The road to wind up is certainly long, unlikely to be dull and is possibly fraught with danger. A successful trip requires pension trustees to determine how best to get there and understand how long the journey is likely to take, whilst avoiding hazards and overcoming obstacles on the way. In this article, Claire Rankin, Legal Director at Burges Salmon LLP, considers the various routes to wind up and recommends some key steps for trustees to take to help ensure a safe trip.
Choose your route
It is in the interests of both trustees and scheme sponsors to agree on their preferred route and travel together. To reach wind up with benefits paid in full, there are two routes to choose from:
Motorway – buy-out. The aim of this route is to fund and proactively invest, perhaps utilising liability-driven investment (LDI) options and/or buying-in groups of pensioners, with a view to fully securing the scheme's benefits at the optimum time. Managing scheme costs during this time would be important, particularly for smaller schemes. Monitoring the scheme's progress against the buy-out target would also be required to take advantage of pricing opportunities and to avoid creating surplus which is taxable and highly regulated. Ideally, the trustees would wish to buy-in the last liabilities on the basis of a cash injection from the employer once the final premium has been determined. The scheme could then be terminated and wound up, and the buy-in policy converted to individual member policies. A buy-in contract is an insurance contract requiring trustees to give complete and accurate information and make full disclosure. Trustees can prepare for buy-in by data cleansing and undertaking a legal audit of benefits to identify any discrepancies before going to market.
Country lanes - until death us do part. This is the longest route to exit (wind up after the last beneficiary has been paid) with management time and costs becoming increasingly disproportionate to scheme liabilities. Most trustees and employers will be hoping for a swifter journey than this.
Journey time and / or costs may however be reduced along the way by...
Pit-stop - trim the DC. Employers may have more than one scheme, some with defined contribution ('DC') benefits. There may be merit in exploring opportunities to buy out the DC benefits with an insurer, or transfer them to a master-trust, to remove the trustees' DC governance obligations and give members access to the full DC flexibility options. Unless the trustees have the power to wind up the DC benefits separately, they will need a power to buy out or make a bulk transfer of the DC benefits whilst the scheme is ongoing and the preservation requirements will apply. In deciding whether to buy-out or transfer, trustees must understand the implications for the members: will member costs increase or investment penalties apply (and will the employer underwrite them), will member options be lost (such as to use DC benefits to provide DB tax free cash, or to receive higher pre-A Day rates of tax free cash)? AVCs linked to DB accrual may be trickier to buy out for these reasons. An alternative is to upgrade and streamline DC governance by using a compliance solution, such as the Burges Salmon Governance Manager (click here for further information).
Car share - merge the DB. Employers with more than one DB scheme may wish to merge them into one to help manage competing funding demands, save on future administration and trustee and adviser time and costs and commute small benefits. The trustees of the transferring schemes would need to make bulk transfers of the DB assets and liabilities (plus associated AVCs) into the receiving scheme, and the receiving scheme trustees would need to agree to receive them. Each transfer would require a merger deed and actuarial certificate to meet preservation requirements, designed to maintain the security of the benefits, protect the members from adverse changes and protect the transferring trustees from claims arising from the transfer. The relative funding positions of the schemes and future funding and/or security on offer would dictate whether the schemes could be fully merged or only on a segregated basis. Care would be needed in relation to the receiving scheme, to ensure that it could receive any contracted-out benefits (where extra restrictions apply) and that its employers would be appropriate statutory employers. Once its assets and liabilities have been transferred out, the transferring scheme could be terminated and wound up without triggering an employer debt (provided the employer meets the wind-up costs). Small benefits left behind in the transferring scheme could be commuted as winding-up lump sums, reducing the transferring liabilities.
Convoy - merger-lite. A full scheme merger is a complex and time-consuming project. Adopting a common trustee across several group schemes may deliver a few savings in terms of time and management without the work required of a merger. This approach would work best with a single professional corporate trustee, given that a group corporate trustee would need to satisfy the member-nominated director requirements in respect of each scheme. Conflicts of interest would need to be managed, particularly if schemes have sponsors in common.
Take a cab - transfer to DB Master-trust. Would a bulk transfer to a segregated DB master-trust help ease management time and be a cost-effective solution? The options on the market differ in approach so due diligence would be needed. Would there be a role for the existing trustees, how would costs compare to using existing advisers, would there be clear investment benefits, how much control would the employers retain over scheme management and amendments, is the receiving scheme truly and robustly segregated to avoid cross-subsidy risk? The points made in "Merge the DB" (above) are also relevant here.
