Introduction

The Department for Work and Pensions (DWP) is conducting a consultation on proposed amendments to the Occupational Pension Schemes (Employer Debt) Regulations 2005 S.I. 2005/678 (the Employer Debt Regulations) which apply to final salary (defined benefit) schemes. The suggested changes are set out in the draft Occupational Pension Schemes (Employer Debt)(Amendment) and Pension Protection Fund (Multi-employer and Entry Rules)(Amendment) Regulations 2007 (the Amending Regulations). The consultation period runs until 1 October 2007. The intended implementation date is December 2007 and the changes will affect events taking place on or after the date they come into force.

The DWP states that the intention of the proposed changes is to make the Employer Debt Regulations easier to operate and more flexible and to provide better protection for scheme members, but whether this aim is achieved is debatable.

The current position - triggering of the statutory debt on the employer

Under the current Employer Debt Regulations, a debt is triggered under section 75 of the Pensions Act 1995 (a Section 75 Debt) in certain specific circumstances, including where an occupational pension scheme starts winding-up or where a sponsoring employer enters insolvency. The Section 75 Debt is calculated on the “buy-out” basis, which is the cost of buying annuity policies to secure all the benefits under the scheme.

In addition, a Section 75 Debt arises, in a multi-employer scheme only, when an “employment-cessation event” occurs. Under the current Employer Debt Regulations, an employment-cessation event occurs where an employer ceases to employ active members at a time when at least one other employer continues to do so.

Employment-cessation events can therefore occur, triggering a Section 75 Debt, in circumstances such as those outlined below:

  • on a sale of all the shares in a participating employer company resulting in a cessation of that company’s participation in the scheme;
  • where the last active member employed by a participating company retires or dies;
  • on a business sale where there is a TUPE transfer and the retained company no longer employs any active scheme members; and
  • where, as a result of a group re-organisation and the internal transfer of employees from one company to another, a company in the group is left employing no active members of the scheme.

However, the current Employer Debt Regulations do permit all the participating employers in a multi-employer scheme to cease participation in the scheme simultaneously without triggering a Section 75 Debt. This is what would typically happen when a scheme is closed for future accrual of benefits.

What are the main proposed changes in the Amending Regulations?

The principal amendments made by the Amending Regulations to the Employer Debt Regulations are in relation to the following:

  • employment-cessation event - the definition of employment-cessation event is amended and will include the situation where all employers simultaneously cease to employ active members;
  • money purchase (defined contribution) benefits - there will be an exclusion from the definition of employer under the Employer Debt Regulations for employers whose sole liabilities relate only to money purchase benefits; and
  • 5 ways of dealing with the Section 75 Debt - these will be: calculating a cessation employer’s liability share of the deficit; putting in place an updated version of the existing approved withdrawal arrangement; or agreeing one of the new form of exit arrangements, namely a scheme apportionment arrangement, a regulated apportionment arrangement or a cessation agreement.

What do the changes mean for employers and trustees?

Employment-cessation event

The term “employment-cessation event” will include an express reference to ceasing to employ active members of the scheme. There is a 12 month period of grace where an employer who no longer employs active members will be permitted to notify the trustees that it intends to employ at least one active member during that period. The triggering of the Section 75 Debt would then be deferred unless the employer failed to employ an active member during the 12 month period, became insolvent or changed its intention to employ such a person.

However, under the new definition, a Section 75 Debt will arise on all participating employers where there is a cessation of accrual in a multi-employer defined benefit scheme - i.e. all employers simultaneously cease to have any active members. Under the Amending Regulations, it will no longer be possible for employers who are unable to afford the continuing cost of defined benefit provision and propose to close the scheme to future accrual (while continuing to fund benefits in respect of past service) to do so without triggering the Section 75 Debt. This is likely to be of significant concern to employers.

Money purchase (defined contribution) benefits

The scheme’s assets and liabilities which relate to money purchase benefits are expressly excluded from the calculation of the overall Section 75 Debt. Employers in the scheme which provide only money purchase benefits are excluded from the definition of employer in the Amending Regulations. This clarifies the current position and employers providing only defined contribution benefits will no longer potentially be liable for part of the scheme deficit.

5 ways of dealing with the Section 75 Debt

  • Liability share - the Amending Regulations introduce a default method of calculating an employer’s liability for its proportion of the Section 75 Debt. This liability share will apply in the absence of an apportionment agreement, a cessation agreement or a withdrawal agreement and is calculated on a buy-out basis. The proposals differ from the current position in that liabilities attributable to each employer are assessed with reference to the members’ pensionable service with that employer (including liabilities arising as a result of transfers-in). Where records are inadequate to divide liabilities accurately between employers, liabilities in respect of a member should be attributable to his last employer. If it is not possible to ascertain the last employer of a member, the liabilities attributable to any such member will not be attributable to any employer and presumably will be treated as orphan liabilities.

