It has been noted over the last decade or so that an increasing number of final-salary schemes have been closed to new members, closed to further accruals or wound up. In the latter case, this has been as a result of the financial failure of the sponsoring employer or because a financially healthy company is no longer willing to continue with the scheme due to the increasing financial demands of funding or the time and effort required.
It is important that we distinguish between the meanings of the terminology I have used even in the first couple of paragraphs.
First, many people are unaware that there is a massive difference between a closed and a wound-up defined-benefit scheme. In very simple terms, a scheme which is closed – whether to new members or to new accrued benefits – continues to exist as an entity with a sponsoring employer, fund, trustees and members. Some members will be receiving benefits from the scheme while others will not yet have reached the scheme’s retirement age.
I would suggest that one of the most important issues to clarify in this respect is that closed defined-benefit schemes can continue to exist only where the sponsoring employer is still in existence.
Where a scheme has been wound up, there is no sponsoring employer – either because a solvent employer has decided to wind up the scheme up or the sponsoring company has ceased to exist – no fund, no trustees and no members, whether active or retired. The scheme, to misquote a Monty Python sketch, has ceased to exist. It is dead. It is an ex-scheme.
By the time the scheme has been wound up, every former member must have been paid off or bought out in one way or another.
What does this distinction in terminology mean to clients whose schemes are already, are about to become or might at some later stage become closed or wound up?
I would like to deal with wound-up schemes before looking at closed schemes, as I would suggest that the latter are much easier to explain and understand.
When a scheme is wound up, it is of no further interest to former members or their financial advisers. The pension benefits of its members have all been transferred out. It cannot be assumed that previous members have lost out on the transfer deal, which will usually have been transacted without their consent or approval, but they probably will not be very happy and will often have been transferred to a replacement pension which will not be appropriate to their requirements.
Advisers must forget the scheme the benefits came from. We must now look at the promises our clients have been made, almost always by an insurance company. Look at the financial situation with a cold heart. These people may well have lost a large part of their promised benefits as a result of the wind up of their scheme but that is now done and dusted. We cannot turn back the clock. Instead, we must concentrate on the current state of affairs.
In short (and I am certain that I will now get complaints from a couple of pension providers), the pension promise to which the client will have been transferred – usually without his or her consent – will be inflexible. The age at which benefits may start to be taken and penalties for deviation from this age, the funds in which they are invested and potential for investment performance (almost invariably the fund will be low or no risk) and the structure of benefits before and at retirement with regard to the provision of a spouse’s or dependent’s pension are all set.
Even though the client’s benefits have been built up within a final-salary scheme, the adviser must forget about all the promises previously made after the scheme has been wound up. He must instead consider whether an alternative arrangement – most likely a personal pension – is preferable to the benefits promised by the replacement. In my firm’s experience, transfer propositions under these circumstances are usually positive.
For advisers perhaps a little less familiar with the process of analysing preserved pension benefits, please do not assume that pension schemes are only being wound up where the sponsoring employer falls into liquidation. Many companies whose schemes have been wound up over the last few years remain financially solvent. In this respect – and as a prelude to my next article, looking at schemes which are closed to new members as opposed to being wound up – I will note a little bit of very recent pension history and even more recent actuarial news.
It is now almost invariably more expensive for solvent sponsoring employers to wind up their defined-benefit scheme without the expressed permission of each of the members. There have been an increasing number of schemes which have started to offer enhanced transfer values to members – usually for a restricted period of time – to a level which, when properly assessed with a transfer value analysis program, makes a transfer seem attractive.
This might seem an expensive course of action to the uninitiated but, believe me, when properly advised and assessed, it can be preferable to the employer than raising the scheme’s funding level up to the stage that it may be wound up. Thus, the employer “wins” for every scheme member tempted to transfer away from the scheme under the enhanced terms although the member can perhaps consider himself a “winner” by gaining the availability of a transfer value sometimes significantly in excess of the accepted actuarial value.
The aware pension adviser can also “win” by identifying this opportunity for an increasing number of clients.
There has recently been some disquiet about this trend, as enhanced transfer values for early leavers reduce the solvency of the scheme for remaining members, at least actuarially, and could lead to more claims against the Pension Protection Fund. Thus, members who do not accept this enhancement (or bribe) could lose out not only on the increased transfer value but also, at the end of the day, on reduced benefits if the PPF is called upon.
See my next article for more detail. It is a tremendous opportunity to add value to many clients’ financial planning.