Pension scheme deficits: the impact of the Employer Debt Regulations

Transcription

1 abc Client note Pension scheme deficits: the impact of the Employer Debt Regulations and its affiliated businesses have offices in: Alicante Amsterdam Beijing Brussels Chicago Dubai Dusseldorf Frankfurt Hamburg Ho Chi Minh City Hong Kong London Madrid Milan Moscow Munich New York Paris Prague Rome Shanghai Singapore Tokyo Warsaw Associated offices: Budapest Zagreb

2 Lovells (the firm ) is an international legal practice comprising and its affiliated businesses. is a limited liability partnership registered in England and Wales with registered number OC Registered office and principal place of business: Atlantic House, Holborn Viaduct, London EC1A 2FG. The word partner is used to refer to a member of, or an employee or consultant with equivalent standing and qualifications, and to a partner, member, employee or consultant in any of its affiliated businesses who has equivalent standing. New York State Notice: Attorney Advertising.

3 Contents Page Introduction 1 The Default Position 2 Periods of Grace 5 Alternative Methods for Calculating Section 75 Debts 7 Transitional Provisions` 15 Miscellaneous Amendments 16 Further Information If you would like further information on the Employer Debt Regulations please contact any of the following or your usual contact at the firm. Contacts Jane Samsworth jane.samsworth@lovells.com Stephen Ito stephen.ito@lovells.com Katie Banks katie.banks@lovells.com Duncan Buchanan duncan.buchanan@lovells.com This note is written as a general guide only. It should not be relied upon as a substitute for specific legal advice.

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5 Introduction Background Section 75 Pensions Act 1995 applies to pension schemes with defined benefit liabilities. It provides that if a pension scheme winds up, an employer becomes insolvent, or (in a multi-employer scheme) an employer undergoes an employment cessation event 1, a debt will become due from the relevant employer(s) (a Section 75 Debt ). Since September 2005, all Section 75 Debts have been calculated on the buy out basis (the cost of buying-out the liabilities by purchasing annuities typically from an insurance company). Section 75 Debts have been governed principally by the Occupational Pension Schemes (Employer Debt) Regulations 2005 (the Regulations ). The Regulations came into force on 6 April Most Section 75 Debts arise in practice when an employer undergoes an employment-cessation event, (rather than an insolvency or scheme wind-up) and so this note focuses primarily on employmentcessation events. Prior to 6 April 2008, there were two options for an employer, if it underwent an employment-cessation event, to pay a lower Section 75 Debt than would have been payable. The first option was an approved withdrawal arrangement. Broadly speaking, the withdrawing employer paid an amount lower than the full Section 75 Debt (Amount A), another company or entity guaranteed the balance of the Section 75 Debt (Amount B), and the arrangement had to be approved by the Pensions Regulator. The second option was that the scheme rules could be amended so as to apportion the liabilities of the scheme in a manner other than the statutory default. The liabilities could be apportioned so as to provide that the total Section 75 Debt due from the employer was lower than it would have been but for the apportionment. The Regulations have been substantially amended with effect on and from 6 April Instead of a default basis and two variants as set out above, Section 75 Debts can now be calculated under either the default basis, or one of four variants. This note explains the changes made by the amended Regulations using the following structure. (a) First, we explain the new default position under the Regulations. (b) Secondly, we explain how employers can benefit from the new 12 month period of grace. (c) Thirdly, we look at the four alternative mechanisms for calculating a Section 75 Debt, which are: (i) a Scheme Apportionment Arrangement; (ii) a Withdrawal Arrangement; (iii) an Approved Withdrawal Arrangement; and (iv) a Regulated Apportionment Arrangement. (d) Fourthly, we consider the transitional provisions which apply until 6 April (e) Finally, we briefly consider some miscellaneous amendments. The amendments were made to the Regulations, rather the Regulations actually being repealed and replaced. However, for ease of convenience, throughout this note the term Old Regulations will be used to describe the position that applied prior to 6 April 2008, and the term New Regulations will be used to describe the position after 6 April The definition of employment cessation event has been the topic of some debate (see page 4 of this note for further details) but has in practice been used to describe the situation where an employer ceases to employ active members in a pension scheme at a time when other employers continue to employ active members 1

