From IDS Pensions Bulletin 206, June 2007

Dealing with pension scheme deficits

In recent years there has been a great deal of pressure on employers to find ways of reducing pension scheme deficits, particularly with the introduction of the Pension Protection Fund's risk-based levy and the Pensions Regulator's scheme funding requirements. But what options are available to employers wanting to reduce scheme deficits?

Inducements

Since the late 1990s, a growing number of employers who have retained some form of defined benefit provision for employees, whether open or closed, have been looking at ways to contain the costs of these schemes. This has often resulted in increasing member contribution rates to schemes and/or reducing the level of benefit accrual available for future pensionable service.

In 2006 employers offering inducements or incentives to scheme members as a way of reducing scheme liabilities, hit the headlines. These inducements were designed to encourage members to agree to changes which would reduce scheme deficits and took the form of:

• an enhancement to a transfer value of benefits were transferred, for example, from a defined benefit scheme to a defined contribution scheme

• a direct cash payment to members if they agreed to a reduction in their benefits, or

• a combination of these approaches.

But before an employer decides to take this route there are a number of issues to take into account. First, the employer has to have enough cash available in order to finance any offer made. There will also be tax and National Insurance implications to be taken into account, and any inducement offer which down grades the benefits available to employees will have a knock on effect on the employers reputation. There may also be HR and operational issues to be taken into account.

Other issues to consider

Where the employer is looking to address a scheme deficit by reducing the benefits on offer to members for future accrual, one of the first considerations will be to look at the powers of amendment in the scheme's trust deed and rules.

The minimum that will be required where the employer has the power to amend the scheme is for the employer to consult with the members where future benefit accrual is to be affected. If the power to amend lies with the trustees, an employer will have to persuade the trustees that any change will be beneficial to the members. This might be achieved by the employer paying substantial additional contributions into the scheme to improve its funding position.

Where the employer wants to remove or reduce subsisting rights, section 67 of the Pensions Act 1995 requires the members to give their informed consent to such a change, which may prove difficult.

Even where the members and trustees agree to the removal or reduction of a benefit, the employer may still run into problems under section 91 of the Pensions Act 1995.

Where the employer offers a cash inducement outside the pension scheme in return for a member surrendering certain benefits, this offer may fall foul of section 91. Some commentators have suggested that an option in this situation would be to exchange one benefit for another, less valuable benefit in addition to the cash inducement. However, if an employer wished to take this route it would need to have the trustees on side.

What’s in IDS Pensions Bulletin 206