For the first time the Pensions Regulator has exercised its Financial Support Direction powers under the Pensions Act 2004 to protect the members of an under-funded pension scheme. In June 2007 the Determinations Panel of the Pensions Regulator ruled that Sea Containers Ltd should be subject to a Financial Support Direction to support its UK defined benefit pension schemes. Hammonds’ Pensions and Pensions Dispute lawyers advised the trustees of one of the schemes.

The “moral hazard” provisions are anti-avoidance measures introduced by the Pensions Act 2004 to ensure that employers properly fund and support their defined benefit pension schemes. A defined benefit pension scheme is one which promises to pay members on retirement a certain proportion of final pensionable pay for each year of pensionable service. The Financial Support Direction is one of these moral hazard provisions, the other being a Contribution Notice.

The Pensions Regulator can issue a Contribution Notice to an employer or others connected or associated with the employer, in situations where there has been a deliberate attempt (or act in good faith) aimed at avoiding pensions liabilities under a scheme. Payment of a sum up to the amount needed to buy-out the scheme liabilities can be ordered.

A Financial Support Direction may be made by the Pensions Regulator where the scheme employer is either a service company (meaning a company that provides services to other group companies and derives its turnover from that activity) or is insufficiently resourced (meaning that its assets do not exceed 50% of the estimated debt) and there is an associated or connected company against which it is reasonable to impose the Financial Support Direction. In considering whether it is reasonable to make a Financial Support Direction, the Pensions Regulator must consider the relationship between the scheme employer and the associated company, for example whether the associated company exercised control, and to what extent, over the scheme employer, what benefits were received by the associated company from the scheme employer and the associated company’s financial circumstances and involvement in the scheme.

A Financial Support Direction requires the recipient to make proposals for the financial support of the whole or part of the scheme employer’s pension liabilities and will remain in place until the scheme is wound up.

The use by the Pensions Regulator of the moral hazard provisions is seen by trustees, employer companies and financiers as a live issue in respect of financial covenants and credit assumptions of finance arrangements involving group companies where there are under-funded defined benefit pension schemes within the group and associated or connected companies with resources at least equal to the actual value of the scheme employer’s assets and 50% of the estimated shortfall of the scheme. This first exercise of the Financial Support Direction powers will be watched with interest by financiers and their customers.