Happy ending

Defined benefit schemes are gently dying. The escalating cost of maintaining a DB occupational scheme is encouraging many companies to re-think their options. Offloading schemes, which are often large and uncontrollable sources of risk, to a third party is becoming increasingly attractive to management and shareholders who consider the risks to be unacceptable.

Paradoxically, it is in trying to give transparency to occupational pension schemes that the government has inadvertently helped to kill off DB schemes. But the net result of the legislative changes, for many companies, is that supporting an in-house DB pension scheme requires too much compliance, is too risky and is just not worth the hassle and distraction from mainstream business activity. In addition, training trustees costs companies time and money.

Accounting standard FRS17 rules can make businesses appear insolvent as businesses must account for any surplus or deficit in a defined benefit scheme and some schemes are now larger in asset terms than the company’s main business. In addition, pension issues regularly hold up or stand in the way of corporate takeovers.

Legislation has given much more power to the trustees, which has altered the originally intended balance of power between the company and its pension scheme. Trustees can pressurise a company to make contributions, even if the company does not think it is necessary, and since trustees generally control investment strategy an over-prudent attitude can increase the cost of running a scheme.

To help resolve these issues, there are now increasing numbers of insurance companies in the pension buyout market. But many pension schemes are not funded to a level where they can afford buyouts with an insurance company and often trustees do not think buyouts are in the best interests of the members.

Pension funds were originally set up to invest in a wide variety of assets and to get a reasonable risk-adjusted return so they could pay members their full benefits. But insurance companies are compelled by regulation to invest in gilt-type assets (often expensive and inappropriate), so unless the scheme is very well funded the insurance route might not be cost-effective.

For many schemes, therefore, remaining in the pensions fund arena may be the best option for members, although after an insolvency event they might have no option but to go to an insurance company or enter the Pension Protection Fund.

An alternative solution has now emerged; occupational pensions trusts. Schemes that might otherwise enter into the PPF may well be able to provide a better payout to members if they could continue as occupational pension schemes. Joining OPT enables them to facilitate this. For other companies, particularly those with weak sponsoring employers, a cash injection today in return for allowing the sponsoring employer to relinquish its covenant could be in the best interests of members. Again, the pension scheme would need a new owner and OPT is available to step into this role.

Finally, as part of a corporate transaction a pension scheme might be transferred to a new sponsoring employer who does not wish to have the responsibility of a pension fund. An OPT transfer solution would be to take on the pension scheme in place of the acquiring company.

Since the schemes continue to run as an occupational pension scheme, they remain backed by the PPF and OPT has appointed a distinguished board of trustees to ensure that the new scheme is likely to enjoy “best of class” trusteeship and governance.

OPT now provides an attractive, safe and highly cost-effective alternative to the conventional buyout route with an insurer, and may enable many schemes to combine the advantages of a trusteed pension, with the benefit of removing the liabilities and compliance obligations from the employer.

Ben Shaw is development director of the Occupational Pensions Trust