David Davison calls for changes to legislation governing multi-employer pension schemes.
2013 dawns and hope springs eternal. A new year and the optimism of new thinking to resolve long standing problems.
The unfortunate case of People Can has once again cast the spotlight on multi-employer pension schemes and the potentially catastrophic impact they can have on charitable organisations. In 2012 I wrote a paper The case for consultation on multi-employer pension schemes in conjunction with the Charity Finance Group and made some proposals about how the situation could be resolved. But as we move in to 2013, despite what seems like greater momentum around the issue, and despite some supportive noises and interaction with government, we don’t really seem to have moved any further in finding a solution to the problem.
The major roadblock to change appears to be the belief, apparently held by pensions minister Steve Webb, that changes to the legislation governing these multi-employer schemes would in some way compromise the security of members’ benefits.
If what was being proposed was a fundamental change to the structure of the ‘last man standing’ nature of these schemes then this contention may hold true, but that is just simply not the case. What is certainly the case is that inactivity is compromising job security and placing an increasing burden on the taxpayer.
I am hopeful that this is just a misunderstanding and if we can clarify the point we could make some positive progress in the very near future before we begin to witness more failures in such a valuable sector.
Hopefully a quick case study will help clarify the issue...
Let’s consider an individual in a standalone final salary pension scheme run for the staff of a single employer. The member is 50 and has built up a pension of £5,000 per annum to date. The scheme has assets of £3m and has liabilities (“technical provisions”) on a statutory funding objective (‘SFO’) basis of £4m so a deficit of £1m. The cost to exit the scheme is however much higher at £3m (ie liabilities of £6m). The costs of the scheme have continued to rise and the employer has finally decided that they can no longer afford to continue. They agree to close the scheme to future accrual (ie no further service will build up) and agree with the scheme trustees to keep the scheme running on a ‘closed’ basis and fund the £1m deficit over a 15-year term.
They’ll continue to review the funding at each three-yearly actuarial valuation and at the end of the 15-year term they’ll look to implement a new plan to fund to the level of the exit deficit. The employer has agreed to pay higher contributions to the scheme should finances permit in an attempt to improve the funding position and shorten the ultimate term to eventual buyout of the benefits. They are hopeful they can do this as the pension contributions to the new scheme they’ve established are lower, which frees up resources for higher deficit contributions.
All sounds pretty logical and consistent with what has been going on in standalone or segmented schemes throughout the UK over many years.
In terms of member protection the individual will only get the full benefit entitlement from the scheme providing the single employer sponsoring the scheme remains in existence until they can afford to pay for the ultimate wind-up of the scheme, which clearly is a number of years away. Should the employer become insolvent prior to that date it’s likely the scheme would go in to the Pension Protection Fund (PPF) and benefits reduced to the level payable by the PPF – approximately 90 per cent for those prior to retirement and 100 per cent for those post retirement. Some rights to future pension increases may also be lost.
If we had an individual in a multi-employer last man standing final salary scheme run for the staff of a number of employer,s how would the position change? The member is still the same age and has built up exactly the same pension on the same basis. The value of the assets and liabilities related to the employer is the same. The employer has also decided that due to rising costs they can no longer afford to continue with the scheme and want to close it to future accrual so that they can pay down the deficit already built up.
This is where it all changes!! If they close to future accrual (ie have no staff continuing to build benefits in the scheme) they will trigger their exit debt and become liable immediately for the £3m deficit. The employer can’t afford this and indeed such a payment would make them insolvent if imposed. They are offered the option of repaying the £3m over three years – also not an option. They’re therefore forced to continue to build up more benefits in the scheme increasing their liabilities, liabilities they’ve already identified they can’t afford. But it doesn’t really matter because if they become insolvent in the future, with this higher associated deficit, all the other unconnected employers who participate in the scheme are forced to pick up what they can’t afford, providing of course they can afford to pay for it!! Is it just me or is this madness?
It is interesting to note that even if the employer could afford to pay the £3m exit debt immediately it would not actually materially improve the level of member protection for their staff, or indeed the scheme as a whole, as the payment would be spread across the scheme which might increase the funding level from 75 per cent to 75.01 per cent, rather than securing their staff benefits at 100 per cent. In addition as many of these schemes are unlikely ever to seek to wind-up, the payments above the SFO basis are effectively being used to subsidise the contributions of those organisations who continue to participate. So the current approach does little to materially improve member security.
Had organisations been able to close to future accrual in the same way as under the stand alone scheme and funded the deficit in exactly the same way would the member’s benefits be more at risk? No, in fact they’d be better protected than under the standalone scheme as should the employer become insolvent they’d be protected by all the other employers in the scheme and only be required to take reduced benefits in the PPF should all the employers fail. Also if organisations were allowed to do this and therefore reduce the liabilities built up its quite clear they would also be less likely to fail therefore also providing greater protection.
As with the standalone scheme the funding plan would continue to be reviewed at each three-yearly actuarial valuation and at the end of the term they would also look to set a new plan in place to fund to the level of the exit deficit (ie the £3m). The focus would rightly become more on having organisations in these schemes fund to SFO level as quickly as possible and to subsequently be able to fund to cessation level over whatever period is affordable.
Such a move would also be likely to encourage schemes to come up with flexible funding arrangements which would allow employers to pay higher contributions to the scheme to improve the funding position and therefore member security.
Also, if we’re talking about member security why should we be limited to purely considering pension security and not job security. If more organisations are forced in to insolvency by these schemes members lose their jobs, their future income and indeed their future pension contributions, resulting ultimately in a lower pension. Such events also place an additional burden on the taxpayer in a number of areas.
In my view the focus initially needs to be on changing the legislation so that a closure to future accrual would not automatically trigger a cessation event and I believe that this could significantly improve the situation. I also believe that such a move would have the support not only of the participating employers but also scheme trustees and administrators. They equally have no wish to see employers continue to fund liabilities which they can’t afford, and indeed will be well aware that to do so puts other employers (and members) who can currently afford their liabilities at greater risk.
So my new year wish is that Mr Webb will provide charities in this hole with the ability to stop digging!!