6 The Default Position Introduction Liability Share In broad terms, the default position for Section 75 Debts arising under the New Regulations is very similar to the position under the Old Regulations. The default under the Old Regulations was that an employer s Section 75 Debt was calculated based upon the liabilities of the scheme which related to employment with that employer, together with a proportionate share of orphan liabilities 2. To put it another way, the employer s Section 75 Debt was a proportionate share of the total buy out deficit of the scheme as a whole. The New Regulations maintain this default option. However, the New Regulations use a new term Liability Share 3 to describe the default apportionment of liabilities to an employer. Who calculates the Liability Share? Prior to 6 April 2008, one issue that caused difficulties in relation to Section 75 Debts was that the Scheme actuary, who had the responsibility for determining the relevant liabilities, had to estimate the cost of buying annuities (usually from an insurance company). As explained above, in order to calculate the Section 75 Debt for a particular employer, it was necessary to calculate the entire Section 75 Debt for the scheme as a whole, so that the employer s proportionate share could be determined. Given that the buy out market was historically relatively undeveloped, for many large schemes with considerable liabilities it would be very difficult, if not impossible, actually to buy out all the benefits. This could lead to the actuary being unable to certify a Section 75 Debt calculation as it was too difficult to estimate the cost of securing the scheme s entire liabilities by the purchase of annuities since there was no market. The New Regulations have tried to make this easier. First, the New Regulations divide the responsibility for these calculations between the trustees and the actuary. The trustees are responsible for determining and calculating the assets. The trustees are also responsible for determining the liabilities (for example how liabilities are to be allocated when an employee s previous employment history is complex see below). The actuary is however responsible for calculating and verifying the liabilities. Secondly, the New Regulations provide that when the actuary estimates the costs of buying annuities he shall do so on terms he considers consistent with those in the available market or, if it is not practicable to make an estimate on terms consistent with those in the available market, in such a manner as the actuary considers appropriate in the circumstances of the case. Lovells comment now the actuary is formally allowed post 6 April 2008 to calculate the liabilities on such terms as he considers to be appropriate if it is not practicable to base an estimate on the available market, hopefully actuaries will feel better able to provide trustees with a certified calculation of the scheme s liabilities. Employee with many previous employers It was generally assumed (although it was not entirely clear) under the Old Regulations that each employer paid a share of liabilities attributable to employment with that employer. This was taken 2 Orphan liabilities is the term used to describe the liabilities of a scheme which relate to employment with an entity which is no longer counted as an employer for the purpose of the Regulations 3 Definition of liability share in Regulation 2(1) of the New Regulations 2

