Pensions Age and Hewitt hosted a roundtable in early June covering the practicalities of closing defined benefit schemes to future accrual for both trustees and employers

Panellists
Chair: Jackie Daldorph is a managing principal and scheme actuary at Hewitt. She advises a wide variety of firms and trustees – with particular experience of UK plans with overseas parents. Having seen many changes during her 29 years in the pensions industry, Daldorph is currently working with trustees and employers to ensure they understand and benefit from the opportunities available to DB plans which have frozen to future accrual – linking together all disciplines to provide the right answer for stakeholders.

Panellist: Kim Gubler has worked in the pensions industry for more than 20 years and specialises in corporate pension provision. Prior to setting up her independent consultancy in 2002 she worked in senior positions with national pensions organisations. She is a director of the Raising Standards in Pensions Administration management team which she joined in 2005, and chairs the DC and off-shore groups. Gubler is also an adviser for the Pensions Advisory Service as well as an examiner for the PMI.

Panellist: Kevin Wesbroom has been advising pension clients for nearly 35 years, as a consultant with Bacon & Woodrow and Hewitt. He is a qualified actuary and currently the UK lead for Global Risk Services at Hewitt, a fusion of actuarial and investment skills designed to help clients make sense of rapidly changing investment markets and new developments such as buy out, longevity and risk driven solutions. He is practicing what he has been preaching about phased retirement by working four days a week.

Panellist: Anna Rogers is the head of UK pensions at Mayer Brown International. She has 25 years experience as a pension lawyer, is a member of the APL and a Fellow of the PMI and a regular public speaker and author on pensions issues. Mayer Brown advises over 200 major pension schemes and has dealt with a significant number of bulk purchase annuity contracts. Rogers advises a number of Mayer Brown’s key clients, including some which have closed to future accrual recently or are currently dealing with proposals to do so.

Panellist: Andy Hanley is both the corporate treasurer at Foster Wheeler Energy Limited and also chairman of the trustee board of the company’s occupational pension plan. Hanley was appointed as a trustee of the company’s pension scheme in 1991 and then became chairman five years later, in 1996. Since then, Hanley has witnessed a period of great change in the pensions industry where, particularly, the provision of defined benefit (DB) has declined dramatically. The Foster Wheeler Pension Plan itself closed its DB benefit strand to new entrants in 2003 and has only just recently closed for future accrual.

Panellist: Graham Withers has 30 years of experience in the pensions industry including more than 20 years as a professional trustee. He has been a trustee of various schemes ranging from small money purchase to large defined benefit schemes. He has worked alongside trustees, either as a co-trustee or adviser, in many different types of negotiations and transactions and helped employer trustees manage conflicts. He now concentrates on professional trusteeship with HR Trustees Limited. He is immediate past Chairman of the Pensions Committee of TACT (The Association of Corporate Trustees).

Panellist: Richard Goldstein is a senior associate in the pensions group of Mayer Brown International. He has been specialising in pensions for over nine years, and is a member of the APL investment sub-committee and a member of the PMI. Richard has a broad pensions practice advising on a wide range of schemes from those with assets in excess of £2 billion to smaller schemes with under £20 million of assets. He has advised both trustees and employers on a number of defined benefit schemes closing to the future accrual of benefits over the last year, some of which have involved complex legal issues and negotiations.

Hewitt roundtable: Frozen plans
Chair: Why is it difficult to freeze a pension plan?

Anna Rogers (AR): So far it's mostly been a question of working out how to get there. It's quite surprising to me that sponsors will think a lot about what they want to achieve, but not at all about how they are actually going to get there.

Kim Gubler (KG): It's not just the legal framework. People are discussing the big strategic issues, but they should also be thinking about how they are going to achieve them. They need to look at the 'what' and the 'how' before deciding to close the scheme. The service delivery will need to be completely refreshed.

Richard Goldstein (RG): Looking at the trust deed and rules for a scheme, the amendment power is often key and people assume that the amendment power gives power to the trustee to make the amendments - which is not necessarily always the case.

