The Minister for Social Protection, Joan Burton, has announced changes to defined benefit pension provision. First, the existing statutory minimum funding standard (the "MFS") will be re-instated for a transitional period of three years, although the MFS will be amended to permit the purchase of sovereign annuities. Secondly, schemes failing the MFS from 2012 onwards will be required to hold a risk reserve as a protection against future volatility in the financial markets. The exact detail has yet to be established but it appears that schemes will be required to meet the new funding standard by 2022.

Additionally, changes will be introduced to the priority order on wind up. In particular, there will be a threshold of €30,000 above which pensioner benefits will not be given first priority. The statutory revaluation rate for deferred pensions will also be amended so as to ensure greater equity between deferred members and active members. Finally, the Pensions Board will have powers to wind up schemes in certain circumstances.

Existing Funding Standard

Since 2009, the Pensions Board have suspended the funding standard deadline, in an effort to allow schemes to deal with their funding deficits. The recent announcement means that the existing funding standard will be restored and underfunded schemes must meet the funding standard within three years. The Pensions Board estimates that 70% of defined benefit schemes are in deficit. Brendan Kennedy Chief Executive of the Pensions Board has stated that the first funding standard deadlines under the new regime will be no earlier than 1 July 2012, to allow "trustees adequate time to prepare funding plans".

Sovereign annuities will now be certified by the Pensions Board, and where purchased by trustees they can be used to help meet the MFS. The sovereign annuities will be linked to bonds issued by EU Member States. In the case of sovereign annuities linked to Irish bonds, these will be state-guaranteed. If trustees buy sovereign annuities and continue to pay pensions out of the fund, there is likely to be a reduction in pensioner liabilities under the MFS. Alternatively, sovereign annuities can be purchased in the pensioner's own name. It remains to be seen whether insurance companies are prepared to create the types of instrument that pensions investors need.

Reformed MFS

The MFS will then be revised to require defined benefit pension schemes to hold a risk reserve as a protection against future volatility in the financial markets. This will apply to schemes which currently fail the MFS and which fail the current standard during the next three years. Schemes will be required to meet the new funding standard, including the risk reserves, by 2022.

The Department of Social Protection has stated that it is estimated that this revised MFS will increase funding requirements by 10-15%. It has suggested certain measures that trustees can take to ease the impact of the risk reserve requirement. These include purchasing sovereign annuities to reduce their funding liabilities, and investing in bonds as an alternative to equities.

Priority on Wind-Up

Currently the Pensions Act provides that pensioner members receive priority on the distribution of assets on a wind-up. When the scheme is wound up in deficit, this will result in active and deferred members not receiving their full benefit entitlement. Legislation will be introduced to amend the Pensions Act to provide for a more equitable outcome for all active, deferred and pensioner members. In particular, there will be a threshold above which pensioner benefits will not be given first priority. It has been suggested by the Department of Social Protection that this threshold will be €30,000 which is two and a half times the State pension, or 75% of expected benefits, whichever is the lower. Next, assets will be distributed among active and deferred members to the same threshold. If an excess of funds remains, pensioners will again be given priority in the distribution of these assets, with active and deferred members receiving further distributions only after pensioner members have received full benefits.

This system still affords a degree of priority to pensioners, but ensures that active and deferred members will receive more of their benefits. While the key impact is on higher pensions this priority change, if enforced, would result in 25% reductions in event the smallest levels of pensions.

Amendment of Revaluation Rate

Currently, revaluation of deferred pensions results in increases in the benefits of deferred members being more favourable than the benefits of active members (who are subject to salary caps or reductions). This situation is considered inequitable, and therefore the proposed changes will aim to achieve a more balanced approach in the accrual of benefits between deferred and active members.

Power to wind up a scheme

Currently a stalemate can exist where termination of a scheme cannot be agreed but continued accrual is detrimental. The Minister for Social Protection has decided to introduce powers that enable the Pensions Board to force trustees to wind-up such a scheme. This power will apply only in limited situations. Examples include where a scheme is underfunded and the trustees and employer cannot adopt a funding proposal, and it is clear that the deficit will increase.

Conclusion

It is anticipated that legislation will be introduced to implement these changes in the coming months. The Pensions Board will also issue revised guidelines for defined benefit schemes by the end of the year. The devil is going to be in the detail.

Trustees and employers of underfunded schemes will need to pay special attention to the announcement of the first MFS deadlines, and turn their minds to preparing recovery plans for submission to the Pensions Board.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.