Government goes ahead with new pensions exit debt flexibility
Last May we issued an update highlighting that the Government was consulting on a new flexibility to allow employers to defer paying a pension scheme exit debt - called a Deferred Debt Arrangement (a DDA). Its aim is to help employers in non-associated employer schemes currently caught in the trap of the cost of future service benefits and the exit debt arising on stopping these benefits both being unaffordable. The Government has now announced that it will go ahead with the new flexibility from 6 April, but with a few changes to make its use more practicable.
Currently, where an employer in a multi-employer scheme which isn't split into actuarially ring-fenced sections terminates accrual of pensionable service for its employees, while other employers continue to have employees building up benefits, it becomes liable to pay its share of the scheme's buy-out funding deficit. Where employers are part of the same group, they can avoid this liability by all stopping benefit accrual at the same time. Alternatively, they can use flexibilities which allow an employer to allocate its exit liability to another employer. These options, however, are often unavailable to employers in schemes for non-associated employers, leaving them in the Catch-22 situation of it being unaffordable both to continue to pay contributions for future service benefits and pay the exit debt on terminating accrual. This problem particularly affects employers in the charity and not-for-profit sectors.
To combat this problem, from 6 April, employers will be able to use a new Deferred Debt Arrangement (a DDA). This will allow employers to terminate accrual of benefits with the exit debt deferred until a later date. Trustee agreement will be needed.
The main change to the final version of the DDA, is the dropping of the requirement for schemes to meet the stricter funding test applicable to other exit flexibilities. This reflects the fact that, unlike under those flexibilities, an employer entering into a DDA will remain a statutory employer, liable to pay contributions and with its covenant supporting the scheme. Trustees will instead need to be satisfied that the employer's covenant is not likely to weaken materially within 12 months of the DDA taking effect. They will also have the power to terminate the DDA at a later date where they consider the covenant is likely to weaken materially over the coming year.
As well as introducing the DDA, the Government is extending the period within which employers may apply for a period of grace from an exit debt where they temporarily cease to employ any active members from two to three months. The new regulations also clarify that an employer can enter into a DDA during a grace period.
The new flexibility will bring much needed to relief to many employers in the charity and not-for-profit sectors who have wanted, but been unable, to terminate accrual of pension benefits. It is good that the Government has listened to feedback and dropped the stricter funding test which could have reduced the number of employers able to take advantage of the new flexibility. The extension in the time limit to notify a period of grace, while small, will also help to prevent employers accidentally triggering an exit debt.