Kevin Wesbroom (KB): Should trustees be negotiating hard to get something from the employer? I would have thought if I came along as the employer and said to the trustees; ‘This hole in the ground we're digging, maybe we all need to agree to stop digging?’ then I would expect them to thank me. But very rarely do trustees say 'thank you very much, we all agree’. Instead they look to get something out of this major change in the way the plan operates.

Andy Hanley (AH): We had virtually seven months notice from the company of their intention to close the DB section of the scheme and we've only just closed in April, so this situation is quite new for us. For the last four valuations, despite all the efforts of the company and the trustees, the deficit increased so there was sympathy from some of the trustees.

Graham Withers (GW): As a trustee I greet the news that a scheme is going to close to future accrual with mixed feelings. When you've got a roaring fire threatening your house the last thing you do is throw logs onto the fire by continuing future accrual. But my feeling is that the Regulator has created an environment where if trustees are handed a negotiating position, they are expected to exploit it and that expectation affects members as well.

RG: The company could do it anyway, they can close the scheme to accrual through the contracts of employment of members. If they go through the trustees – then they need to be convinced that there is a good case. Trustees, especially member nominated trustees (MNTs), are conscious of what they are going to have to tell their colleagues.

KW: Is that consistent with the primary duty of a trustee, which I thought the Pensions Regulator had said was to protect the accrued benefits of employees?

AR: The Regulator believes that trustees have a duty to act in the interests of members, but that is less clear cut in case law than a lot of pensions lawyers used to think it was. In the Cowan v Scargill case, that's what the judge seemed to say – you've got to look out for the best interests of your beneficiaries – but maybe it is a bit more complicated than that.

KG: Whilst you could say trustees should have an eye to the future, their primary duty is to say 'I am going to protect the past'. Maybe in five years' or 10 years' time the company might not be around. Once upon a time you used to think it was only poorly run companies that went under. Now it can just be bad luck.

KW: Companies get very nervous about pressing the button to cease accrual, even if they are properly advised and have checked their deed and rules, because they don't know what sort of reaction they are going to get from the trustees.

AH: The conflict trustees find themselves in, in this scenario, is an interesting point, where the question that keeps cropping up is 'should we be negotiating on behalf of the workforce?' The workforce expects us to do that. Some trustees, maybe MNTs, thought that was part of what their role was, but some of the other trustees didn't think that was appropriate, so there was this huge conflict.

GW: I apply what I call the coffee machine test. It considers what the MNT would say after the event when they are at the coffee machine with one of those people who have lost their future accrual and gets asked the question: 'what did you do about it?' The trustee has got to have a story and be able to say something like: 'the company could have gone down the contract route if we'd dug our heels in and not spoken to them, but by doing this we've got you X per cent extra into the DC scheme'.

Chair: What about the relationship between trustees and employers?
I question whether when trustees and employers are negotiating funding they always consider all options. Sometimes the blindingly obvious thing is to cease future accrual.

GW: Nobody wants to do it, but in some cases it's necessary and it’s the sensible thing to do.

AR: The messages from the Regulator are a bit confusing. One of the powers of the Regulator under the Pensions Act is to stop future accrual and we've certainly heard people from the Regulator's office talking as though that was easy, as if that was the balancing item, that you just turn the switch off to future accrual.

KW: But I see why you'd need that power as the Regulator because otherwise people could conspire to game-play against the Pension Protection Fund (PPF): Keep the scheme limping on, with members getting another few years' accrual and hoping that the employer is not going to go bust yet. Then if we do go bust in five years' time, members will have five years' more accrual to take into the PPF.

AR: I don't think the Regulator is fighting against closure to future accrual.

KW: The Regulator is saying that you should consider closing to future accrual if that gave you a better chance of protecting past benefits. But the reality is often that closure to future accrual is very different to many of the other conversations that trustees and companies have – even difficult funding conversations. This is 'Crossing the Rubicon' and once we've gone past this point attitudes will change.

