Section 75 Employer Debt in Non-Associated Multi-Employer Defined Benefit Pension Schemes

 

Employer Debt in Non-Associated Multi-Employer Schemes

Question 3.1 – if we were to make any changes, should we exclude associated multi-employer schemes / limit the provisions to multi-employer schemes? Changes should be made purely in relation to non-associated multi-employer schemes. Question 3.2 – if we were to exclude associated schemes / limit the provisions to non-associated schemes, how could we best achieve this? The CFG/NAPF working party made proposals for changes to the Section 75 regulations which would deal with this and we are supportive of those proposals.

Stakeholder views

Question 4.1 – has your organisation had any experience with the S75 debt regime as it applies to non-associated multi-employer defined benefit schemes? Yes. SCVO is member of The Pension Trust Scottish Voluntary Sector Pension Scheme and Growth Plan Scheme. Many of SCVO members are also members of these and other such schemes Question 4.2 – do you think that the employer debt regime for these schemes needs to be changed, or does it work as it currently stands? It does not work and needs to be changed. Question 4.3 – what data do you have that might support your answer to questions 4.1 – 4.2? No data to present.

Existing easements designed to help employers manage employer debt

Question 5.1 – has your organisation had experience of these easements? How often have they been used? It has not and our understanding is that withdrawal arrangements and apportionment arrangements have rarely been used in non-associated MEDBPS. Question 5.2 – how effective are the easements: For Schemes / For Employers? They remain complex and costly to implement and often do not deal with the need to cease future accrual which is usually a primary requirement as part of a corporate transaction. Question 5.3 – are there any weaknesses or problems with the current methods of managing employer debt? Yes, as per comments above. Question 5.4 – could we make the easements easier to understand and to use? Potentially, yes. However the easements fail to deal with the primary issues. Question 5.5 – what data do you have that might support your answer to questions 5.1 – 5.4? No data to present.

Other suggested easements

Question 6.1 – do the current employer debt provisions for multi-employer schemes need to be amended, or could better use be made of the existing easements to manage any problems employers or schemes may face? The debt provisions need to be amended for non associated employers. The easements do not deal with the automatic S75 debt trigger or provide the necessary flexibility required to deal with long term debt funding and trustee flexibility. Question 6.2 – what data do you have that might support your answer to question 6.1? No data to present Question 6.3 – should DWP support and encourage greater flexibility regarding debt repayment plans? The issue is that for many participants flexibility around the repayment of a cessation debt does not go far enough and does not deal with the timing issue over the settlement. In a stand alone scheme an employer may take 15-20 years to meet the technical provision deficit and then funding the cessation debt may take a further 15-20 years. That would mean that the cessation debt amount has a repayment term of 30+ years. The cessation debt flexibility would need to go beyond just having trustees impose the debt and lengthen the repayment term but also provide the flexibility not to trigger the cessation debt so that employers may have more flexibility around the timing of the cessation debt calculation. This would need to look more like the standalone or segmented funding flexibilities. Question 6.4 – how could any repayment plan recognise and balance the needs of employers and the scheme? This is effectively what happens in all other schemes. There needs to be a balance between the security of individual member’s benefits and a recognition that a strong employer provides security for benefits so contributions need to be affordable. We see no difference, therefore, between adopting the same approach which works for stand alone and segmented arrangements with MEDBPS. Question 6.5 – would a longer timescale increase the risk of default? Are there ways that this risk could be mitigated? The longer the timescale the greater the risk of default; however this must be offset against potentially lower liabilities on default given the ability to cease future accrual, the likelihood of higher deficit contributions as future service contributions are re-directed in to past service deficit repayments, and the likelihood of a greater number of participants being able to settle the ultimate debt, which would not be the case with future accruals. Question 6.6 – what data do you have that might support your answer to questions 6.3 – 6.5? Our membership, and feedback of SCVO’s members supports answers to 6.3 – 6.5 Question 6.7 – what could the consequences and risks of making this change be for:

• The Scheme? – Schemes could ensure that only those employers who actually wished to accrue further DB liabilities and could afford to do so were continuing to build future service benefits. Schemes could also ensure that the focus of contributions was on meeting the past service liabilities rather than on accruing further liabilities and could ensure that the cross contamination risk among employers was minimised.

