Limiting liabilities

The ;current ;climate ;of economic uncertainty and the threat of a recession brought about by the subprime debacle and the ensuing credit squeeze have only added to the long list of risk issues facing companies. Coupled with added pensions pressures of, for example, longevity risks, mortality assumptions, deficits and the obligations now placed upon trustees (including their importance in the M&A market), this means there will inevitably be companies that will wish to consider – in some cases again – ways to reduce costs and risks associated with their defined benefit pension arrangements.

A great many employers have already sought to manage liabilities by closing schemes to new entrants or even ceasing future accrual – neither of these steps being without their difficulties, as we have seen in recent press. Different benefits designs have been adopted and specific benefit changes made. The pressures on companies and trustees have invariably pointed to other trends and developments.

More recently, there has been increasing activity in the buyout market, with a greater number of providers and a number of innovative solutions on offer. There has also been greater scrutiny of scheme provisions, such as where the powers lie between employer and trustees and the conditions attaching to the payment of benefits.

In this extremely complex pensions environment, keeping up to speed on legislative and regulatory developments is crucial. They could be the key drivers in managing pension scheme liabilities. And while change has been the flavour of the past few years, we have certainly had a strong dose over the past few months.

So what is new? Developments in the pensions market and concerns surrounding certain business models led the Department for Work and Pensions (DWP) to issue, on 14 April, far-reaching proposals to change The Pensions Regulator’s (TPR) powers to issue contribution notices and financial support directions, better known as the ‘moral hazard’ or ‘anti-avoidance’ powers.

Contribution notices

Of the changes, the significant shift relates to contribution notices. TPR will, with retrospective effect (from 14 April), be able to issue a contribution notice where the effect of an act is materially detrimental to a scheme’s ability to pay members’ current and future benefits, thus removing the link to the statutory employer debt. The requirement to prove intent has also been removed. The result is a much wider-ranging power.

Considerable concerns have been voiced in the pensions industry about these changes, and unsurprisingly. At a practical level, how are current and future transactions going to be affected by these changes? Will we see a greater level of clearance applications to TPR? Measures to contain pension costs must now take these changes on board.

One of the DWP’s stated aims behind the changes is to protect the security of members’ benefits where the link between employer and scheme is severed and well-funded schemes are run for profit, which could be detrimental to the scheme. There has been some clarification from the DWP and TPR which suggests that the powers might be of narrower application. However, we need to see both the outcome of the consultation exercise and what the draft regulations say.

We now have TPR’s new clearance guidance (March 2008) which, while saying nothing new (simply because in many respects it reflects how practice has developed), sets out in some detail the role of companies and trustees in relation to clearance issues and how the employer covenant is to be approached/assessed.

The employer covenant (the ability and willingness of the employer to support the scheme) is not a new concept, but the inclusion of detail in TPR’s guidance will serve to reinforce the message to companies that when looking to manage liabilities, trustees have clear obligations to evaluate the employer’s financial position (and/or the wider group) when asked to agree scheme changes.

The threat of an employer statutory buyout debt (under Section 75 of the Pensions Act 1995) being triggered always looms heavily in any exercise that involves an element of corporate restructuring. New debt regulations took effect from 6 April 2008. These make significant changes to the employer debt regime and we need to see how these new provisions work in practice.

Of assistance is the 12-month ‘period of grace’, which buys time so as to prevent the debt being triggered. It is unfortunate, however, that the new regulations do not appear to have been sufficiently thought through – the result being that further amending regulations were issued shortly afterwards. There are still a number of areas that continue to be in need of clarification.

While grappling with these complex requirements, there remain a host of other issues that need to be considered by companies when considering options – including other areas falling within TPR’s remit, consultation with members/employees, as well as corporate finance, banking and, potentially, insolvency issues.

Jay Doraisamy is head of the London pensions department at Hammonds