7 to mean that if, for example, an employee had been a member of the scheme for 25 years, and worked for three different employers during that time, in order to calculate the Section 75 Debt for each employer it would be necessary to establish exactly which employer the employee had been employed by and for how long. Lovells comment these changes are helpful they should make it easier for scheme actuaries to calculate Section 75 Debts even if there are some gaps in the data. Definition of employment cessation event The New Regulations expressly provide that this is how Section 75 Debts ought to be calculated if an employee has been employed by more than one employer 4. Lovells comment this is how the Old Regulations had applied in practice but it is helpful to have the point clarified In practice the calculation was often difficult if not impossible to complete due to a lack of available data concerning employment history. Sometimes companies and trustees were obliged to enter into an apportionment arrangement even if the employer wished to pay the full Section 75 Debt, simply because the actuary didn t have sufficient information to enable him formally to certify the Section 75 Debt. The New Regulations have sought to provide some solutions. First, the New Regulations provide that the trustees have the responsibility for determining the liabilities to be attributable to each employer. Secondly, the New Regulations specifically provide that if the trustees are unable to determine to which employer a particular employee s liabilities should be apportioned because either the employee s full employment history is not available, or it can not be obtained without disproportionate costs being incurred, the trustees can either: (a) determine that the employee s liabilities can t be apportioned to any particular employer (and hence all the liabilities become orphan liabilities); or (b) determine that all the employee s liabilities are in fact apportioned to whichever employer is his or her last (or current) employer. 5 The Old Regulations defined an employment cessation event as being the occasion when an employer ceases to be an employer employing persons in the description of employment to which the scheme relates at a time when at least one other person continues to employ such persons 6. It was not clear what was meant by the phrase persons in the description of employment to which the scheme relates. For example, did it mean simply that an employment cessation event happened when an employer ceased to employ any active members of the scheme? Or did the phrase also include employees who, although not active members, were deferred members of the scheme. Deferred members could be said to be persons to which the scheme relates. Additionally, what about employees who had not joined the scheme because they were in a waiting period? The DWP had indicated that an employment cessation event was triggered when an employer ceased to employ any active members so even if the employer still employed deferred members or people in a waiting period, it could have triggered an employment cessation event. The New Regulations have now clarified the position, at least in terms of employment cessation events after 6 April The New Regulations make clear that an employment cessation event is triggered when an employer ceases to employ active members of the scheme. 7 Lovells comment this clarification confirms what has typically happened in practice prior to 6 April However (and confusingly and unhelpfully) the old definition is retained in the New Regulations 4 Regulation 6(4)(b) of the New Regulations 5 Regulation 6(4)(c) and 6(5) of the New Regulations 6 Regulation 6(4) of the Old Regulations 7 Definition of employment cessation event in Regulation 2(1) of the New Regulations 3

8 in respect of employment-cessation events prior to 6 April 2008 which suggests the old definition means something different from simply ceasing to employ active members of a scheme. Updated asset and liability valuations It is not necessary for a full audit of assets and a full valuation of liabilities to be undertaken in respect of employment-cessation events. The trustees may, after consulting the employers, decide to use an unaudited update to the asset figure for the scheme set out in the most recent trustee report and accounts. 8 The trustees may also, again after consulting the employers, decide to determine the liabilities by using the solvency (ie buy out) numbers from the last actuarial valuation, updated to reflect the actuary s assessment of changes between the valuation date and the employment-cessation event. 9 Lovells comment this is a helpful change: it is now not necessary in all situations to do a full valuation of the scheme s assets and liabilities. The extent to which trustees will wish to rely on an updated assessment of the liabilities will depend on how much time has elapsed since the last valuation, and on the advice of the actuary. 8 Regulation 5(5) of the New Regulations 9 Regulation 5(14) of the New Regulations 4

