The current funding regime for multi-employer, defined-benefit pension schemes which are not split into ring-fenced sections for each employer requires that, where an employer ceases to employ active members, it becomes liable to pay a share of the scheme's deficit. Significantly, the deficit is based on the cost of securing benefits with an insurance company - the most expensive way of pricing benefits. The employer's deficit share also includes part of the cost of so-called "orphan liabilities". These are liabilities for benefits which can't be attributed to any particular employer, a common feature of many long-running schemes.
There are already flexibilities which allow exiting employers to avoid making a payment. For example, under a Flexible Apportionment Arrangement, an exiting employer and scheme trustees can agree that another employer will assume responsibility for the exiting employer's liabilities. These flexibilities work well in schemes where the employers are part of the same group but, are usually unworkable for unconnected employers participating in industry-wide schemes. The result can be that an employer is left in the Catch-22 position of being subject to an unaffordable debt if it discontinues benefit accrual but, with the cost of funding additional benefits being equally unaffordable. In some cases, insolvency may be the inevitable outcome. Employers in the charitable and not-for-profit sectors are particularly hard-hit by this problem.
Recognising this problem, the Government is proposing that employers should be able to delay paying their debts under a new Deferred Debt Arrangement. This will be subject to similar conditions which apply to current flexibilities. The scheme's trustees must agree to the arrangement and be satisfied that the scheme's employers will be reasonably likely to be able to fund the scheme to cover its ongoing, technical provision liabilities. Exiting employers will remain liable for paying their share of the scheme's ongoing funding costs, as though they still had active members, and the trustees can discontinue the Deferred Debt Arrangement if they consider the employer's covenant is likely to weaken in the next 12 months or, the employer fails to comply with its funding obligations. The new arrangement will be available from 1 October.
The change has been a long time coming but is to be welcomed. It will give hard-pressed employers in industry-wide schemes a much needed flexibility in dealing with their pension liabilities. At the same time, it ensures that the security for members' benefits isn't compromised. We expect that the effect of the new flexibility will be that many employers in these schemes will now look to discontinue further accrual of DB benefits.