KG: If you've closed now or quite recently, there's probably not a lot of difference with the relationship, but in five years' time we're likely to see a completely different picture.

AH: Thus far I don't feel any different, but it is early days. We're fortunate that we have a very strong employer covenant so as long as the company is there to support the accrued benefits, we should be happy. But the issue that concentrates my mind more is the composition and the future activity of the trustee board in a frozen situation.

GW: You start on the track as soon as you close to new entrants. I'm never happy with the consultants' line that as soon as you stop future accrual it's a completely different animal.

Conflict eased?
Chair: Why shouldn't the company and the trustees work more together? Doesn't freezing take away some of the conflict?

AH: My expectation is that this is precisely what will happen, but it depends very much on the type of scheme. We already had a hybrid scheme with a large number of DC members and now we've got DB members who have moved into DC as well so we still have administration matters to deal with. However, in a frozen situation where there are only deferred and pensioner members I imagine the administration should be much easier.

RG: There still might be some tension on the investment side, as some employers might want trustees to take a bit more risk, whereas trustees know they've got a closed scheme, they really want to take risk off the table.

KG: My guess is that as people get used to being closed to future accrual, that timeframe is really going to truncate. But also, what does de-risking mean? It could mean something completely different for the employer than the trustee.

KW: Most employers like the idea of de-risking, just ‘not now thank you’. They like the idea of leaving that risk on the table long enough that they don't have to pay in a huge amount of money. That's why they get very nervous about trustees because they all know the power of investment is in their hands.

AR: The sponsor and the trustees will probably want to be looking at not your 80-year timescale, but the period from now until when there is a market opportunity to buy-out, running the liabilities off so it's a more manageable chunk. There's going to come some D-day when it would be feasible to buy-out.

Chair: What do we think to a strategy that says when you get to a certain funding point then you will de-risk and the trustees and the company having that discussion together?

GW: It's one of those ideas which is fantastic in concept, but in practical terms it isn't really possible to de-risk – there aren't the instruments available to most small schemes.
You can reduce it, but you are never going to take it away.

RG: But, as you say, the trustees have the investment power. However, for the employer it's a liability they are going to have to pay off and they are increasingly looking to have control over that. Having a plan obviously helps the employer to know with more certainty what's going to happen in the future. It's a way of employers trying to get some control over their trustee board.

GW: Frozen plans move from being an employee benefit to a common financial problem. So we should allow an investment sub-committee to include the finance director who's usually left the trustee board because of conflicts of interest. The regulatory regime has pretty much driven senior management off trustee boards, but when it becomes a legacy you need that link to the company.

KW: The employer may well have access to some of the tools and techniques in his business. There is often say hedging expertise in the company, and you ought to be able to tap into that knowledge.

AH: We have regular meetings to discuss investment strategy with the chief financial officer; it's what we've been doing for years. To do something other than that would be quite strange because the company has such a large stake in the scheme and there is a requirement to discuss the Statement of Investment Principles with the sponsor anyway.

RG: There are employers getting frustrated that it's their liability and they can't control it.

KW: We particularly see this with overseas parent companies who struggle to understand how the UK got into this mess.

Chair: Do you see schemes having long-term end game objectives or are they more short-term focused? Surely it should be a long-term plan, with identified triggers for movement along the way?

GW: For most of my clients the pension contribution is a question of affordability. There's an amount they can pay and if an opportunity came up to de-risk and it involved paying £1m more they'd have to let it go.

KW: There's quite a lot that goes into planning a flightpath. Not only looking at possible asset triggers but also looking at liability management. For instance, we might plan to do an enhanced transfer exercise when conditions are right, or a longevity swap or a buy-in. These exercises all have quite a big overhead cost in terms of preparation time, so spend that time upfront to give yourself the best chance of achieving the transaction, when conditions are right.

AR: We've done the same for future pension increases for pre-97 benefits, and there are quite a lot of things that can be done in advance, but people don't want to front end load the cost.

