CONSIDERATIONS FOR TRUSTEES
As widely reported, there are controversial proposals for the States of Guernsey’s final salary scheme to be replaced with a cheaper alternative. This reflects a trend over the last decade that has seen the number of final salary workplace pension schemes in the UK and the Channel Islands fall dramatically, as employers close generous, gold-plated final salary schemes and move to defined contribution or money purchase schemes. AXA and DHL also hit the headlines in 2013 when it emerged that they were to begin consultation on closing their final salary schemes.
The reasons an employer may seek to close its final salary scheme are many but factors that play a big part are poor fund performance, low gilt yields and increased life expectancy that all make final salary schemes expensive to run.
Reference to ‘closing’ a final salary scheme is typically a reference to either closing the scheme to new members with new employees being eligible to join a defined contribution scheme or closure of the scheme to future accrual of benefits.
A great many of final salary schemes have already closed to new members, with it being reported that Royal Dutch Shell was the last FTSE 100 company to close its scheme to new members in 2012. Once a scheme is closed to new members it is arguably only a matter of time before an employer looks to close the scheme to future accrual of benefits or move to a cheaper alternative.
Closing a final salary scheme to future accrual of benefits means that on retirement a member is likely to have a poorer retirement than the member would otherwise have had because on retirement a member’s pension will typically be calculated according to their length of service until the closure date (and not their actual leaving date) and usually by reference to their salary at the closure date.
Every pension scheme is different so in order to close a scheme to future accrual, as well as giving careful thought to any contractual rights the members have under their employment contracts or under the general law, careful consideration also needs to be given to the scheme documentation. In a great many of cases the employer will wish to obtain (or may need) the scheme’s trustees’ consent to move forward to close the scheme to future accrual of benefits.
In considering whether to consent to a proposal to close the scheme to future accrual the trustees must carefully consider their role and obligations as trustees of the scheme in connection with the proposal, including:
Conflicts of interest
An important issue that should be addressed at the outset is whether there may be any conflicts of interest. Where (as can be common), key individuals have management level authority both of the employer and the scheme’s corporate trustee, it is critical that potential conflicts of interests are managed appropriately to ensure decisions made by the corporate trustee in relation to the scheme which enhance the employer’s position are not susceptible to challenge. In some, where conflicts are simply unmanageable, it may be necessary for the trustees of the scheme to be replaced with independent trustees.
The power to agree to the proposed closure will almost always be a fiduciary power which means that it must be exercised by the trustees in good faith, in the best interests of the scheme members, taking into account relevant considerations and excluding irrelevant considerations, and for a proper purpose.
It is important to note that the interests of the employer are not relevant considerations for the trustees except to the extent that what is in the interests of the employer is also in the interests of the members.
To protect themselves from assertions by members that the trustees have not fulfilled their fiduciary duties the trustees should independently scrutinise proposals put to them by the employer. This means ensuring that the trustees fully understand the reasons for the proposal to close the scheme to future accrual and satisfying themselves that there is a robust business case for the closure. The trustees should also ensure they understand the impact on the members and satisfy themselves that all other alternatives have been explored and discounted for good reason.
Security and funding of past service benefits
The trustees should recognise that overtime there may be an increasingly small number and eventually no active employees of the employer who have benefits accrued in the scheme and therefore the relationship between the employer, the trustees and the scheme members will change. In addition, unlike the UK, there is no legislative protection for pensions in Guernsey or Jersey which means that there are no statutory obligations for employers to continue to support final salary schemes when such schemes are closed to future accrual. With these factors in mind, the trustees should seek to ensure that all past service benefits are fully protected over the scheme’s remaining lifetime.
If there is no legally binding obligation under the rules of the scheme for the employer to continue to fund the scheme going forwards, as a condition of the trustees’ agreement to the closure, the trustees may seek to put in place a long term, legally binding commitment from the employer to ensure that funding is available throughout the life of the scheme, to cover all potential future funding requirements, including ‘top ups’ as and when required pursuant to actuarial advice and expenses of the scheme being met by the employer.
Thought to the strength of the employer’s ability to fund future deficits in the scheme’s assets should also be given and if necessary the trustees should seek to put in place more robust arrangements such as a legally, binding agreement supported by contingent assets put forward by the employer and / or a guarantee from the employer’s parent.
Thought should also be given to what safeguards could be put in place in the event of the employer’s future insolvency. In the UK statutory provisions apply in the event of an Employer’s insolvency that provides a level of comfort for the members that the employer’s obligations will be met. The UK’s Pension Protection Fund, which is the UK government’s safety net for final salary scheme members, also provides UK members with additional comfort in the event of the employer’s insolvency. Guernsey and Jersey do not have these safeguards which mean that it is important for trustees to try to put in place the best possible protections for past service benefits as they can.
It would not be unusual for additional incentivisation to be offered to scheme members to transfer from a final salary scheme to a defined contribution scheme. For example the employer may agree to improve the contributions it will make to the employer’s defined contribution scheme for the members.
While there may not be an absolute ‘industry standard’ when final salary schemes are closed as to what might be reasonable in respect of future benefits the trustees should try to negotiate the best deal they can for the members and if necessary engage the services of a firm that offer pension advisory services who may be able to provide some objective indication of what might be a reasonable expectation.
Consequences of failing to consent
The Trustees should be clear what stance the employer will take if the trustees fail to consent to the closure. An employer may unilaterally have the ability to cause the scheme to be wound up, although this is often seen as a heavy-handed approach which the employer will probably want to avoid. However, if the trustees do not agree to the closure, it is a route to closure that the employer may be prepared to take with the result that past service benefits may not be protected.
If the closure of the scheme to future accrual proceeds the trustees should carry out a review of the scheme’s investment strategy to ascertain if a more prudent strategy should be adopted, in order to reduce volatility in the funding position. A significant change in the investment strategy could in turn impact on the actuarial valuation of the scheme as so the level of funding required to meet benefits goings forward.
With the absence of any legislative protection in Guernsey and Jersey, trustees often play a vital part in negotiating the best deal possible for scheme members if an employer is intent on closing its final salary scheme. In order to satisfy their fiduciary obligations trustees should understand their role and obligations in this respect, which may include doing their utmost to secure the best protections and deal for the members that they can.