Three Key Issues for Employers with Defined Benefit Pension Schemes

In this bulletin, we take a look at three key pensions issues which need to be on the radar of employers who sponsor a defined benefit pension scheme.

1. A more aggressive, more powerful Pensions Regulator

2018 is likely to see the Pensions Regulator being much quicker to use its powers, and the fall out from Carillion's insolvency may result in the Regulator being given more powers, such as the power to claw back bonuses from executives if a company fails leaving a pension scheme in deficit.

The Pensions Regulator already has a broad range of powers, including its "moral hazard" powers which allow it to require extra funds from scheme employers and connected persons including directors personally if they have been party to an act or omission that increases the risk of members not receiving their benefits in full. In the wake of BHS's insolvency, the Regulator was publicly criticised by Parliament's Pensions Select Committee for being too slow to make use of those powers. In response, the Regulator announced it would be more pro-active and quicker to act in future. By the end of 2017, we were already seeing evidence of this, and that was before the insolvency of Carillion.

One issue which has attracted media attention in relation to both BHS and Carillion is the level of dividend payments made during periods when the pension scheme deficit was increasing. The focus of MPs and the media on this issue could cause the Regulator to take a tougher line on companies paying dividends while their schemes are in deficit.

A joint inquiry by the Work and Pensions and BEIS parliamentary committees is investigating the way Carillion was run and the implications for company and pension scheme regulation. The Chair of the Work and Pensions Committee has already written to the Pensions Regulator with a list of questions about the Regulator's involvement with Carillion. The pressure on the Regulator to demonstrate that it is willing and able to use its powers means that we expect to see the Regulator becoming increasingly proactive.

The government has blown hot and cold over the past 12 months on the issue of whether to grant the Regulator more powers. Carillion's insolvency has put this back on the political agenda, with the Prime Minister writing in the Observer shortly after Carillion entered into insolvency, "In the spring, we will set out new tough new rules for executives who try to line their own pockets by putting their workers’ pensions at risk – an unacceptable abuse that we will end."

Although the Prime Minister's statement does not go into detail on the proposed new measures, the press is reporting that other measures being considered include:

• new powers to block or place conditions on takeovers that would put schemes at risk;
• power to financially penalise executives personally if the employer goes bust leaving a pension scheme with a deficit, perhaps by clawing back executives' bonuses; and
• power for the Regulator to issue punitive fines on company directors in cases of clear wrongdoing.

Before Carillion's insolvency, the government had already announced a White Paper on defined benefit pensions, but the timescale for its publication has twice slipped. The Prime Minister's intervention makes further timetable slippage unlikely.

Separately from the fall out from BHS and Carillion, the court is due to give a ruling in the long running "Box Clever" litigation regarding the extent to which the Regulator can look back at events before its moral hazard powers came into existence (6 April 2005) when deciding whether to use its moral hazard powers.

Employers who are undertaking any corporate activity e.g. significant acquisitions or disposals, dividend payments, group reorganisations or refinancing need to be considering very carefully the impact of this on their defined benefit pension scheme.

The parliamentary select committee's response to the BHS and Carillion insolvencies has shown that if a large company goes bust leaving a large pension scheme deficit, senior personnel from the company can expect to find themselves called before the committee to account for their actions or failure to act.

It is crucial to have a clear, consistent and thorough paper trail in place (which may include appropriate board minutes supported where necessary by legal and covenant advice) to demonstrate that the pension scheme was given due consideration by the board in any corporate activity.

2. RPI/CPI: will the latest developments impact your scheme?

The statutory minimum basis for pension increases changed from RPI to CPI from 1 January 2011. The impact on individual schemes depends on the wording of their scheme rules. Cases relating to the ability of schemes to move from RPI to CPI continue to occupy the courts. Recent case law has led some employers to re-consider whether a move from RPI to CPI might be possible in relation to their scheme. We attach a link to our guide on this issue.

The case law in this area continues to develop as more schemes re-consider this issue. In January 2018, the High Court gave its judgment in a case involving a section of the BT Pension Scheme. The rules provided for "cost of living" increases, calculated by reference to RPI but allowed the scheme's principal employer to substitute a different measure if RPI "ceases to be published or becomes inappropriate". The employer argued that RPI had become inappropriate. Although the court did not find in the employer's favour on this occasion, it is a reminder that a scheme's liabilities can be materially reduced if it is possible to move from RPI to CPI and employers are therefore well advised to consider the possibility of doing this for their scheme if they haven’t already. BT has been granted permission to appeal and expects the appeal to be heard within the next year.

3. Impact of transfers-out on de-risking strategies

Many defined benefit schemes have been seeing a significant increase in transfers out of the scheme in the last 12 months. Overall this is likely to be good news for employers, as it should result in reduced scheme liabilities and an improvement to the funding position.

Many schemes are finding that the combination of transfers out (which increases the proportion of remaining scheme liabilities attributable to pensioners) and good pricing from insurers is making buy-out viable much sooner than may have been anticipated. There is a considerable amount of preparation that needs to be done in advance of a buy-out of benefits. If this work is completed it can enable a scheme to move quickly to take advantage of optimum insurer pricing.

We recommend that employers proactively engage with their trustee boards to understand the impact transfers are having on their scheme and to consider whether de-risking strategies including buy-out may be viable in the short to medium term.

In some cases a large number of transfers out may have an accounting impact which should be discussed with the accountants to avoid any surprises.