The changes envisage further involvement for trustees in calculating, determining and verifying the scheme’s assets and liabilities. In the case of assessing the scheme’s assets, the trustees must consult the scheme auditor; regarding the assessment of the scheme’s liabilities, the trustees and the actuary have an equal role. For these purposes, where the scheme’s valuation and accounts are less than 12 months old, the trustees may use updates rather than commissioning new reports.

  • Scheme apportionment arrangement - these are agreements between the scheme trustees and the employer. They introduce a new requirement for trustees to agree the cessation employer’s negotiated share of the scheme debt. The trustees must be satisfied that the remaining employers will be willing and able after the cessation employer has left the scheme: (a) to fund the scheme to the extent necessary for provision of members’ benefits; and (b) to make the payments due under the scheme’s schedule of contributions and any recovery plan in place. However, this requirement does not apply in cases where the debt arising under the scheme apportionment arrangement is higher than that calculated under the liability share mechanism outlined above.
  • Regulated apportionment arrangement - again, these are agreements entered into by the scheme trustees and the cessation employer. The difference is they must be submitted to the Pensions Regulator for approval, which requires the agreement of the Pension Protection Fund (PPF). These agreements apply where the trustees are aware that it is reasonably likely the scheme will enter into a PPF assessment period in the next 12 months. There is currently no guidance as to how trustees are to assess this likelihood. One of the conditions for approval is that the Pensions Regulator must consider that the agreement would result in better scheme funding than if an employer insolvency event were to occur.
  • Approved withdrawal arrangements (AWA) - the mechanism and approval provisions relating to these existing arrangements, which allow cessation employers to exit without paying their full share of the buy-out debt, have been updated.

There are two methods of calculating the withdrawal arrangement share:

  • Amount A - the debt which arises if the liability share calculation mechanism is used; or
  • the alternative amount - an amount agreed between the trustees and the employer and subject to approval by the Pensions Regulator.

Before approving the AWA, the Pensions Regulator must consider:

  • the potential effect of the employment-cessation event on the scheme’s level of technical provisions (the “technical provisions” are an actuarial estimate of the assets needed at any particular time to make provision for benefits already accrued under the scheme);
  • the financial circumstances of the proposed guarantor;
  • the amount of the cessation debt;
  • the amount of the withdrawal arrangement share; and
  • the effect of the proposed AWA on the likelihood that all members will receive full benefits from the scheme.

Hopefully, the approval criteria set out above will prove less restrictive than the current test used by the Pensions Regulator i.e. that if the AWA is approved it is “more likely” that any Section 75 Debt becoming due is capable of being met by the guarantor(s). In practice this requirement has prevented many employers from using AWAs.

  • Cessation agreements - these are simplified versions of AWAs which are agreed between the employer and the trustees of the scheme without reference to the Pensions Regulator. They may be agreed before or after the employment-cessation event occurs in relation to an employer. The concept of the “cessation agreement share” is introduced, which allows the cessation employer to agree with the trustees to pay an agreed share of the scheme’s Section 75 Debt (Amount A). A guarantor will be party to the agreement and will be liable for the difference between the cessation agreement share and the sum representing what would have been the cessation employer’s due debt under the liability share calculation mechanism (Amount B).

The trustees must be satisfied that: (a) the remaining employers’ ability and willingness to fund the scheme are not adversely affected by the payment of the cessation agreement share by the cessation employer; and (b) that the guarantor is likely to be able to pay Amount B.

Further amendments to note

The Pension Protection Fund (Entry Rules) Regulations 2005 are amended so that cessation agreements, scheme apportionment agreements and regulated apportionment agreements are not treated as compromise agreements for the purposes of the PPF, so that a scheme does not, as a result, become ineligible for PPF entry.

New notifiable events which arise where a scheme has an AWA or a cessation agreement in place are listed in new Schedule 1B to the Employer Debt Regulations.

Conclusion

The DWP’s stated policy aim in the consultation paper is that the amended definition of employment-cessation event will apply where some or all of the employers simultaneously withdraw from the scheme. It may be that in seeking to prevent scheme abandonment by participating employers, the DWP has not appreciated the effect the new definition will have on proposals to close schemes to future accrual.

It is hoped that comments provided to the DWP as part of the consultation process will result in the DWP looking more closely at this proposed amendment and providing a carve-out for the situation where all employers cease simultaneously to employ active members when “freezing” a scheme. Possibly, the DWP may not have appreciated the full effects of what they saw as an innocuous change intended to prevent scheme abandonment.

The DWP has commented that the intention of the Amending Regulations, at a time when the Government policy is generally about de-regulation, is to improve the flexibility of the existing Employer Debt Regulations. The Amending Regulations widen the scope for various ways of apportioning scheme debt and trustees will need to take care in negotiating such arrangements, particularly in transactions where the most recent employer could be burdened with a disproportionate share of the seller’s scheme liabilities. However, if the Amending Regulations ultimately lead to greater flexibility, that is to be welcomed.