RG: It's quite emotive, especially on ETVs and pension increase exchange programmes and it's going to be difficult to go to trustees well in advance of actually doing it.

KG: As you say, if you're working together on a plan, particularly with ETVs and exchanging future pension increases, they are not always bad and can be successful. There is a place for these things. You may not want a front end load costs or to put the whole mechanism into play now, but you need to have some idea of how much this is going to cost and to understand the timescales.

AR: The problem with de-risking is that there is also legal risk because pension increase exchange or enhanced transfer values do leave the trustees with some risk of mis-selling.

GW: I take a view on ETV exercises that done properly all you're doing is offering your members another option that they wouldn't otherwise have.

KW: If I was advising the employer on this I would actually want to know how the trustees feel about possibly offering ETVs - in advance. If they agree to the idea in principle, then the employer can see this as an option to help deal with a deficit.

KG: We talk about the trustees and employers as if all trustees are homogenous and all employers are homogenous. So we have this idea that trustees need to understand to accept it. But there are some trustees that will never willingly accept the idea and will have to be nudged into it, others will have a rational conversation and will be fine. They will be able to square that circle as to whether it's in their members' specific best interests.

KW: But knowing where the parties are going to be coming from is fairly important, again from the employer's perspective.

KG: Well, because of the regulatory risk and the legal risk, the Regulator has said 'we don't like ETVs'.

AR: It's a yellow card from the Regulator. But when you read what the Regulator actually said about all that, it is all about process really. It's about people being pushed into things.

GW: I do have a slight concern that the very successful ones have been driven by either the unsavoury practices that luckily aren't happening anymore, or situations where there was a really bad relationship between the employer and the workforce.

Chair: There's a danger that we think we know today what's the right or wrong answer. As a member you might have wanted the option of taking an ETV rather than potentially ending up in the PPF.

KW: In the overall context, the Regulator has done a good job in terms of weeding out the really bad cases. There were some bad examples of ETV exercises out there. But the view that you should assume that if it's in the company's advantage it's against the members' interest, is fundamentally wrong.

AH: I am uncomfortable that I am not allowed to provide members with advice. For example, in the recently frozen DB section of our scheme, two people approached me and said that they had been told to transfer their DB benefits into their DC pot. In such circumstances, I say that I am not allowed to give financial advice but suggested that they obtain a benefit statement and that this is reviewed alongside some annuity sites. It's the same with ETVs, the fact that trustees are not allowed to provide advice to members is difficult.

RG: The material from the Regulator is not so helpful because although it's trying to get employers to promote their schemes, when you actually read the detail there are so many caveats in there that it probably puts off a lot of trustees from doing anything.

Changes
Chair: What changes would you expect to see to the operational structure of a frozen plan?

KG: Closing the scheme is a watershed, things have changed, even if it doesn't seem so different at first. But you won't get the full operational advantage if you still act like an open scheme. We need to be smarter and not only make assets sweat, but make advisers sweat too.

AR: It seems to me that the data aspect is the crucial aspect. Nothing else really fundamentally changes. Once you've fixed your benefits effectively and you are on that flightpath to eventually buying out if you can, when you can, you need to spring clean your data and get those benefits specified whilst you've still got people who remember the history and while you are in the best position that you're ever going to be in.

KG: If you don't think about and engage with the people delivering the front line services to your members, when you want to do something big they can then turn around to you and say 'actually that might be quite hard. But if you talk to them up front they can usually suggest ways where you still get what you want.

Chair: If you completely freeze and break the salary link, - there is no annual renewal and you can determine benefits. It comes back to the point about getting membership data right: once you have frozen you are in a position where you can go and completely spring clean your data.

AH: We've started that process and I cheekily asked our administrators for a reduction in fees considering that we are now frozen, and they responded along the lines of 'you don't understand, the pressures are actually greater now'.