• The employer? – Employers who have recognised the unsuitability of further DB accrual will be able to deal with the issue. They will also be able to simplify and rationalise the benefit provision they offer. In the round we can only see such a change having a positive impact.

• Other employers in the scheme? – Employers who have gone ‘beyond the point of no return’ within schemes represent a significant risk to other employers in MEDBPS. There is no incentive for them to effectively manage their liabilities and they know that at some point these will be picked up by other employers or the PPF. This has the potential to lead to reckless behaviour.

• Members of the scheme? – With no further enforced accrual, contributions can be focussed on meeting past service obligations to improve member security.

• The PPF? – the greatest risk to the PPF is the continual accrual of benefits for organisations who can’t afford to support them, resulting in a domino effect in the scheme, resulting in multiple insolvencies and therefore a requirement for PPF protection. Limiting accrual greatly limits this risk.

Question 6.8 – how could the relationship between a scheme and its non-active employers be managed best? Future accrual of benefits does not in our view create a stronger bond to the funding of a pension scheme; in fact if that accrual is being enforced it could well create a negative relationship with the scheme. There are a huge number of closed schemes now operating in the UK and we do not believe that there is any statistical evidence which can be presented to say that employers are less likely to fund these, or indeed less committed to do so. If employers are placed in a position where they can see a definitive target to aim for they are, in our experience, much more focussed on achieving it as quickly as possible. In addition, ultimately the Trustees retain the ultimate sanction as should contributions not be maintained in accordance with any agreed funding plan they can chose to enforce the section 75 debt at any point. Question 6.9 – would a scheme’s risk profile be affected, and if so, how would this be managed? What would the consequences be? In terms of investment sectionalisation this is again something which is dealt with regularly within schemes. There should be a difference between the investment strategy adopted where schemes are closed to future accrual than those which remain open, and indeed between employers with different covenant strengths. Currently in MEDBPS there is a significant mismatch given the artificial mechanisms used to manage liabilities and the lack of even notional segmentation. Most schemes are in any case already adopting much more prudent investment approaches to reflect a decline in new joiners. Question 6.10 – what data do you have that might support your answer to questions 6.7 – 6.9? If we take the two leading social housing pension schemes, The Social Housing Pension Scheme (‘SHPS’) and the Scottish Housing Association Pension Scheme (‘SHAPS’); both of these offer a DC option under the Trust to allow employers to cease DB accrual. The Pension Trust also provides similar flexibility in their CARE Schemes and Growth Plan. The Trustees can communicate with employers on a consistent basis and have adjusted the investment profile to reflect the number of employers continuing to accrue benefits Question 6.11 – are there any other ways in which an employer’s covenant strength could be assessed and liability could be calculated. In terms of private sector MEDBPS in most cases the ultimate objective should an employer cease accrual is to move to a point where the liabilities can be secured with an insurance company. This means that any basis calculating the cessation cost should reflect the ultimate cost of securing benefits via an annuity. This is consistent with the basis currently adopted by most schemes. Should there be no intention, or ultimate requirement, to secure benefits then it is questionable if a buy-out type basis is applicable. In the case of LGPS for example it is not subject to the employer exit debt regime of Section 75 of the Pensions Act 1995. However the Fund Actuary will tend to adopt the same approach for assessing the debt due when employers exit the LGPS. Whilst this is not surprising given the actuarial experience of using S75, such an approach we would contend is inequitable as the design of the LGPS scheme itself does not fit well with the rationale behind the actuarial methodology and policy intentions that created S75. Within LGPS the benefits will continue to be provided from the Fund so that the S75 level of Exit Debt sought by LGPS Funds is therefore only being used to effectively subsidise other employers remaining in the Fund as benefits will never be secured outside the scheme. There is a recognition that an LGPS needs to adopt a margin for prudence on an employer exiting to ensure that those organisations remaining have limited risk of being required to pick up liabilities on behalf of another organisation. However, adopting a gilts based cessation basis is excessive given benefits are not being secured and as the admitted bodies’ assets post cessation are not being invested in a gilts based strategy to de-risk this is a totally unreasonable approach. A more realistic scheme orientated basis should be adopted e.g. adjusted rate based upon the discount rate applied in the LGPS on-going funding valuation plus a discontinuance margin. LGPS should in our view seek to recoup any deficit up to the on-going level over as short a period as practically possible however with any agreed ‘margin payment’ due paid over the medium to long term based upon affordability or if additional security is offered in lieu of the debt payment. The key point is that the S75 legislation and the LGPS Regulations should be flexible enough to allow for both an exit debt to be calculated and imposed on an on-going basis and also for the debt to be paid over time. In terms of covenant assessment we have already seen some flexibility in approach adopted by the Pensions Regulator in designing a specific charitable score-card to look to deal with the differences in financial assessment of charities. It is undoubtedly often going to be the case that charities will not have access to large lump sums in cash to provide Escrows or access to property or other security however they do tend to have a very steady long term income stream which can support repayments over the longer term. Trustees of MEDBPS will also have to recognise that for most a cessation debt is unaffordable and in most cases accessing some form of funding is much preferable to seeing a charity enter administration and no further contributions being available, with a resultant increase in orphan debt. It is therefore key to realistically identify what is affordable and have that paid to the fund. Therefore whilst we would support a revision to the cessation basis applicable in funded public sector schemes we believe that the basis applicable under S75 is broadly correct in protecting members and all employers’ interests in non LGPS arrangements. Question 6.12 – what could the consequences and risks of making this change be for

