Closing a defined benefit pension scheme to future accrual can be complex and not without difficulties
In the current economic climate, increasingly employers who sponsor defined benefit schemes are seeking ways to control the spiralling costs of supporting them. In the past many employers have undertaken less extreme liability management exercises such as closing schemes to new members, offering enhanced transfer values, or reducing future pension accrual (rather than ceasing future accrual altogether). The spiralling cost of pensions has now resulted in the closure of schemes to future benefit accrual being the preferred option, and employers with open defined benefit schemes look likely to become a relic of the past.
The proposal to close a scheme to future benefit accrual is often initiated by employers, but implementation may require involvement of others. Typically the consent of the trustees is required. Employers should recognise and be aware of the extent of the trustees’ powers and role in implementing a strategy, and be fully aware of the trustees’ considerations and responsibilities. This may result in detailed discussions/negotiations with trustees, which should be factored into any strategic planning.
Closing to future accrual is not without difficulties, and employers and trustees should take appropriate legal, actuarial and financial advice to ensure that any proposed strategy has a sound basis and will deliver the intended result(s).
If the trustees’ consent is required to cease future accrual, the trustees must of course act in accordance with their trustee duties. One of the primary duties of the trustees is to safeguard benefits already earned under the scheme.
In reaching a decision trustees can consider the employer’s interests. This can of course require the trustees to carefully balance the interests of the employer and scheme beneficiaries.
Typically trustees will wish to be satisfied that the employer’s business reasons for ceasing future accrual are sound (with consideration having been given to alternatives to cessation of accrual), that the proposals are practicable, and that legal obligations will not be breached. Much will depend on the actual circumstances of the employer and the scheme, including any enhancement of the security of benefits already accrued in terms of the employer’s proposals.
A preliminary issue to be resolved is how cessation of accrual is to be achieved. In some schemes their governing documents may contain an express power that would allow the employer or the trustees to stop future benefit accrual without triggering the winding up of the scheme and any statutory debt (calculated on a buyout basis) becoming due by the employer(s).
If there is no express power, ceasing accrual may be achieved by using the scheme’s amendment power. Rarely will the employer have the unilateral power to amend a scheme’s provisions, and in most cases the consent of the trustees is required. The employer will require to adopt a strategy to achieve this and in doing so will need to recognise the trustees’ responsibilities and considerations, as discussed above.
If exercising the amendment power to cease future benefit accrual, close attention must be paid to the terms of any restrictions imposed on the way in which the amendment power may be exercised, and on the nature and extent of the changes which may be made. Depending on the wording of the amendment power, employers may find that it is not possible to break the “final salary” link in calculation of benefit for those who continue in service after a scheme is closed to future “pensionable service”.
An alternative strategy to achieve the same end (which can be used whether or not there is a restrictive amendment power) might be by amending contracts of employment. Altering contracts of employment is not without its difficulties, and detailed legal advice should be sought before embarking on this route.
Section 67 of the Pensions Act 1995 prevents amendments being made which would or might adversely affect any entitlement or accrued rights of members unless prescribed requirements are met (including member consent in certain cases).
Under the Pensions Act 2004 and related legislation, employers are under a statutory obligation to consult active and prospective members on proposals to close a scheme to future benefit accrual. Consultation must take place in a prescribed way before any decision (or series of decisions) to cease accrual is taken.
Contracts of employment of active members should be reviewed in order to ascertain what pension provisions they contain and whether those provisions would prevent cessation of future benefit accrual. Legal advice should be obtained if changes to contracts of employment are required.
Closing schemes to future pension accrual can contain liability and reduce risk if tackled correctly. Careful project management and appropriate advice being taken at the outset are essential if that is to be achieved.
Colin Crocker, legal executive, Pensions, Biggart Baillie LLP