9 Periods of Grace 10 Introduction One of the major complaints with the Old Regulations was that an employer could inadvertently trigger Section 75 Debts. For example, an employer in a multi employer scheme might have only one active member among its employees. If that active member resigned, it would trigger an employment cessation event and a Section 75 Debt. These debts could be unplanned and unforeseen, and hence no alternative arrangements (such as an apportionment) put in place. The New Regulations have made a major change here by allowing employers in this situation to benefit from a 12 month period of grace. If the employer does what he intends to, and employs an active member within the next 12 months, the period of grace comes to an end at that time. As he is now employing an active member of the scheme, again no Section 75 Debt becomes due. End of the period of grace If the 12 month period ends, and the employer has not, within the period of grace, actually employed an active member of the scheme, the employer s original Section 75 Debt becomes due this debt is calculated based upon the funding position of the scheme at the time of the employment cessation event not at the end of the 12 month period of grace. Period of grace notice If an employer ceases to employ active members, but the employer intends to employ at least one active member of the scheme within the next 12 months, the employer can give the trustees a period of grace notice. This notice must be given as soon as possible after the employment cessation event, and in any event within 1 month of the employment cessation event. If the employer knows in advance, he can give a period of grace notice before the employment cessation event. Effect of period of grace notice If an employer gives a period of grace notice, he will be treated for the next 12 months as if he did actually employ an active member of the scheme. In other words, the employer is treated as if the employment cessation event had not happened, and hence no Section 75 Debt becomes due from him. Debts due before end of the period of grace There are two ways in which the employer s Section 75 Debt can become due before the end of the period of grace: (a) first, if the employer decides that he will not, within the period of grace, actually employ any active members during the period of grace once the employer makes that decision, he must tell the trustees. The period of grace then comes to an end at that point, and the Section 75 Debt becomes due (again, it is calculated based upon the funding position of the scheme at the time of the employment cessation event); and (b) secondly, if the employer becomes insolvent during the period of grace if this happens the original Section 75 Debt becomes due and the trustees can claim for it in the insolvency proceedings. 10 Regulation 6A of the New Regulations 5

10 Where periods of grace cannot be used There are two circumstances where periods of grace cannot be used. (a) The first is where the employer has no intention of employing active members within the 12 months immediately following the employment cessation event. If this is the case, the full Section 75 Debt becomes payable in the normal way. (b) The second is when the employer is aware that it is intended to close the scheme to future accrual within the next 12 months. A period of grace can only occur when it is anticipated that the scheme will still continue to have active members at the end of the period of grace. Lovells comment the provisions concerning periods of grace will make it much easier to deal with inadvertent employment cessation events. However, it is not clear who (if anyone) will actually police this. Additionally, given the requirement for a period of grace notice to be given within one month of the employment-cessation event, it may not be possible to give this notice for unplanned employment cessation events, although as the next section of this note explains the new arrangements can be made retrospective. 6

11 Alternative Methods for Calculating Section 75 Debts Introduction This Section looks at the four different methods for calculating Section 75 Debts if an employment cessation event occurs, and the employer or trustees wish to use a method other than the Liability Share. The four different methods are: (a) a Scheme Apportionment Arrangement; (b) a Withdrawal Arrangement; (c) an Approved Withdrawal Arrangement; and (d) a Regulated Apportionment Arrangement. These four methods will be considered in this order, and at page 15 there is a table which briefly compares them against each other and the Liability Share. Part A Scheme Apportionment Arrangements Introduction A Scheme Apportionment Arrangement is similar in theory to the method under the Old Regulations for apportioning the scheme s liabilities. However, the New Regulations contain detailed requirements concerning Scheme Apportionment Arrangements. There are four conditions which have to be satisfied, and then certain other issues that are relevant. Part I of this section deals with the four compulsory conditions, Part 2 deals with the supplementary issues. Part I four compulsory conditions 1. a Scheme Apportionment Arrangement must be an arrangement under the scheme rules; 2. it must provide that the withdrawing employer pays a share of the scheme s total Section 75 Debt that is different from the Liability Share; 3. where the share paid by the employer is less than the Liability Share, the difference must be apportioned to one or more of the other employers in the scheme; and 4. the Scheme Apportionment Arrangement must meet the Funding Test. Condition 1 an arrangement under the scheme s rules The definition of Scheme Apportionment Arrangement expressly states that the arrangement must be an arrangement under a scheme s rules. This is a subtle change from the provisions under the Old Regulations concerning apportionments, which simply applied where the scheme provides but did not expressly say that an apportionment arrangement had to be made in the rules. Lovells comment we recommend that if it is proposed to use a Scheme Apportionment Arrangement then a generic rule permitting their use should be inserted into the rules. However, when it comes to the exercise of that power in specific circumstances, we do not believe that the exercise needs to be documented in the rules. Instead, we recommend that the employer and trustees enter into a separate agreement outside the rules (for example a joint resolution or deed) which documents how the power will be exercised for specific situations. In order to have a Scheme Apportionment Arrangement, there are four conditions that must be met, each of which is dealt with in detail below 11 : 11 See the definition of scheme apportionment arrangement in Regulation 2(1) of the New Regulations 7

