Employers ceasing to participate in an underfunded multi-employer DB scheme: draft amendments to employer debt requirements

Summary

The current employer debt regime is complicated, problematic and inflexible. The De-Regulatory Review published on 25 July 2007, judicial comment and industry lobbying have all led the Department for Work and Pensions to consult on amendments to it.

The proposed amendments would make sweeping changes. In particular they:

• Clarify what events trigger an employer debt.
• Provide a new default method for calculating an employer's share of the debt.
• Set out ways in which an employer debt may be apportioned provided schemes are not abandoned.
• Change the operation and approval of withdrawal arrangements.

This briefing note considers the proposed amendments. For details of some of the developments leading to the current proposals please see our earlier briefing notes, especially:

• August 2005: "Employers ceasing to participate in multi-employer schemes: buy-out debt imposed"
• January 2007: "Apportionment of employer debts: L v M Ltd"
• May 2007: "Regulator's guidance on abandonment of DB schemes"

How the employer debt regime operates at present: a quick reminder

Currently, when an employer ceases to participate in a multiemployer DB scheme (but at least one other employer continues) a debt will arise unless the scheme is fully funded on the buy-out basis. The amount of the employer's debt is, in essence:

• The proportion of the buy-out debt which is attributable to employment with that employer plus a proportionate share of the "orphan debt"; and
• The expenses attributable to the employerís ceasing to participate,

(together the "buy-out debt").

How an employer may currently reduce its buy-out debt: a quick reminder

The leaving employer does not have to meet the full buy-out debt where:

• The Pensions Regulator has approved a "withdrawal arrangement" - an agreement that the leaving employer will pay at least the minimum funding requirement debt and the guarantor(s) will pay (broadly speaking) the balance.
• The scheme rules provide that the debt is apportioned in a different way (but, at least since the L v M case, this needs Regulator approval in practice).

The new debt regime: when will an employer debt be triggered under the proposed new regime?

The draft regulations provide that an employer debt will be triggered on the date:

• The employer ceases to employ any person who is an active member of the scheme; or
• Where the employer has notified the trustees that it intends to employ an active member in the next 12 months and the scheme is not closed to new active members, the end of that 12- month period (or sooner if a change in that intention is notified or there is an insolvency).

Scheme assets and liabilities: how will they be calculated?

The trustees will be involved with decisions on calculating, determining and verifying the scheme assets and liabilities.

New scheme accounts or valuation will not be needed before the employer debt is determined. Instead, trustees can, when it is appropriate, update current accounts/valuation in consultation with the auditor/actuary. Current accounts/valuation may only be updated where their effective date is no more than 12 months before the effective date of the employer debt calculation.

How will the leaving employer's share of the debt be calculated/apportioned?

The draft regulations provide five ways in which the employer's share of the debt is to be calculated/apportioned:

• Liability share
• Scheme apportionment arrangement
• Regulated apportionment arrangement
• Cessation agreement
• Approved withdrawal arrangement

What is the liability share?

This is the default method of calculating the leaving employer's share of the debt. The employer's scheme liabilities are determined by the trustees and actuary as follows:

• The liabilities in relation to the employer's scheme members (only those liabilities relating to pensionable service with the leaving employer, but including transferred in benefits).
• Where the trustees are unable to determine the exact liabilities attributable to the leaving employer (or where that would lead to disproportionate cost):
  1. If the leaving employer is the last employer of any member, all liabilities will be attributable to the leaving employer, or
  2. If the trustees are unable to determine if the leaving employer was the last employer of any member, the liabilities in respect of that member shall not be attributed to any employer.

What is a scheme apportionment arrangement?

It is an arrangement made before or after the date the leaving employer ceases to participate which sets out the leaving employer's share of the debt.

The trustees may only enter into an arrangement where:

• They agree the amount of the leaving employer's share of the debt.
• They are satisfied that at the date of the agreement the remaining employers are able and willing to:
  1. Fund the scheme's technical provisions.
  2. Make payments to the schedule of contributions and the recovery plan.

This requirement does not apply where:

1. The scheme apportionment share is greater than the liability share and the leaving employer is able to pay, or
2. At the date of the agreement the scheme is in winding-up, the apportionment share is less than the liability share but the trustees are satisfied that the leaving employer would be unable to meet the liability share if it applied.

