Debt On The Employer Regulations: DWP Consultation

• 1991: The debt regime is born. Debts only arise on scheme wind-up and are calculated on a transfer value basis.
• 1997: The debt regime now operates by reference to the minimum funding requirement (MFR) valuation basis and covers:

  • scheme wind-up
  • employer insolvency
  • (in multi-employer schemes) "employment cessation events" and employer insolvencies
  • save for scheme wind-ups, the expanded regime presented few problems until the bear market of 1999-2003 when many schemes became under-funded on an MFR basis.
• June 2004: Government announces that employer debts will be calculated on a buy-out basis. Lawyers begin developing strategies for managing the significant debts, which arise on routine corporate transactional activity. These typically involve apportioning debts under scheme rules (as allowed under the existing regulations).
• April 2005: A new set of regulations is issued without any consultation. The regime is conceptually quite similar but there are important differences. Chief among these is the introduction of "approved withdrawal arrangements" whereby an exiting employer can pay something less than his proper debt provided there is a guarantor for the balance and the Regulator gives approval.

DWP’s Proposals

The consultation covers the following areas.

Definition Of "Employment Cessation Event"

Under the existing regulations, a debt is triggered if an employer ceases to employ active/prospective members of a scheme at a time when at least one other employer continues to do so. The new proposal is that a debt will be triggered whenever an employer ceases to employ active members in a scheme (with a 12 month period of grace to minimise the risk of "accidental" debts). This was widely interpreted by industry and scheme professionals to mean that a debt would be triggered if an employer sought to close its scheme to future accrual or if a scheme was merged with another scheme. The weight of adverse responses has forced the DWP to issue a clarification confirming that the change in the definition was not intended to affect legitimate scheme mergers or closures to future accrual. It is assumed the DWP will therefore re-work the definition so that it accurately reflects its policy intention.

Money Purchase Employers

The DWP proposals will close an anomaly whereby a money purchase only employer in a hybrid scheme could theoretically become liable for a share (or all) of the defined benefit deficit in a scheme in which it participated. The clarification is welcome.

The DWP’s proposals involve giving trustees a greater say in the value of assets and liabilities used in the debt calculation rather than undertaking full calculations at the relevant date. This is particularly important with reference to the liabilities as it is also proposed that the actuary will be able to estimate what the buy-out liability would be (rather than obtain an accurate quotation from the annuity market). The current regulations are silent as to who prevails if the scheme actuary and the trustees cannot agree on what level of liabilities to use.

Trustees will be able to use updates of existing valuations and net asset statements provided they are no more than 12 months old at the calculation date. This is a welcome relaxation.

Approved Withdrawal Arrangements (AWAs)

The key proposed change here is a relaxation of a test that the Regulator must apply before approving an AWA. Under the existing test the Regulator must be satisfied that it is "more likely" that members will receive their benefits in full as a result of the arrangement. The test has been problematic in practice and the proposed relaxation is welcome.

Currently, in multi-employer schemes, an employer’s share of a debt is calculated by reference to liabilities attributable to employment with that employer (unless scheme rules provide otherwise) including any proportionate share of "orphan" liabilities. The current proposal is broadly similar save that where a member has worked with more than one employer in a scheme and it is not possible to identify how to apportion those liabilities accurately, all liabilities associated with the member will be attributable to the last employer. In addition, if it is not possible to ascertain the last employer then liabilities will not be attributable to any employer. This introduces the possibility of considerable unfairness and even the development of avoidance mechanisms.

The DWP’s proposal introduces three new ways of dealing with debts (in addition to AWAs and the default apportionment basis). The stated policy intention is to frustrate employers who intend using apportionment arrangements as a way of abandoning schemes. We are not clear that the stated problem exists in practice but, nevertheless, the proposals do give welcome additional flexibility to employers and trustees. The three new mechanisms are as follows:

• Scheme Apportionment Arrangements

  This will replace the existing flexibility for scheme rules to provide for debts to be apportioned otherwise than on the statutory default basis. The mechanism is cloaked in safeguards, notably the requirement that the trustees must be satisfied that the remaining employers will be able and willing to fund the scheme to its technical provisions (ie not necessarily a buyout level) including supporting the schedule of contributions and any recovery plan.

• Regulated Apportionment Arrangements

  These will only be available where the trustees believe that the scheme will enter a Pension Protection Fund (PPF) assessment period within the next 12 months and will require the agreement of both the PPF and the Pensions Regulator.

• Cessation Agreement

  This is intended to be a simpler form of AWA. It is simpler because Regulator approval is not required. However, trustees must be satisfied that the ability and willingness of the remaining employers to fund the scheme will not be adversely affected and that the guarantor has sufficient financial resources to cover the guaranteed amount.

In all these cases, trustees are likely to need to have extensive employer covenant review work undertaken before they can agree to a proposal. This may well not fit with a typical corporate transaction and timetables could become a problem.

Hammonds has submitted its own response to the consultation. In general terms, we welcome the DWP’s attempt to rework regulations that were frequently causing difficulty. The DWP’s clarification that its proposed change to the term "employment cessation event" is not intended to catch scheme closures and scheme mergers is particularly welcome. We consider the introduction of the three new ways of dealing with scheme deficits to be a useful development, although we are not convinced that the mischief they are designed to remedy exists in practice. We are also concerned that in some cases, the requirements upon trustees will prove to be incompatible with the timescales often associated with corporate transactional activity.

We await the publication of the formal regulations and will be interested to see which of the available methods for dealing with scheme deficits becomes popular with employers and trustees.

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