Are you having sleepless nights worrying about your deficit? Are you plagued by a nagging doubt that you have missed the boat on buying in or buying out liabilities? It is easy to get caught up in a feeling that managing pensions liabilities is an impossible task.
Buying out liabilities may not currently be an affordable option for many schemes, but there are still a number of steps that employers and trustees can take to manage risk and better secure past service liabilities.
Scheme specific "de-risking solutions" have been an integral part of the pensions landscape for years under their simpler description of "benefit changes". Whilst such changes can be a precursor to cessation of accrual, some are simply stand alone changes which operate to reduce risk without ceasing accrual. Historically changes have usually been made on a permanent basis, but in the same way that funding is reviewed annually, it should be possible to put in place temporary or "conditional" changes that revert to the unamended position on, for example, the employer meeting certain financial triggers or targets.
As a reminder, here are ten benefit changes and liability management exercises that can generally be made to an occupational pension scheme to manage and, in some cases, share risk but without going as far as ceasing accrual.
1. Close the scheme to new entrants – the Pension Regulator's Purple Book 2008 www.thepensionsregulator.gov.uk/pdf/PurpleBook2008.pdf showed that 31% of the PPF–eligible predominantly private sector schemes surveyed were still open to new members.
2. Reduce the rate of future accrual and/or require increased member contributions for the current (ie higher) accrual rate. Here active members can opt to pay more for their current accrual rate or pay the same for a lower accrual rate for future service.
3. Vary the definition of "pensionable salary" for future service to reduce the cost of ongoing accrual - for example by excluding overtime or capping pensionable pay rises. The latter option has been adopted by both Legal & General and Marks & Spencer.
4. Raise the normal retirement age. The state pension age for men and women will rise to age 68 by 2046 and so occupational schemes may well follow this trend.
5. Put in place salary sacrifice to take advantage of national insurance savings for the member and the employer.
6. Review and update commutation, early and late retirement factors to remove funding strain from the scheme if they are not currently cost-neutral.
7. Limit the rate of increases on pensions in payment and revaluation of deferred benefits to the statutory minimum. This is likely to require some form of financial compensation to be paid to any members giving up a right to increases above the statutory cap. ITV is in the process of offering members a uplift to their pension in return for giving up future increases.
8. Carry out an enhanced transfer value exercise – but read the Pension Regulator's guidance first at http://www.thepensionsregulator.gov.uk/guidance/inducementOffers/index.aspx to ensure that members are given sufficient information to make an informed choice.
9. Remind deferred members of any right to take early payment of their pension. This this may be a timely exercise given that the earliest age for drawing pension benefits will rise to age 55 in April 2010.
10. Remind members of any right to the trivial commutation. This involves cashing in a small pension pot.
Of course I am not recommending that employers or trustees charge ahead with any of these options without taking appropriate advice and having a very good look at the powers and provisions of their trust deed and rules and also at the contents of the employment contracts of active members. The statutory restrictions on scheme amendments under section 67 of the Pensions Act 1995 may need to be considered and possibly also the rules relating to benefits contracted out on a reference scheme basis.
For employers, the guiding principle is not to do anything that would seriously damage its relationship of trust and confidence with its employees. Formal employee consultation will be needed for "listed changes" (such as increasing member contributions, increasing normal pension age, reducing future accrual rates and/or closing the scheme to new members) and any responses to that consultation carefully considered.
Where amendments to the scheme rules are proposed, the trustees will need to act in the best interests overall of the beneficiaries but also take into account the employer's views. In the current economic climate it should not be too difficult to demonstrate that benefit changes and/or a liability management exercise are reasonable in the circumstances, in particular where the result is to better secure benefits earned to date.
