The Pensions Regulator (the Regulator) issued a statement on 25 October 2013 warning against "double-counting" in defined benefit pension schemes.
The Regulator is apparently dealing with a number of cases where section 75 debts on the one hand and regular contributions otherwise due on the other have been offset against each other.
The Regulator believes this fails to reflect the distinct funding obligations provided for in the legislation, posing significant risks for the schemes in question.
What's the problem?
Where an employer leaves a multi-employer defined benefit scheme, a section 75 debt is often triggered, for example, in the context of a corporate re-organisation.
A section 75 debt is essentially a discontinuance payment, payable by the departing employer to ensure the scheme remains able to pay the full cost of the relevant members' benefits in the future. It represents the departing employer's share of the anticipated costs of providing annuities to those members and can, therefore, be a considerable sum.
Quite independently of any change in the number of employers participating in the scheme, there is a separate, continuing payment obligation on employers under the scheme funding regime.
The Regulator is concerned that where an employer leaves a multi-employer scheme, payments made under the scheme funding regime are being viewed by trustees and employers as settling any section 75 debt (and the other way around too). Consequently, the Regulator considers that this risk of so called "double-counting" needs to be addressed: its view is that discharging an obligation under the section 75 debt regime does not extinguish an obligation arising under the scheme funding regime and equally, making a payment in respect of a schedule of contributions does not satisfy any obligation under section 75.
The consequences of double-counting
On a practical level, the Regulator is concerned that lower contributions are paid to schemes in these circumstances than the legislation provides for. This has a number of serious consequences including the fact that:
- it potentially constitutes an agreement to reduce the section 75 debt, thereby prejudicing Pension Protection Fund (PPF) entry
- it leaves a contribution due to the scheme unpaid with a detrimental impact on member security which, in some schemes, could also be a winding up trigger
- it may, for a number of other reasons (for example, through a failure to monitor properly the on-going employer covenant or because it is indicative of a failure otherwise to act in the members' best interests) constitute a breach of trust.
What should trustees do now?
The Regulator's statement sets out how it thinks trustees ought to approach this issue going forward. Essentially, trustees need to consider separately the appropriate mitigation to be paid where an employer exits and the on-going funding consequences of that exit. The Regulator will not consider the section 75 debt paid by the exiting employer to be sufficient in itself to allow it automatically to reduce existing contribution obligations.
Trustees will, therefore, need to consider, with independent advice where appropriate, what changes, if any, are necessary to the existing recovery plan and statement of funding principles. The action required will depend on the size of the section 75 debt relative to the funding position of the scheme and the strength of the remaining employer covenant.
What about the past?
The Regulator's statement highlights the fact that trustees who fail to recognise the difference between the section 75 debt and the scheme funding regime could have acted in breach of the law. Where that occurs, a wide range of individuals have an obligation to notify the Regulator of the breach.
A decision that results in any debt due to the scheme not being paid is also notifiable by both trustees and employers.
In highlighting these provisions, the Regulator clearly expects to be able to identify cases where concerns might arise and review might be called for.
The distinction the Regulator has drawn between the section 75 and scheme funding regimes has been questioned in some quarters. In our view, however, trustees and employers would be well advised to consider the approach the Regulator's statement identifies where those two regimes have the potential to interact.
As far as the past is concerned, given the potential implications for PPF entry, the status of the scheme and the risk of personal claims for breach of trust, we would expect trustees whose schemes might be affected by this issue to want to investigate it further.
Given the uncertainty that might otherwise arise, sponsoring employers would also do well to consider this issue, whether or not prompted by their trustees to do so.