UK: Pension Scheme Deficits - A Corporate Nemesis

Last Updated: 17 October 2011
Article by Julia Ridger and Peter Maher

Pension scheme deficits are often at the centre of restructuring negotiations. We discuss the issues.

Recent corporate activity such as that surrounding Uniq (formerly Unigate), Cattles Plc and Aquascutum, along with court judgments such as Bloom & Ors v The Pensions Regulator (2010), have shown that defined benefit pension schemes are often at the centre of restructuring discussions and that pension trustees and the Pensions Regulator are key players in this arena.

Contributory factors

Many companies remain responsible for substantial pension liabilities, even when the build up of new benefits under the scheme has long since ceased. There are numerous factors that have contributed to the prominence of pension scheme deficits. Increased regulation, together with the Pension Protection Fund (PPF) levy (based on the strength of the employer covenant), has escalated the cost of funding a defined benefit pension scheme. The volatility of equity markets continues to exacerbate funding deficits and the increase in liabilities under schemes from longer member life expectancy has also had a negative effect on the funding positions of such schemes.

Pension debt due by an employer on insolvency is calculated on an annuitised buy-out basis. This involves calculating the cost of buying out the pension scheme liabilities with an appropriate provider, either an insurance company or a noninsurance company. The latter are not subject to the same regulatory regime as the former and so are free to use different structures, although this carries its own risks. The cost of taking on pension scheme deficits is normally quite high as conservative assumptions are used in valuing liabilities. Alternative investment strategies and funding methods for the scheme are not considered.

Moral hazard/anti-avoidance Powers

Another matter which must be considered in all corporate restructurings is whether the Pensions Regulator could view it as an excuse to abandon the pension scheme liabilities and 'dump' the scheme into the PPF. If this is the case then, under its so-called 'anti-avoidance powers', the Regulator can impose a liability for pension scheme funding on companies and/or the directors of companies 'associated' or 'connected' with the sponsoring employer. A financial support direction and/or contribution notice is issued by the Regulator for settlement and can be imposed even if the associated company has never participated in the pension scheme.

Early compromise

Employers and trustees should always consult at an early stage when it becomes evident the employer's covenant is weakening. The Pensions Regulator should be included in the discussions from the outset as it may be possible to obtain a compromise over the pension deficit, thereby perhaps saving the employer from insolvency and enabling a rescue plan. There must, however, be buy-in from all parties. If, in the initial restructuring discussions, the employer is granted clearance from the Regulator, then although the clearance statement will not give the transaction approval, it will give assurance that the Regulator will not use its anti-avoidance powers in relation to it.

If it can be demonstrated that the outcome of a consensual restructuring will be better than formal insolvency, by allowing the company to survive and so preserving greater value, then the Regulator may agree to the transfer of the scheme to PPF control. This leaves the employer in a better position to meet its commitments to other creditors. Solutions of this kind may not work for every situation, but can have measurable benefits for protecting businesses and jobs if adopted successfully.

An additional factor which may increase the burden of pension schemes on employers is the ongoing running cost. This could easily be reduced by reviewing the adviser's/administrator's costs and by looking at methods of matching a proportion of the liabilities held within the scheme in the form of an annuity buy-in.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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