Charlotte Moore explains how to navigate the route to pension scheme closure

According the latest Purple Book, the number of defined benefit pension schemes available to new members or future accruals continued to decline, with the proportion of open DB schemes falling to a new low of 14 per cent. The majority (57 per cent) of pension schemes are closed to new members, while over a quarter, (26 per cent) are closed to future accrual and 2 per cent are winding up.

The reasons for a company wanting to close a pension scheme are well documented but have become even more pressing recently as persistently low sovereign bond yields have caused pension liabilities to balloon. In addition, volatile financial markets mean that marked-to-market accounting makes the valuation of the pension scheme’s assets very difficult to predict.

Towers Watson senior consultant Ben Stone says: “As far as the executive board is concerned, the pension fund’s valuation is moving all over the place. For those companies, for which it is a large part, if not the largest part, of their overall financial position, it’s frightening to have so little control.”

He adds: “Trustees are no longer surprised when approached by companies seeking closure, particularly for schemes facing substantial and escalating deficits.”

A company should be clear about its motivation for discontinuing the pension scheme to determine whether it’s worthwhile embarking on this complex process.

Buck Consultants principal and senior consulting actuary David Piltz says: “Some PLCs might want to close their scheme because it shows the marketplace that they are in control of the DB scheme. Or they might want to close their pension scheme to make the company more attractive to a potential purchaser. It may be that the company is a subsidiary and wants to avoid the parent company taking more draconian measures.”

Discontinuing the pension scheme is not straightforward. Stone explains: “The biggest challenge often is the risk of adverse employee reaction, particularly where the business case for closure has not been thought through or is not strong enough.”

Piltz says: “It’s vitally important to get the right advice about closing the scheme, especially to get legal advice on the precise role of the trustees and rules that govern the scheme.”

There are two routes available to close a pension scheme. The first route is to use the scheme’s amendment power and the second is for the employer to effect a change to the employees’ contract.

Stephenson Harwood pensions partner Fraser Sparks says: “The legal approach will vary according to which route is taken. For example, it needs to be determined if there are any restrictions within the scheme’s amendment power that will prevent the closing of the scheme.” It’s also quite likely that the trustees will have a role to play in the scheme amendment power route.

Using the scheme amendment power is not always straightforward, especially when closing a scheme to future accrual. Sparks says: “The amendment power might have a restriction that says no amendment shall adversely affect accrued rights or rights secured up to the date of change.”

The courts have interpreted this legal wording to mean that, although pensionable service can be terminated, the service will have to be used to calculate their pension when they finally leave service: when the employee dies, retires or leaves to go somewhere else.

If the scheme amendment power prevents a company from closing to future accruals, then it might be easier for the company to take the contractual route. “This is a matter between the employer and employee and means that future service will not add towards the employee’s pension,” adds Sparks.

If an employer does not get agreement from an employee to change the pension conditions, then ultimately he can threaten to fire them and then re-employe with a new contract that changes their pension rights.

Sparks says: “If an employer takes this route then he does have to take on some additional consultations but it does avoid using the scheme amendment power and minimises the discussions with trustees. But the contractual route is also likely to be more contentious.”

Like Minds communications consultant Trevor Rutter thinks that the firing and re-hiring route should be avoided: “This option is really Armageddon. It would be very difficult to put a positive spin on this strategy.”

Whichever route the company opts to take, there are some key steps that will help to make the process as smooth as possible.

Piltz says: “Closing the pension scheme needs to be planned as a six month project. It’s not something that can be rushed and it must be properly mapped out.”

Sparks says: “Once the company has determined whether it will take the scheme amendment or contractual route, it should start the communication exercise by having an informal conversation with its employees. That needs to be a genuine conversation so they can determine their concerns.”

A good communication strategy is absolutely vital to ensure that the closure of the pension scheme will be accepted by the employees.

Rutter says: “It’s important to remember the context; pensions are currently perceived in a very negative light. Any employer looking to make a change to the pension scheme has to overcome that backdrop.”

Key to that communication is ensuring that employers understand the compelling business reason for this change. “That’s not easy because these changes will ultimately mean reduced benefits for employees. The risks associated with the pension scheme are complex and hard to explain clearly,” adds Rutter.

The informal consultation process, however, will give the company a good idea of the concerns of employees and how hard or easy it will be to make these changes. If everything is going to plan, these findings can then be presented to the trustee board, if the company has determined that it wants to take the scheme amendment route.

When considering whether to approve the proposed changes, trustees need to keep in mind their role. Piltz says: “The key role of the trustees is the correct stewardship of members’ past benefits. This usually far outweighs any concerns about future benefits.”

A formal consultation process can then be undertaken. The hope is that the informal consultation process will have mapped out the lay of the land and there will not be any surprises. To implement the proposal, a deed of amendment must be exercised.

If the company goes down the contractual route, then the consultation process with the employees is the same but trustees will be much less involved in the process.

Neither companies nor trustees can afford to become complacent once the scheme has been discontinued. PTL managing director Richard Butcher says: “Once the scheme has been closed, it is now on the road to being wound up. Many employers and trustees do not realise this is the case.”

Closing the scheme crystallises the fund’s liabilities and it has now become a legacy issue. “Both company and trustees need to make the necessary adjustments and make sure that the right investment strategy will be pursued in order to the schemes strategic objective can be achieved. The members’ benefits should be secured as soon as possible at the least cost to the sponsor,” says Butcher.

Stone concurs: “We’re talking to many clients about what asset and liability strategies they should put in place once the scheme is closed to help achieve a smooth path to full buyout.”

Companies should be realistic, however, about the outcome of any changes. Rutter says: “The best outcome any company can hope for is that employees will understand why the changes are being made even, if they are not happy about them.”

Written by Charlotte Moore, a freelance journalist

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