors’ and officers’ insurance policy.
Trustees
will often have conflicts of interest, being both pension scheme members and
directors or senior managers. To avoid risks of members later challenging
the changes, it is important to either ensure that the trustees have separate,
independent advisers or change the trustees so that those running the change
project for their employer are not also approving it as trustees. This can
be done by bringing in an external independent trustee or by appointing new
trustees from in the company.
Another
complication is that the trustees must look after the interests of all the
members of the scheme not just employees. While employees have an interest
in the company’s survival, this will not always be important to pensioners and
former employees with preserved benefits. If the employer’s proposals would
harm the funds held for these members, the trustees may have no choice but to
resist the employer’s proposals.
Discussing
proposals with the trustees at an early stage when there is still scope to
alter them is the best way to minimise potential problems.
If
the trustees are opposed to the employer’s proposals they have a number of
weapons in their armoury. These range from making their own announcements to
members, applying to court to stop the employer or even, depending on the
scheme’s rules, threatening to wind-up the scheme completely so as to impose a
substantial debt burden on the employer.
It
is vital for a successful change project to consider at an early stage what the
trust deed allows the employer and trustees to do and what the attitude of the
trustees will be.
It
is also important to focus on what the future pension provisions for employees
are to be after any change and what the impact will be on the benefits members
have already earned. Some employers offer members a choice – pay a higher
contribution or earn lower benefits. But this can be expensive in
administration terms and raises problems as to what to do with those who refuse
or fail to select an option. For most employers, it is easier to apply the
chosen option to all employees once a decision has been made.
Employment
law considerations
Employers
contemplating changes to pension provision for existing employees must also
consider how these affect the contract of employment. The ideal position is for
the employer to establish a clear contractual discretion to amend or withdraw
the scheme, either as an express term of the contract or through incorporation
(often via a scheme booklet) of the powers of amendment and termination in the
trust deed and rules.
In
these cases, the employer’s actions would be consistent with the contract of
employment, there would be no legal requirement for the employees to agree the
variation and no legal issue of dismissal or collective consultation would
arise.
This
assumes, however, a clarity in the contractual documentation that is often
impossible to realise. Very often the waters are muddied by missing or unsigned
documentation, badly drafted contracts and booklets, ambiguous or contradictory
statements in offer letters and staff handbooks, and the typical lack of
uniformity in employment contracts at any one time across group companies,
sites and business units.
Employers
must consider all of these factors when assessing whether they have a clear
contractual right to move away from final salary schemes.
If
this clear contractual right is absent, the process of change involves a
variation in terms and conditions of employment. It is naïve to expect that all
employees will voluntarily give up their final salary pension rights –
variation by consent is typically impossible to achieve and the employer must assume
that the process will involve termination of the existing contractual rights
and re-engagement on new terms and conditions.
This
process of change will trigger the obligation to consult in respect of
collective redundancies under s188 Trade Union and Labour Relations
(Consolidation) Act 1992. This appears counter-intuitive because the employer
is not reducing its headcount. However, redundancy for these purposes has a
much wider scope, meaning any dismissal (ie contract termination) that is not
for a reason relating to the individual employee.
The
duty to consult requires the provision of information on the reasons for and
detail of the employer’s proposal and consultation before a firm decision is
made with a view to reaching agreement on ways and means of avoiding the
dismissals, reducing their numbers and mitigating the effects of the
dismissals.
The
employer must consult trade union representatives in respect of categories of employee
covered by trade union recognition. For employees not covered, consultation
should be with employee representatives. Detailed statutory rules govern the
election of employee representatives. The consultation obligation is an
important area of risk in the change project, as breach can result in a
protective award of up to 90 days pay per employee (there is no maximum amount
of a weeks pay for these purposes) and the award is based on the extent of the
employer’s breach and not on any financial loss.
Even
if there is the contractual flexibility to change the scheme, the impact of the
change will demand that consultation takes place. An employer that simply makes
the change risks serious damage to employee relations and industrial unrest.
The
employer will hope that the process of consultation results in employees
agreeing to the change. If not, the only way forward is to terminate the
existing arrangements on full contractual notice. This may trigger unfair
dismissal liabilities, so the employer will have to be able to show a
compelling business case for changing the pension scheme – to establish some
other substantial reason for the change – and that a fair procedure involving
individual consultation has taken place.
The
process of employee consultation must also be carefully choreographed with
obtaining approval from the trustees. There is no point in damaging employee
relations through a controversial proposal if the trustees ultimately reject
it. Equally, seeking trustees’ consent
without commencing some form of information and consultation makes it difficult
to be seen to be undertaking genuine consultation at a later stage. The two
processes will have to run in parallel, with the trustees’ consent being sought
in principle subject to the outcome of employee consultation.
Summary
The
key to a successful process of change is communication with the workforce and
genuine consultation, even if this is not strictly required. Employers will
need to develop and communicate a convincing reason for their actions, spelling
out the reasons why the change cannot be avoided. It will also be important to
identify and explain the impact of the change on each individual employee and
the benefits they would receive under the replacement scheme.
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And
employers should try to avoid own goals in terms of disputes over boardroom pay
or excessive severance payments that will only fan the flames of controversy
and increase the risk of serious industrial unrest.
Christopher
Mordue is a partner in the employment group at Pinsents. Susan
Thomas-Green is a partner in the pensions group at Pinsents