• The scheme? The Scheme needs to consider a number of factors. Would it improve the overall security of the Scheme by not allowing weak employers to continue to accrue additional benefits? We believe it would. Whilst the Scheme would not benefit from the immediate payment of the cessation debt (which most participants would not be able to pay anyway) would it be more likely to receive a greater proportion of the debt due from more employers? We believe it would as the debt could be paid off over affordable timescales and we believe that the money derived would be greater than that lost as a result of insolvency where there is likely to be a minimal recovery. From experience clear communication around this issue is vital and this could become a core element of scheme reporting.

• The employer? We believe that employers would be more committed to funding down their deficit if they could see a clear strategy to reduce it over time rather than a constantly growing unaffordable objective. Clear parameters could be set based upon affordability and employers in non associated MEDBPS would be on a consistent footing with other schemes.

• Other employers in the scheme? Employers who can afford to continue to accrue additional DB liabilities would be placed in a more secure position knowing that employers who were unable to take these risks were not being allowed to do so.

• Members of the scheme? The scheme covenant would be stronger so benefits would be better protected as only those who could afford the risk would be in a position to take it. Schemes would see future service contributions redirected to pay off past service debt thereby improving the finding position and overall member security.

• The PPF? As with members PPF security would be increased through higher deficit funding contributions and a stronger overall covenant.

Question 6.13 – what data do you have that might support your answer to questions 6.11 – 6.12? No data to present Question 6.14 – are there any other approaches not listed here that we should consider that might improve the employer debt regime for employers, schemes and members? Currently there is a risk that should a Trustee seek to compromise a debt within a MEDBPS that this will place the Scheme in a position where it would lose PPF protection across the whole scheme. We believe that, as with other schemes, trustees should be allowed to negotiate compromises with employers should they consider them to be in the interests of the Scheme as a whole without this threat. It is quite clear from a number of examples that should this be available trustees would have recouped a significant amount of additional funds from a charity for the benefit of the Scheme and remaining employers than would be the case in the event of an insolvency. This would also reduce the risk of a claim on the PPF. Question 6.15 – what data do you have that might support your answer to question 6.14? Spirit of Enniskillen Trust and People Can are both relatively recent examples of this in the public domain.