New section 75 flexibility for employers and trustees
Pensions update - 21 December 2011
Long-awaited amendments to the Employer Debt Regulations were laid before Parliament last week. These allow employers leaving multi-employer defined benefit schemes to transfer their funding liability to one of the remaining employers without triggering a section 75 debt. Trustee agreement is required, a funding test must be met and the Pensions Regulator must be notified.
This is a welcome addition to the options for dealing with the section 75 issues that arise on corporate restructurings and disposals. It is likely to prove more practical and popular than the alternatives.
The "period of grace" in which an employer ceasing to employ active members of a scheme can delay triggering a section 75 debt in anticipation of it employing active members in the near future is extended from 12 to 36 months, if the trustees agree.
These amendments come into force on 27 January 2012.
How does section 75 work?
When an employer ceases to employ active members in a multi-employer defined benefit scheme where other employers continue to have active members, then it must pay the trustees its share of the underfunding calculated by reference to the cost of securing benefits with a third party provider – the "buy out" cost. Its share will take account of the cost of the benefits of its current and former employees as well as a portion of the scheme benefits which cannot be attributed to any employer. This liability arises under section 75 of the Pensions Act 1995 and is known as the employer's "section 75 debt".
There are a number of options under the Employer Debt Regulations for mitigating the impact of this requirement. For example, part of the section 75 debt could be apportioned to one of the continuing employers (a "scheme apportionment arrangement") or payment of part could be deferred until the scheme winds up when it would be paid by a guarantor (a "withdrawal arrangement"). Most of these options require the agreement of the scheme trustees and a funding test has to be met.
What is the new option?
The new option is called a flexible apportionment arrangement. Where it is put in place for an employer, no section 75 debt will arise at all when it leaves the scheme. The main features of a flexible apportionment arrangement are:
- One or more of the remaining scheme employers must take over responsibility under a legally enforceable agreement for the scheme liabilities of the departing employer. The DWP intends there to be flexibility to divide the liability amongst several employers, with each being responsible for only its share. But the new regulations are unclear that this can be done effectively.
- The trustees, the departing employer and the remaining employers who take over liability must all consent to the arrangement.
- The trustees must be satisfied that a funding test is met. This is the same test as for scheme apportionment arrangements, focusing on whether the remaining employers will be able to fund the scheme and whether the security of members' benefits will be prejudiced.
- Unless it has already ceased to employ active members, the departing employer must cease to employ any within 28 days after the flexible apportionment arrangement has been put in place.
- The scheme must not be in wind up or in an assessment period or, in the opinion of the trustees, likely to enter an assessment period in the next 12 months.
- The departing employer does not need to make any payment to the scheme on account of the section 75 debt that would arise but for implementation of the flexible apportionment arrangement; but if it does, the trustees must reduce the liabilities taken over by the remaining employers.
The remaining employers that take on the departing employer's liability do not themselves need to employ active members as long as they are, broadly, statutory employers in relation to the scheme. This is intended to allow flexible apportionment arrangements to be used in relation to multi-employer schemes which have become frozen – ie no longer have any active members, but have not gone into wind up.
A flexible apportionment arrangement is notifiable to the Pensions Regulator.
How is this better than the other options?
The main advantage of the flexible apportionment arrangement is that it enables an employer to leave a scheme without any section 75 debt becoming payable. And when a section 75 debt does become payable for the remaining employer that takes on the liability of the departing employer, that debt is calculated by reference to the funding of the scheme at the time (so any improvement – or deterioration – of the funding position in the interim is taken into account).
For this reason, we expect flexible apportionment arrangements to prove popular with employers considering re-organisations or disposals involving scheme employers. But we also expect the Pensions Regulator to issue guidance which will stress the importance of trustees considering what advantage they can obtain for their scheme in return for their agreement.
Periods of Grace
Sometimes a section 75 debt can be triggered inadvertently where the last remaining active member leaves an employer. This can be avoided if the employer employs another active member within 12 months and tells the trustees that it expects to do so within one month of it losing its last active member. These periods will be extended to up to 36 months (subject to trustee agreement) and two months respectively.