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Final countdown – Keith Popplewell

In this series of articles, I am identifying and discussing recent and impending developments in various aspects of pensions. Leading on from my last article, I am now considering issues relating to financial protection for sch-eme members of final-salary wind-ups.

I have reviewed some of the well known disasters in recent years in which members have lost some or all of their promised benefits and categorised the measures which Governments have taken or are about to take:1: Scheme funding requirements.2: Transfers of undertakings (where employees and, in effect, their pension rights, are transferred from one emp-loyer to another).3: The priorities of various categories of members on a scheme wind-up.4: The forthcoming pension protection fund.

In my last article, I concentrated on changes to sch-eme funding requirements and the likely implications of these changes, not only on the schemes themselves but also on their members, noting a number of issues which should be borne in mind by advisers, for example, the effect of these developments on pension transfer advice.

In this article, I will conclude my discussion of funding requirements by briefly looking at the changes made a year ago to actuarial guidance note GN9 (funding def-ined benefits – actuarial reports) and then move on to developments in transfers of undertakings.

As I mentioned last week, in calculating and stating a final-salary scheme’s solvency situation, the actuary now has to assume that the scheme is to be wound up on the date of the valuation, a requirement which significantly increases the scheme’s funding level.

This requirement was, in fact, introduced by the most recent version of GN9 which further requires the actuary to estimate and declare the affect of any solvency level lower than 100 per cent on different categories of benefit.

For example, they must state separately the approximate level of reduction in benefits for pensions in payment (that is, retired scheme members) and for active and def-erred scheme members.

This requirement should be of particular interest to scheme members, of course, but also to advisers considering the possible merits or otherwise of a pension transfer for a deferred scheme member (that is, an early leaver).

It must be remembered, though, that the statement only shows the likely reduction in benefits on the assumption that the scheme is immediately wound up, with no further contributions from the employer.

Additional funding req-uirements (as I discussed in my last article) would imp-rove this notional situation on the assumption that, of course, the employer rem-ains in business, Courts furniture stores being the most recent high-profile example of where this assumption has not applied.

On the other hand, the solvency position could worsen if the scheme’s assets fall in value faster than the additional contributions were to improve the position. Pension advisers should consider these scheme statements not only in mathematical isolation but also by considering the financial stability of the emp-loyer and the asset allocation of the scheme.

Moving on to transfers of undertakings, these apply where companies merge or in a company takeover or where, as in recent years’ examples within local authorities, emp-loyees are transferred from a council’s employer to a separate legal identity.

In the past, where any of these events have happened, the level of pension scheme rights of the employees of at least one of the employers involved have been jeopardised. As an example, emp-loyees in a company which has been taken over might have been active members of a final-salary scheme but, following the takeover, have this scheme paid up (massively reducing the value of their existing benefits) before joining the new employer’s (possibly money-purchase) scheme with, perhaps, far lower value in future accruals. Indeed, in some cases, the “transferred employees” were not even granted access to a pension scheme with the new employer.

The Pensions Act includes provisions to protect the pension rights of employees in these situations by requiring the new employer to grant such employees the right to accrue future pension benefits with the new emp-loyer’s scheme.

This might, on first reading, appear to represent a major development for these members but you should note that there is no requirement for the new scheme to represent anywhere near the same level of value to members that these employees enjoyed bef-ore, simply that they must be given access to a scheme of some description.

Explanatory notes to the act give guidance as to minimum requirements of the new employer’s scheme but a number of pension observers have commented that these are ambiguous in certain resp-ects and could, indeed, prove unworkable.

In any event, the act certainly does not require final-salary members with the previous employer to be granted membership of a final-salary scheme with the new emp-loyer. How could it?.

Previously “active” final-salary scheme members now become deferred members of that scheme which, in most cases (that is, unless there are still some active employees and members of the previous employer), will then become a closed scheme or – I would suggest more likely – be wound up altogether. Again, surely this is another area in which advisers should become active.

The third issue listed for consideration at the start of this article is the protection for various categories of pension scheme members where a final-salary scheme is wound up. This is perhaps the pension issue which has provoked the greatest amount of public uproar in the last few years, as I discussed in my last article and mentioned briefly again a little earlier, with a number of high-profile wind-ups leading to a great loss of benefits to employees. Maersk and ASW spring immediately to mind although Maersk subsequently – and very commendably – made up these losses.

Most important, regulations issued a year ago which require a solvent employer to make up the full cost of securing the promised benefits where a scheme is wound up. This might sound obvious but the previous position was that, in simple terms, a scheme could be wound up if it could be shown to be fully funded.

This requirement used the funding requirements which have recently been replaced, as I discussed in my last article, meaning that, again in general terms, sch-eme members’ benefits could be bought out on an “early-leaver” basis.

It can be seen, especially by combining our discussion of these two issues, that the cost of winding up a scheme has been significantly inc-reased with, consequently, higher benefits for members.

This is a huge development, with particular implications, once again, for pension transfer advisers who legitimately in the past have brought to the attention of clients in appropriately und-erfunded schemes their possible loss in the event of the scheme being wound up.

The possibility of such a loss is now significantly red-uced but, importantly, it must be noted and remembered that these regulations only apply where the emp-loyer is solvent. If the emp-loyer is in liquidation (“gone bust”, in common parlance) there is clearly no possibility of requiring it to address the underfunding.

For example, ASW emp-loyees would not have been helped by either the higher funding requirements or these new winding-up regul-ations as not only was the scheme massively underfunded but also the employer had gone bust.

So, this leaves employees in an ASW-type situation still exposed to the financial dem-ise of their employer, leading to my last issue listed at the start of this article – the pension protection fund.

Before discussing the PPF – in my next article, I will conclude my winding-up summary by briefly noting the changed priorities of various categories of employee, where a scheme is unable to meet all its liabilities.

Fundamentally, it is still the case that greatest priority is given to pensions already in payment (that is, they will get a bigger proportion of their benefits than non-pensioners) but fairly recent fundamental changes increase the proportion of benefit to non-pensioners in general and to younger members in particular.

In short, non-pensioners are less worse off than had previously been the case. Moving on to the PPF in my next article, I will examine protection for the people I have just described who would have lost out on the winding up of their scheme.

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