Throughout the journey, the trustees will need to be alive to obstacles and hazards in their path, to avoid a crash scenario. This is where the scheme is in deficit and the employer (and/or former employer(s)) responsible for the scheme deficit become insolvent. In this scenario, if the scheme is funded below Pension Protection Fund (PPF) level, the scheme's route may lead to the PPF. If the scheme is not eligible for PPF protection, the trustees would need to use the available fund to secure benefits in the order set out in the Pensions Act 1995 and the scheme's winding up rule, leading to reductions in member benefits.
There are a number of steps trustees can take to prepare for changing conditions and help them make the right decisions when hazards arise. Change is a constant and trustees with keen road awareness are more likely to overcome the challenges they face. Avoiding hazards may not be possible in every case, but if trustees are prepared, the record of their actions should hopefully silence those 'blessed' with hindsight.
Understand your scheme powers. Every pension scheme was established with the powers and duties as determined by its first sponsoring employer. A trustee should assume that the scheme's powers are unique and get to know how they operate. Who has the power to set the employer's contributions, to alter the benefits or to terminate the scheme? One or more of these may be trustee powers, and give the trustees useful leverage in testing times. A trustee power to determine contributions may mean that the employer need only be consulted on the schedule of contributions and recovery plan, or that the trustees can seek a special contribution if the circumstances demand it, for example in the event of an imminent insolvency or abandonment risk.
Know your statutory employers. The group may be financially strong but is the scheme sponsor? It is vital to know who is legally responsible for funding the pension scheme in normal times and for meeting the employer debt upon insolvency or wind-up (under section 75 of the Pensions Act 1995). Unfortunately this is far from straight-forward. Past employers may remain liable for an employer debt and present employers may have no such liability if they have only ever employed defined contribution members. Also, are the statutory employers eligible for entry to the Pension Protection Fund (PPF), particularly if they are overseas entities? Trustees must seek legal advice on this.
Understand your employer covenant. Once the scheme sponsors are clearly identified, trustees should understand their financial strength and prospects. The scheme is a creditor of the sponsor and the trustees need to assess the appropriate period of credit to extend to it (in the form of the recovery plan). The longer the period of credit the greater the trustees' (and members') risk.
Get good information. A formal written information sharing agreement between trustees and sponsors will help sponsors understand what information the trustees need (and are entitled to see) and help trustees keep track of corporate developments. A well-structured covenant assessment will give trustees further support; this can cut through the web of intra-group accounts and debt and hone in on the scheme's position as a creditor both in the present and in the event of insolvency. Armed with this advice, trustees are better placed to negotiate mitigation for key risks such as a parent company guarantee, or security over assets to give protection where the scheme would otherwise be an unsecured creditor.
Understand how covenant and investment risks combine. Integrated risk management is a hot topic amongst pension consultants. How much investment risk should trustees take if the sponsor's covenant is weak? Generally, if the sponsor is not in a position to underwrite investment risk, trustees are advised to reduce it. This approach may have the effect of locking in deficit and higher contributions, but investment and covenant advice may suggest other options. For example, a comprehensive parent company guarantee may allow continued investment in growth assets and lower cash contributions.
Negotiate, even against the odds. Trustees should negotiate for the contributions and/or other security the scheme needs. The sponsor may not always be receptive, but the old adage of "if you don't ask, you don't get" is very apt. Sponsors will have other calls on their free cash and paying down the pension scheme debt may not be a priority, but trustees should understand their negotiating hand and play it commercially in the same way as any other creditor.
Keep records. Trustees are legally obliged to keep records of their meetings and decisions. Keeping records of negotiations, including correspondence, emails and notes of telephone calls and meetings between trustee meetings is becoming increasingly important. These are the trustees' evidence of good governance when the Pensions Regulator or disgruntled scheme members (or members of Parliament) come knocking.
In summary, trustees cannot avoid facing challenges, but they can choose how they manage or deal with their sponsors and how they plan for future events. Not every sponsor is helpful and co-operative and well-meaning sponsors may face an uphill struggle against large pension deficits and volatile or changing markets. Great trustees are able to identify the most effective route through the challenges ahead to the most appropriate destination and are able to demonstrate this after the event.