With persistent defined benefit pension scheme deficits and volatile assets and liabilities, sponsoring employers continue to search for ways to manage their exposure to funding their schemes.
Many employers have already taken action to address these issues, but there may still be further steps that can be taken to improve the funding position of their schemes.
Aside from the injection of further cash, there is a wide range of ways of reducing the funding deficits of defined benefit pension schemes by liability management.
One of the most common ways liabilities can be managed is by closure to future benefit accrual. This will limit the scheme’s liabilities and its risk exposure to benefits accrued before the date of closure.
In addition, employers will no longer have to meet the cost of future defined benefit accrual for existing active members.
Although some other form of pension provision will have to be made for these members (not least because of auto-enrolment requirements), the cost of future benefit accrual may be significantly reduced, although care must be taken to price in revaluation costs.
The way in which closure can be achieved depends on the drafting of the scheme’s rules.
The rules may allow an employer to effect the closure unilaterally or, alternatively, the rules may need to be amended in accordance with the scheme’s power of amendment.
The power of amendment may require the consent of the scheme’s trustees and may be subject to other restrictions, such as a requirement to maintain the link between service accrued up to the date of closure and each member’s salary while they remain employed by the employer.
Restrictions may also be imposed (albeit less commonly) by the members’ contracts of employment and consultation with employees will be required, subject to the employer having 50 or more employees (whether or not they are affected by the closure).
This is a complex area, but several options (including those described above) are open to employers who wish to achieve this.
However, care should be taken that the closure does not inadvertently trigger the termination of the scheme and the payment of the employer’s section 75 liabilities.
Further complications may arise from recent case law (in particular, the IBM case). Following this, in carrying out any necessary consultation, employers must be open with their employees about the reasons for the proposed closure and must consider employee responses in good faith.
Changing the benefit structure
If the scheme is still open to future benefit accrual, an alternative way to reduce future service liabilities would be to change the basis on which members continue to accrue benefits.
Whether this is to provide future service benefits on a defined contribution basis or a change to a different defined benefit basis (for example, at a reduced rate of accrual or on a career average salary basis), it is likely that the change will have to be made by exercising the scheme’s power of amendment.