In these straitened times there are a lot of companies battling with their customers and their creditors. Those with defined benefit pension schemes may feel that, whatever is to the left or right of them, they will always be stuck in the middle with the pension liability.
A business with a defined benefit pension scheme cannot simply negotiate it away. The scheme is attached to it employing companies, and any attempt to move valuable assets to other group companies uninfected with the pension scheme may result in the Pensions Regulator making enforceable demands for payments into the scheme. Terminating the scheme to take it off the books is a long and costly process, involving negotiating with an insurer to buy out the liabilities and provide the pensions to all members directly, involving a significantly higher funding cost than that of running the pension scheme on.
So, what can a business that is stuck in the middle with its defined benefit pension scheme do? Assuming that the business has already taken the cost cutting steps around closing the scheme to accrual (that is, stopping anyone earning more money in it), it is a case of managing the existing liability, rather than reducing it.
The good news is that, eventually, pension schemes do become cheaper. Members retire, some of them die, and the cost of buying benefits for the ones that remain gets significantly lower as they get older. For many businesses, if they can get through the next decade or so, the cost of their pension schemes will become substantially more manageable and terminating and buying out the scheme will be a practical and relatively straight-forward solution.
However, many businesses are not comfortable about the next decade, or much less than that, and are trying to juggle the pension scheme with all the other demands, making sure that the pension doesn’t bring everything else down. There are various options available, although none of them is a silver bullet.
The most obvious option is to give the pension scheme some security over an asset. This has become extremely popular over the last decade or so, as cash-poor businesses give the trustees of their pension schemes something to provide protection should the worst happen to the business. Of course, this often requires the consent of the main lender, but increasingly the banks are aware of this option and are comfortable with it.
The biggest challenge is that trustees, and the Pensions Regulator, tend to want to use a form of charge that was originally drafted for the Pension Protection Fund to assess employer strength, and it is very trustee- (rather than business-) friendly, amongst other things, not being limited in time.
Another option is to try to invest out of trouble. Pension scheme assets can be invested in more or less income seeking (and therefore generally higher risk) funds. It is often attractive to try to increase the return profile of assets to improve the longer term funding.
The problem for businesses is that the funding of the pension scheme is in the hands of the trustees, who are obliged to “consult” the employer on changing their investment policy, but do not need to get employer consent. As a result, a business can be pouring a great deal of money into a pension scheme and see little return, whilst liabilities increase, and is able to do very little about it.
The business can always try to reduce the contributions it pays. However, this needs the consent of trustees – whatever has been agreed as the contribution rate remains payable (and can be enforced by the trustees). If the trustees agree, a new or amended contribution schedule can be entered into.
The good news is that the trustees should take into account “affordability” when setting a contribution schedule, so not being able to make the payments is a good reason for changing the schedule. However, the Pensions Regulator will see any revised schedule, and can impose its own if it feels it is not sufficiently prudent. This means that keeping the Regulator on side is increasingly important if the business is struggling.
In challenging economic conditions, businesses may increasingly be stuck in the middle with the Pensions Regulator as well as the pension scheme. The Regulator does take an interest in businesses in trouble, not least because one of its statutory objectives is to minimise the number of calls on the Pension Protection Fund, ie the number of businesses with defined benefit pension schemes that file for some form of insolvency protection. If all else fails, the Regulator knows that the scheme will go into the PPF, and it is not keen on seeing that happen.
This does not mean, however, that the Regulator gives businesses an easy ride if they say that they have financial difficulty. The Regulator is an old hand with insolvency, and is aware of the difference between being unable to pay, and not particularly wanting to.
Providing the trustees and the Regulator with strong evidence of financial difficulty is really the only way of getting helpful answers at times of distress. The business may be stuck with the pension scheme, but with the right approach, it doesn’t have to be at war.