The overwhelming majority of defined benefit pension schemes are running deficits at present due to a combination of factors, including adverse performance of investment markets, longevity of pensioners and tighter regulatory controls. So what are the options available to companies operating such schemes? Fiona Thornton explains. When a defined benefit pension scheme has a deficit, tough decisions have to be taken. The sponsoring employer needs to decide whether or not it wants the scheme to continue and what is involved in making that happen. It may also wish to establish if the scheme's documents allow it to terminate future contributions and effectively walk away from the deficit.
Separate actuarial and legal advice should be taken to inform the employer and scheme trustees of what might be done to restructure the scheme to enable its survival and to establish what options both parties have in this regard. Trustees and employers have different roles and responsibilities and they need to take separate advice.
The employer will need to reflect on the implications for the workforce of withdrawing the promise of a defined benefit pension as well as considering what alternative pension arrangements might be offered in the future. The employment law issues of making such a change must be examined in detail to ward off any claims by affected employees. And the position of employees, pensioners and those who have left service with accrued entitlements in the scheme must all be addressed.
Under the terms of the Pensions Act 1990, all pension schemes that are running deficits have to submit a funding proposal to the regulator, the Pensions Board. If a funding proposal is not submitted, either the scheme trustees will be directed to implement benefit reductions by the Pensions Board or, most likely, the scheme will be wound up. Funding proposals usually envisage that the employer and, increasingly, also the active members agree to pay extra contributions to the scheme to enable it to meet the Pensions Act's funding standard by the end of the recovery period.
A funding proposal needs to be agreed between the scheme trustees and the employer. Its purpose is to explain how the funding deficit will be eliminated over an agreed recovery period. The terms of the proposal need to be signed off by the Pensions Board. Recovery periods can be anything from three to ten years, and in exceptional cases longer. The Pensions Board has recently extended...