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Closing time

Closure has a ring of finality about it. Closing something implies that you have finished with it and that you are now moving on. But in the world of pensions though closure often means something fundamentally different.

A recent survey conducted by Hazell Carr of small to medium-size enterprises with defined-benefit pension schemes found that 25 per cent had made the decision to close their scheme in the next 12 months. Leave to one side for a minute the surprising finding that one in four companies which have had schemes for many years have suddenly decided they can no longer support them. The further interesting discovery is that only 3 per cent of these schemes were to be wound up.

The frequent reaction by companies when faced with a defined-benefit scheme that they feel is no longer appropriate for them is to close it. Unlike the usual use of this word, this does not mean the end of the scheme. It usually means that no new members are to be admitted.

The scheme continues and may continue to grow for a further 20 or 30 years. Even if closed to future service (a less common form of closure), it may continue to grow for 10 to 15 years. In both cases, the issues that probably led to the original decision to close the scheme are still there. Closure has not addressed those issues.

In some ways, this approach introduces many further concerns such as having to run two schemes side by side (defined benefit and defined contribution) with the concomitant increase in costs and management time required.

Companies are also likely to end up with obvious inequity between staff on different benefit packages.

Importantly, though, they are still exposed to potentially higher costs through lower investment returns, rising lifespans or an increased regulatory burden.

What is the alternative?

Winding up a scheme does bring an end to it and does resolve those issues which led to the decision to close in the first place. But let us recognise that this is not a simple option. Winding up a scheme is complex but it is not impossible.

In our survey, we found that 47 per cent of those questioned felt it was not practical to wind up their scheme. Of the reasons cited, the most common was the negative reaction of staff. This reaction is well illustrated by the difficulties experienced recently by Ernst & Young, the Big Food Group and Caparo.

But dig a little deeper. Many of the companies surveyed ran a defined-contribution scheme alongside their defined-benefit scheme. In 74 per cent of cases, the contributions to the defined-contribution scheme were less than the standard contribution rate to the defined-benefit scheme (that is, the rate needed to buy benefits without adjustment for surplus or deficit in the fund).

This demonstrates the confusion of two objectives when altering pension arrangements for staff. Two common concerns for employers are that pension costs are too high and that they will get higher.

Indeed, 65 per cent of those questioned expected their contribution rate to rise at the next valuation and this survey was conducted before the most recent falls in equity markets.

Closing a defined-benefit scheme is about trying to contain future costs and control the risks that an employer may face. Reducing the current cost of pension benefits is a separate exercise. Perhaps it is not surprising that many employers take the opportunity to address both issues together when closing their defined-benefit scheme. But this is likely to be one of the biggest causes of staff dissatisfaction in resolving pension scheme arrangements.

Reducing current pension costs is a separate exercise and, if necessary, needs to be addressed by the employer with staff in an up-front manner and considered in the context of overall compensation.

Employers which confuse the two issues run the risk of not solving those issues associated with their defined-benefit scheme and potentially of misrepresenting the replacement scheme.

Decisions on the defined-benefit scheme should boil down to the form in which pensions are provided. Yes it is true that there is a transfer of risk to employees in respect of investment returns and life expectancy.

On the other hand, though, for employees likely to change company several times through their career a well funded defined-contribution arrangement could be superior. These arguments are well rehearsed within the pension industry.

Companies which avoid the issue in the short term will still have to face up to it at some point and waiting could make the pain much worse.

For some companies, the failure to address the problems of their defined-benefit scheme could be fatal. That would bring closure – but of employees&#39 jobs.

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