Issued: February 2009
Years ago, your organisation set up a defined benefit (DB) pension scheme to look after employees in their retirement. The scheme was closed to new members to reduce costs and risks, but this hasn’t solved the problem. Costs are increasing, scheme trustees are difficult to find and the funding and investment risks have worsened. Sound familiar? This article outlines some options for dealing with ‘legacy’ DB pension schemes.
• Reviewing your scheme
A review will identify the key issues, explore options for dealing with them and propose appropriate solutions. Start with some simple questions. How does the ‘legacy’ scheme benefit your organisation - is it a valuable retention tool? What is it costing, and how much can you afford? What risks does it present to the business? Can these be managed at an acceptable cost? Does it worry donors? What about members’ future pension provision?
Once you are clear on issues and objectives, do you need a consultant to conduct the review? What is your budget? Fees for professional advice can quickly mount up.
What options are likely to emerge from the review?
• Keep defined benefit provision
If this is important to the organisation it may be possible if costs and risks can be controlled satisfactorily.
Reducing benefits for employees’ future pensionable service – by reducing the accrual rate (say from 1/80th to 100th) or by switching from a ‘final salary’ to a ‘career average’ design – can save money.
An ‘industry wide scheme’ offers a one-stop shop with economies of scale. Joining this type of scheme requires a very long-term commitment; it can be very expensive to withdraw.
• Consider ‘cash balance’
A ‘cash balance’ design may appeal to employers uneasy about removing DB provision completely. The employer promises (and takes on the risk of providing) a lump sum at retirement – say 15% of pay for each year of service – which is used to buy a pension for the member.
However, if these options present investment and funding risks that are unacceptable to the sponsor, a more radical solution is needed.
• Close the Scheme to future accrual
Approach with caution! The rules may trigger winding up, putting the pension scheme trustees in the driving seat. If a scheme is wound up, solvent employers must provide members’ accrued benefits in full. Securing benefits via insurance policies is very expensive.
Rules permitting, a closed scheme can be run indefinitely, but it is sensible to plan to wind it up at some future date. Meanwhile consolidating – ‘bundling’ – the scheme’s service providers will help to manage costs. Insurance companies and some consulting firms offer these services.
Members’ future pension benefits can be provided via the arrangements offered to the rest of the workforce. Legal advice is essential.
• Consultation
If there are more than 50 employees, consultation with ‘affected members’ is required if ‘listed changes’ (including reducing or stopping future accruals in the scheme) are proposed.
Changing a pension scheme, even a closed scheme, is a challenging exercise. Careful planning and good advice will pay dividends – eventually.