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Parallel
universe
Running an occupational pension scheme
is a complicated business, and running two schemes simultaneously
could get tricky. Angela Pasceri examines the logistics of handling
both a DB and a DC scheme in the same organisation
Over
the last 15 years, layers of legislation have increased employers’
revenue commitment to defined benefit schemes with guaranteed benefits,
greater benefits post April 1997 and the revaluing of pensions in
deferment.
Add to all this the legislative and administrative burden of compliance
and your costs increase again. The surplus nests, built up in the
eighties, are beginning to dry up and employers no longer have the
monies to mop it all up.
Stepping towards change
The main driver pushing companies to switch from a final salary
scheme to a money purchase scheme is cost control. Jeremy Dell,
a partner at Lane Clark & Peacock, thinks that although employers
say they adopt DC schemes in order to fix their costs, enabling
them to forecast and budget in a more predictable way, they are
also concerned about reducing their contributions.
His colleague Francis Fernandes adds: “A lot of it has to do
with controlling the risks associated with providing the benefits.
People are living longer and the employer doesn’t want to pick
up the tab, or the shareholders are not happy about it.”
Having both schemes in place could also be part of a strategic decision
to close the DB scheme to new members and establish a DC scheme.
The DC scheme may be technically part of the same pension trust
as a new section or it might be a brand new scheme. In the future,
it might be a stakeholder scheme. The increased level of merger
and acquisitions in the last few years also creates situations where
companies find themselves straddling two schemes during the interim
settling period.
“The difficulty in switching completely is that you have to
look at the commitment you’ve made to the employees from a
contractual view point,” says Marie Stimpson, who heads the
pension practice at Ashurst Morris Crisp. She explains that quite
a few schemes were provided on an exgratia basis such that the benefit
will be provided for as long as the employer is able to and they
reserve the right to amend the scheme or to close it down in the
future.
Yet, Stimpson argues: “In reality you have to look at the employees’
expectations and whether in fact it’s a little more than an
exgratia benefit. In fact, you’re going to have employee relations
problems with suddenly turning around and saying alright it’s
no longer DB; it’s now DC.”
So although the employer in this case has the right to stop or amend
the DB scheme at any time, there is the risk that employees will
object. Ideally, employers will try to merge the schemes so that
they do not have the legislative and administrative burden of compliance
with a number of different schemes.
Rodney Jagelman, director of corporate affairs at Gissings, agrees:
“The main challenge is to manage the employee’s perception
and expectation between one style of benefits and another. You do
not want the DC group to feel that they’re second class or
an inferior group.”
Another variable pushing the switch from DB to DC is the changing
nature of the workforce, says Hewitt’s David Freedman, head
of pensions.
“No more jobs for life. DB is suitable when you’re with
the same employer for 40 years but for a young mobile workforce
DC is more attractive,” he says.
Scheme
mechanics
If you cannot escape running two schemes in the same organisation
then be prepared for a bit of extra work in the area of fund management,
record keeping, administration and custodian selection.
Hewitt’s Freedman comments that with regard to fund management,
although in many cases the procedure for selecting fund managers
and the investment strategy is similar, it’s the focus of the
individual schemes that differs.
“On the DB side there is more concern from the trustees in
getting the right investment strategy and benchmark while for a
DC scheme, they’d be worried about offering the right selection
of funds to the members,” he says. In both cases, trustees
have an underlying duty of making sure that the fund managers are
performing and meeting their benchmarks.
The differences in record keeping and administration are even more
pronounced. Trustees have a duty to ensure that proper records are
kept and that the right benefits are paid in either scheme, but
the nature of what you will have to do is different.
Freedman explains: “In a DC scheme I think it’s fair to
say that the administration is assumed to be simpler but in actual
fact it’s not; it’s the exact opposite. DC allows no room
for slip up while in a DB scheme you can make a mistake and go back
and correct it.”
In a DB scheme, calculations that are not time sensitive can be
completed. For instance, the trustee knows when the employee is
retiring and based on what has been paid into the fund and the terms
of agreement, the amount to be paid out can be calculated.
On the other hand, in a DC scheme, you are operating in real time.
The trustees have investments that they are responsible for selecting
so timing is everything. Both the timing and the investment choice
makes a difference to the outcome. When an employee retires, the
units being held for them have to be sold, so if they are sold on
the wrong day or time, or the wrong number of units is sold, it
makes a fair bit of difference.
On the accounting side, income and expenditure for both schemes
are handled in the same part of the accounts. The only real issue
is the net asset statement which must segregate the two schemes
by assets and liabilities by virtue of the fact that the DC scheme
has multiple funds.
The trustee’s report and the statement of investment principles
has to cover both. “That can be one statement but it’s
unlikely because both schemes may have slightly different statements
of investment principles as the liability rests with the individual
on one and with the employer on the other,” says Peter Maher,
head of corporate benefit at accounting firm Smith & Williamson.
The DB scheme is likely to be invested 50-60 per cent in equities
and the rest in gilts, while a DC scheme will be about 70 per cent
invested in equities. It is believed that with the arrival of the
new accounting standard FRS 17 next year, more employers will contemplate
switching from DB to DC schemes.
FRS 17 requires UK companies to measure the assets and liabilities
in the DB schemes they operate on an annual basis, hence revealing
the volatility in pensions costs.
“It doesn’t have anything to do with the trustees and
the long term costs of the benefits but the volatility will be hard
to manage which is another reason if they can get out to DB and
into DC they’ll lose that volatility. A move that would only
pay off if they are able to convert DB members to DC. You wouldn’t
have the advantage if you just shut the scheme to new members,”
says Jagelman.
The safekeeping of your assets in terms of custody, depending on
the type of scheme, is not really going to make much difference
between a DB and DC scheme – you have assets and you want someone
to look after those assets securely.
Freedman explains: “Typically in a DC scheme you’ll be
using a provider’s unitised funds so you would have less control
over who is the custodian because when you buy into a pooled fund
you buy everything about that fund.
While for DB schemes, it’s far more common to have segregated
fund management and choice of custodian.”
While there is no rush amongst employers to convert all their employees
to DC schemes, there are many issues to take into account when weighing
up the advantages and disadvantages of each option, which deserve
careful consideration.
–
Pensions Age June 2001–
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