KW: At the very least you've taken out one of those processing cycles, in removing the annual renewal, so you can structure it so that there is less work involved in a frozen plan. It throws the emphasis on who's running the DC benefits. That may be a DC section in the same trust, which makes for easier administration. But the future DC benefits may be in a contract-based GPP or GSIPP. There's an element of coordination with DC needed, but freezing should simplify the DB administration.

GW: I see a future where there is going to be a lot of demand for trustee organisations that have got infrastructure that can just run it.

KW: I suppose the question is what would the employer want from the trustees? Would he still be happy to have the MNTs and a bunch of other people dabbling in investment?

GW: Complete de-risking is only going to happen when a scheme's at or near discontinuance funding level. Then the potential risks are small and it's just about the administrative burden.

KG: Employers manage a huge amount of other risk just within their day-to-day operation, so it's not that they don't understand or aren't able to put in place strategies to mitigate risk. The problem is right now that the pension risk can flip and obscure the company.

KW: My concern here is that the employer may well feel that he needs more involvement or control over the investment process, which is so critical to restoring funding levels. Some companies feel that despite putting in large amounts of contributions, investment markets have moved against them, and they are back to square one. They want some sort of control.

Chair: In that period after freezing but before having sufficient money to "buy out" is it possible that you actually need a trustee board that's more nimble - for instance a sub-committee, with less people?

KG: All of the consultancies have various models that will help trustees manage the flightpath, but it's not full delegation. It still happens that trustee boards make a strategic decision, and then spend months trying to get a signature to implement

AR: With implemented consulting, there must be a need for it, but what you hear anecdotally from clients and at conferences is that this just seems like another layer of fees for consultants.

KG: If the trustees have decided all they are ever going to be is a passive scheme, then they are probably not going to be able to afford or want implemented consulting. But if they want to make use of some of the more complex financial instruments, then maybe implemented consulting could be the best option.

AH: With electronic communication the way it is today, we can make decisions pretty quickly through an exchange by e-mail. We can also organise meetings in the office at fairly short notice, but we do have pensioner trustees; one lives quite close to the office but the other lives quite far away so we can communicate by e-mail and make some decisions.

KG: But there are other trustee boards that never manage to get together and the operation of these schemes is in a pickle. They maybe spend a total of 'say' only 20 hours a year meeting on scheme business and then waste some of that time talking about operational things when they should be thinking strategically.

Chair: Will there be differences in what's needed from advisers? Do you think there will be a difference in what you want as support from administrator, actuary, legal adviser etc, say, in five, seven years' time?

GW: When you get to the scenario where they are safe it will dumb down. It will become more care and maintenance and you won't need innovation and all these bright ideas and delegation and that sort of thing. The whole thing will become more administrative. You'll need that extra expertise on buy-out for those who are lucky enough to get to the queue in time.

AR: But to get there you first need to get your data fixed. It's very easily said, but it's not easily done.

KG: I hear in the press about the burden of regulation around record-keeping, but one of the reasons why last week's guidance was issued is because few schemes have really done anything; only those that already followed good practice in the first place have done something. People are complaining about the cost, but its all relative. It could mean the difference between paying £100,000 to cleanse your data, or paying an extra £10m on your buy-out premium.

AR: We've worked on a lot of buy-in and buy-out contracts and when you get to the stage of doing re-calculations and premium reconciliations, first premium, second premium, third premium, millions of pounds worth of differences will come out and this is for a well run scheme.

AH: How often do you have to clean data? We switched administrators some years ago and they told us that our data was in pretty bad shape, which meant we had to pay additional fees at that time. We have also, subsequently, looked at our data again.

KG: The thing is, if you don't make sure you have the right processes in place with your new data then it's going to degrade over time.

Chair: When you ask people who froze their plans some time ago - "what's the one thing you wish you'd done earlier?", they say 'sorted out the data'. Its an overwhelming response - the loudest thing that I'm hearing.

AR: The research shows that pension schemes still have progress to make on this journey, as they do not see data as a priority compared to say investment.

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