Flexible apportionment arrangements have become a commonly used tool for employers but, as Andy Lewis says, there can be issues for the unwary.
Many of you reading this will have come across flexible apportionment arrangements (FAAs) before. The great advantage of FAAs is that they allow an employer to leave a multi-employer scheme without any residual liabilities, avoiding a statutory section 75 debt becoming payable when the employer exits the scheme.
However, there are also more sophisticated ways of using FAAs wherever it is desirable to move scheme liabilities from one employer to another - for example, as part of a group reorganisation or when preparing for the sale of a company.
FAAs have become so familiar that it's easy to think there is nothing more to say about them. But sadly, they do still contain traps for the unwary - so even today it is worthwhile pausing before signing on the dotted line. Here are some top tips.
Start with the bigger picture
FAAs are sometimes presented as simple administrative matters. This may or may not be true, depending on the wider circumstances, in particular because FAAs can (and very often do) affect the employer covenant.
Sometimes this impact may be minimal - such as where other scheme employers take over not only the leaving employer's pension liabilities but also its business and assets, or when the leaving employer's covenant is negligible compared to a much larger or more profitable fellow sponsor. Other cases will be trickier - for example, where the leaving employer is being sold out of the employers' group, what is happening to the sale proceeds? Difficult calls can also arise if the leaving employer's individual statutory debt would be small but its value within the overall covenant is significant, or where 'replacement' covenant support is structured around a holding company - which on the face of it looks good but in fact may have few assets of its own save for its subsidiaries.
It is certainly possible for everyone to approach an FAA in a pragmatic way, but the choice of approach should be an informed one based on a rounded understanding of the FAA's context. Pensions Regulator guidance makes clear that there needs to be a solid justification an FAA, taking account of the covenant implications. It therefore makes a lot of sense for businesses and trustees to discuss the bigger picture surrounding the FAA with their advisers (and each other) at an early stage.
Don't dismiss the 'funding test'
The funding test is one of the key legal requirements for an FAA. Broadly, the funding test is designed to ensure that the remaining employers will be able to continue funding the scheme on an ongoing basis after the FAA, and that the security of members' benefits isn't prejudiced.
On the face of it, this does not look like a difficult test to meet, especially if the wider covenant impact of the FAA is neutral.
However, a closer inspection of the precise legal drafting of the test reveals some potentially deeper questions. How often, for example, is there a serious discussion with the scheme actuary about whether and how the scheme's ongoing actuarial funding basis and arrangements are affected by the leaving employer's departure under the FAA? There are also other arguable legal readings of the test which make it much stricter, requiring a much wider consideration of things like possible long-term outcomes for the scheme and higher contribution demands on the remaining employers.
So although there can be a strong temptation just to tick the box, it is right to treat the funding test as something more than a formality.
The funding test is only one part of an FAA. The legislation contains additional legal hoops, and it's a good discipline to work through these carefully. If something gets missed, even if it's relatively minor, the FAA may not work as intended.
For example, if the scheme is closed to further accrual of pensionable service, a change in the legislation last year removed some of the legal bureaucracy around entering into an FAA but created potential wrinkles in other areas. And if there are defined contribution (DC) benefits in the scheme, take care when selecting the replacement employer: an employer that has only ever employed DC members can't participate in an FAA unless special arrangements are made for it to employ people who accrue some (probably notional) DB benefits.
Show your working
Trustees are required to notify The Pensions Regulator about FAAs and the regulator's starting point is to ask a series of questions about the circumstances and how the trustees got comfortable Planning for these sorts of questions from the outset, bearing in mind the regulator's guidance mentioned above, and documenting advice and decisions thoroughly as the FAA process moves along, can all therefore pay dividends in the long run.
Andy Lewis is a pensions partner at Travers Smith
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