Trustees should take independent advice before agreeing to any transaction which could lead to the abandonment of a defined benefit occupational scheme, warns the Pensions Regulator.
Following concerns it first raised in October on scheme abandonment, the Regulator has issued trustee guidance and a 47-page discussion paper to ask for views from the industry on its plans to regulate possible instances of scheme abandonment, and the factors trustees should consider when looking at proposed transactions.
In the document the Regulator debates the available methods open to schemes to manage the risks to their DB schemes, such as the buy-out of liabilities by insurers, and the use of contingent assets.
But while the Regulator says trustees have the prime responsibility for safeguarding member’s interests and warns it expects trustees to “place an especially high level of scrutiny on any arrangement which breaks the link with the current employer”, it does recommend trustees to seek independent advice.
It points out trustees should take “independent advice before agreeing to any proposed abandonment arrangement. The advice should be appropriate and commensurate to the arrangement being proposed.”
But it also warns trustees should identify exactly how the advice will be paid for, adding “trustees should not agree to any proposed abandonment arrangement without suitable advice, and should not agree to consider the arrangement without ensuring they have secured the resources to finance the advice without jeopardising the scheme’s security.”
In addition to outlining the questions trustees should ask when considering a transaction which breaks the employer link, the paper lists the options currently available to mitigate the risks of a DB scheme, but warns the buy-out of pension liabilities by a regulated insurer is not likely to be an attractive short-term solution.
Despite an influx of new entrants to the bulk annuity market over the last few months, the Pensions Regulator says employers may be put off by the high exit cost, as it claims on average the buy-out cost is 50% higher than the Financial Reporting Standard 17 (FRS17) calculation of scheme liabilities.
And while it suggests the difference between FRS17 and full buy-out costs may narrow as schemes mature, it says in the near future employers are more likely to seek intermediate solutions to mitigate the risks of DB schemes at a lower cost than a buy-out.
As a result the Regulator says while it is keen to see innovative thinking being applied to the way pension schemes manage their funds, it says it has become aware of proposed corporate transactions where the primary intent is for the employer to abandon a scheme by transferring it to a nominal employer without paying the Section 75 debt, which is the full buy-out cost of the scheme’s liabilities.
Meanwhile the discussion paper, which closes to responses on 9 February 2007, reveals the organisation will apply the rules it uses in its current clearance procedure to potential abandonment cases.
Tony Hobman, chief executive of the Pensions Regulator, says: “We recognise the definition of abandonment may not be clear cut in every case. That is why we believe guidance is needed. It will help trustees identify transactions which may result in abandonment, and guide them on factors to assess when reviewing the merits of the transaction for scheme members.”
But he points out the Regulator continues to believe that in most situations the best means of delivering pension scheme members’ benefits is to have the continued support of an employer of substance.
“We encourage early discussion between those involved in any potential abandonment case and ourselves to identify whether abandonment is involved and what should be done to scrutinise the proposals,” adds Hobman.
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From 6 April 2019