Where the scheme has not had its first scheme funding valuation, the trustees must be satisfied that the arrangement does not adversely affect the likelihood of all members receiving full benefits after the cessation of participation, after taking into account the financial resources of the remaining employers.

What is a regulated apportionment arrangement?

It is an arrangement which:

• Applies to a scheme where the trustees are aware that there is a reasonable likelihood that the scheme will enter a Pensions Protection Fund assessment period in the next 12 months.
• Sets out the amount of the leaving employer's debt.
• Is agreed by the trustees.
• Is approved (together with any amendments to the arrangement) by the Regulator.

The Regulator may issue a notice of approval for a regulated apportionment arrangement where:

• The application is made by the employer before the debt is triggered with the relevant supporting information.
• The PPF agrees.
• The Regulator considers that the arrangement may result in a higher level of scheme funding than if an insolvency event occurred in relation to the employer.
• The Regulator has considered all relevant matters including:
  1. The likelihood of an insolvency event not occurring, and
  2. The financial effects of the proposed arrangements on the employer's creditors and shareholders.

What is a cessation agreement?

It is a less prescriptive version of an approved withdrawal arrangement. It must meet certain requirements including:

• Specifying the amount the leaving employer must pay and when. This must be (broadly speaking) an equal to or more than its liability share (Amount A).
• Specifying the amount the guarantor(s) are liable for (Amount B).
• Specifying who (other than the trustees) will meet expenses.

The trustees may only enter into a cessation agreement where they are satisfied at the date of the agreement that:

• The ability and willingness of the remaining employers to fund the scheme is not adversely affected by the fact that Amount A plus Amount B will not equal the liability share.
• The guarantor(s) have sufficient financial resources to be likely to pay Amount B.

What is an approved withdrawal arrangement?

This is a proposed evolution of the current withdrawal arrangement regime under which it will be easier for an arrangement to be approved. The main changes are:

• An arrangement may be entered into before an employercessation event.
• The amount to be paid by the leaving employer is, broadly speaking, the liability share unless the Regulator agrees an alternative amount which may be lower.
• The amounts to be paid under the arrangement may be paid in installments.
• The requirement for an arrangement to be approved only where the debt is more likely to be met if an arrangement is in place has been removed. Instead the Regulator must consider relevant matters.

Comment

At present the full buy-out debt is payable unless a withdrawal arrangement is approved or the scheme's rules provide for it to be otherwise apportioned (and, generally speaking, the Regulator agrees). In practice, employers used the scheme rule route more often. However, as the L v M case demonstrated, this approach presents difficulties. The DWP's attempt in the draft regulations to address the problems with the employer debt legislation is, broadly, to be welcomed.

One of the difficult issues now is exactly when an employer debt is triggered. The draft regulations make it clear that a debt will be triggered once an employer has no more active members (unless the relevant notice is given where the employer expects to have further active members in the next 12 months). The issue with this is that an employer debt may still be triggered on a group restructuring even where there is no adverse affect on employer covenants and the employers wish to stand behind the scheme. In addition, the debt will be triggered on closure to future defined benefit accruals where future pension provision is provided from a different arrangement (again regardless of the strength of the remaining employers' covenants).

Another difficult area now is how a member's liabilities are allocated where the member has been employed by more than one participating employer. We welcome the fact that the DWP intends that liabilities should be divided between the different employers unless records are inadequate, in which case liabilities are attributed to the last employer.

The DWP has now recognised that it is not always appropriate for leaving employers to have to shoulder the full amount of the debt which has to be paid immediately. To that end, the DWP proposes various agreement mechanisms which can be used to apportion the employer debt and avoid scheme abandonment. We welcome the fact that the draft regulations allow apportionment agreements to be put in place both where the scheme can cover its technical provisions and the remaining employers are strong as well as instances where the scheme is in deficit and the remaining employers are weak. At the same time, it is important to note that the option to apportion the debt under the scheme rules will be removed. It will be interesting to see which new option proves most popular with employers and trustees.

This briefing note is based on the DWP consultation document "Amendments to the Occupational Pension Schemes (Employer Debt) Regulations 2005: consultation on the draft Occupational Pension Schemes (Employer Debt)(Amendment) and Pension Protection Fund (Multi-employer and Entry Rules)(Amendment) Regulations 2007" published on 7 August 2007. Consultation closes on 1 October 2007