Why your corporate DB pension liabilities may not be what you thought – and why it’s worth knowing.
The liabilities in a defined benefit occupational pension scheme are regularly valued and reported on by employer and trustees, but they are rarely subject to any probing audit. When latent issues come to light, the pension liabilities can prove to be significantly higher – or lower – than expected. This matters to members and survivors who may not be receiving the right benefit. It also matters to a corporate wanting to move towards settling its liabilities, and it can mean unmanaged changes in accounting disclosures and cash contributions.
“Our actuaries and auditors know what they’re doing”
There is a legal angle here too; it’s clear from experience and from published court cases that many reputable schemes have found that their benefts are understated. Here are some of the reasons:
Admin departs from the scheme’s rules
It is not uncommon to fnd that administrative practices have grown up which are not in line with the scheme’s governing documentation. The risk factors seem to include:
- Older-established schemes, for example, dating from the 1970s or before.
- Complex schemes with many employers and probably past scheme mergers.
- Changes of administrator.
If the rules or data relating to earlier generations of leavers have been lost it may be hard to establish the correct position.
Scheme rules themselves are wrong or invalid
The rules may not ref lect the benets that the employer or trustees think they are providing:
- Schemes often got it wrong when equalising retirement ages for men and women, and some so-called “Barber windows” were not properly closed until much later than all parties thought.
- Drafting mistakes: pension scheme rules are complicated and there can be misunderstandings, errors or ambiguities.
- Technical defects.
The recent case of Briggs v Gleeds illustrates the danger of technical defects. The legal requirements about how Partnerships execute deeds changed in 1990 and this led to a series of about 30 deeds being invalidly executed. This was bad news for the employer, which thought it had reduced benefits closed to future accrual and introduced a new defined contribution section. Essentially, the scheme’s history was rewritten: some members gained windfall benefts and others are at risk of losing their pension. The employer didn’t lose on every point but whatever happens, it is going to face heavy unexpected contributions.
“Are you always this cheerful?”
Well, it does all go both ways; liabilities can be overstated as well, for example:
- Present, past and future pension increases are often valued as entitlements when they are not.
- Survivor benefts may be subject to conditions that haven’t been applied.
- Auditing the original calculations at retirement can show systemic errors.
Most employers would want to avoid clawing back past overpayments, but they might want to reinstate the correct pension going forwards, and they would probably want to approach future increases as discretionary if they are entitled to do so.
“This sounds like the proverbial can of worms, why would anyone want to open it?”
The issues tend to come to light in one of three situations:
- A member dispute.
- Drafting a new set of rules (though this is likely to f lush out only patent errors and not data problems).
- In the flight path to winding-up
The first two situations are reactive but the third is more positive. An employer may be willing to pay a significant top-up contribution to settle its pension liabilities by transferring them to the insurance market, by a bulk annuity purchase. Securing pensions in full is generally a good outcome for members and it can be good for shareholders too so it’s a possible “win-win” situation. It may be worth doing some “vendor due diligence” by way of preparation. Firming up on the benefts payable from the scheme may increase or reduce the capital value of the known liabilities, but at least there can be a real clean break – and it is likely also to have a materially beneficial effect on pricing.