Managing pension scheme liabilities

17 / 01 / 2018

Wedlake Bell’s Pensions & Employee Benefits Team has significant experience in assisting employers and trustees in navigating liability management exercises similar to those being proposed by BT.

Sponsoring Employers and Trustees continue to look at ways of controlling defined benefit pension scheme liabilities to reduce cost, to reduce volatility and to manage risks. For regulatory reasons it is essential to consider accrued benefits – relating to historic employment – and future benefits separately. There are a number of mechanisms at the employer’s and trustees disposal for reducing pension costs (details of which we have set out below).

Future Service Benefits

Usually it is more straightforward to reduce future benefits than past benefits but communication and negotiation with the Trustees is key. It should also be noted that the Pension Regulator actually encourages cuts in future service benefits if a scheme is becoming unaffordable.

1) Reduce future service benefits: Employers can increase member contributions, reduce accrual rates, switch from final salary to career average pension, lower the base of pensionable salary, increase retirement age or reduce non-statutory pension increases.

2) Salary sacrifice: This can generate significant National Insurance savings for both employer and employee.

3) Closure to future accrual: If your scheme is already closed to new entrants, the next step may be to close the scheme to future benefit accrual. Such a proposal needs to be carefully structured so that (i) all employers (if more than one) cease future service contributions at the same time; and (ii) the provisions of the trust deed and rules are carefully adhered to.

Accrued Benefits

It is more difficult to amend or vary accrued or historic benefits as these enjoy significant legal protection both in terms of legislation and often in provisions in the trust deed. Usually in order to reduce such benefits, member consent is required. However, there may be opportunities to negotiate direct with the Trustees in order to control the cost and funding of accrued benefits.

1) Discretionary benefits: Where employer consent is required for discretionary benefits to be paid the employer can take a measured approach to approving these in the future. It will be necessary to take account of what has become custom and practice and members’ expectations but in most cases the withdrawal or reduction of discretionary benefits can be achieved.

2) Commutation Review cash commutation terms at retirement: It’s important to be fair to members but not so as to increase the funding strain on the scheme and remaining members.

3) Late retirement: With the abolition of the default retirement age late retirements are becoming more commonplace. Late retirement uplifts should be assessed against members’ increased life expectancy.

4) Cap pensionable salary growth: This would involve negotiation with members as pension benefits are linked to final pensionable salary. It is usually achieved outside of the scheme via employment contracts so that Trustees do not need to be involved.

5) Enhanced transfer exercise: Offer members an incentive over and above their statutory entitlement to transfer their benefits out of the scheme. Whilst there is an upfront cash cost it does tend to generate savings as the cost of the enhancement is usually less than the subsequent reduction in deficit.

6) Compromise accrued benefits: So long as statutory minimums are not breached employers can negotiate with members on accrued benefits e.g. exchange future pension increases for an immediate one-off uplift.

7) Buy-out: Subject to receiving suitable quotes, employers and trustees may wish to take steps to buy-in or buy-out members’ benefits with a regulated insurance firm. This is usually the last step before winding-up.

8) Alternative funding arrangements: Making use of alternative assets classes (i.e non cash) such as real estate, intellectual property and financial instruments can help alleviate the funding strain faced by many employers, improve cash flow and offer Trustees added security.

Some of these options may not be relevant to your scheme’s circumstances and almost all will require employee consultation. Wedlake Bell’s Pensions & Employee Benefits team have significant experience in each of these areas. If you would like to discuss any of these options or liability management generally, please do not hesitate to get in touch with your usual contact.