12 Condition 2 employer pays Scheme Apportionment Share rather than the Liability Share The principal purpose of entering into a Scheme Apportionment Arrangement is that the employer can pay a Section 75 Debt calculated on a different basis than the normal Liability Share. A Scheme Apportionment Arrangement must specify what proportion of the scheme s total Section 75 deficit is payable by the employer. This share of the total Section 75 deficit is called the Scheme Apportionment Arrangement Share. Accordingly, a Scheme Apportionment Arrangement must specify what the Scheme Apportionment Arrangement Share is for the withdrawing employer. This Scheme Apportionment Arrangement Share is therefore the Section 75 Debt that the employer has to pay. The New Regulations do not contain any restrictions on how large or small the Scheme Apportionment Share can be. The resulting Section 75 Debt can therefore be a nominal amount (for example 10). Condition 3 must specify how the difference between the Liability Share and the Scheme Apportionment Share is itself to be apportioned between the employers. It is possible that a Scheme Apportionment Arrangement could be used so that the employer pays a Section 75 Debt that is higher than the Liability Share. However, in practice this is exceedingly unlikely, and so it will usually be the case that the Scheme Apportionment Share is lower than the Liability Share. The difference between the Liability Share and the Scheme Apportionment Share has to be apportioned to some or all of the other employers. The relevant employers (and the shares apportioned to them) have to be specifically identified in the Scheme Apportionment Arrangement. Over funding risk? a Scheme Apportionment Arrangement are not forgotten, the New Regulations provide that when calculating the Liability Share for an employer, any liabilities apportioned to that employer under an earlier Scheme Apportionment Arrangement must be included. However, the precise wording used in the definition of Scheme Apportionment Arrangements does not refer to liabilities being apportioned to other employers it instead refers to an amount of debt being apportioned. This could lead to a risk of over-funding. Assume that there was only one employer left in a scheme, the scheme wound-up and a Section 75 Debt became due. The employer s Liability Share would equal the total Section 75 deficit of the scheme (as he is the only employer). However, one reading of the legislation is that, in addition, one has to add on any amounts apportioned to that employer as a result of historical Scheme Apportionment Arrangements if the Scheme used to be a multi-employer scheme. This could lead to the last employer having to pay a Section 75 Debt that was actually larger than the scheme s Section 75 deficit. Lovells comment it is not clear from the New Regulations exactly how they are supposed to work. It seems highly unlikely that Parliament intended that an employer could be forced to pay a Section 75 Debt that was greater than the total Section 75 deficit of the scheme. Nonetheless, until further guidance is available, or a relevant case comes to court, clients should think carefully about the possible risks of over-funding if they decide to opt for a Scheme Apportionment Arrangement. There are ways in which this risk can be managed and we can consider the options with our company and trustee clients in detail. Condition 4 the Scheme Apportionment Arrangement meets the Funding Test Under the New Regulations, a Scheme Apportionment Arrangement is only permissible if a Funding Test is met. 12 In an attempt to ensure that sums which have been apportioned to a continuing employer under 12 The Funding Test is found in Regulation 2(4A) of the New Regulations The Funding Test is met for a Scheme Apportionment Arrangement if the trustees are reasonably satisfied that: 8

13 (a) when the Scheme Apportionment Arrangement takes effect, the remaining employers will be reasonably likely to be able to fund the scheme; and (b) the effect of the Scheme Apportionment Arrangement will not be adversely to affect the security of members benefits as a result of any material change in circumstances which would justify a change to the valuation assumptions or any recovery plan in force. Lovells comment although this is formally something new, in practice we suspect that trustees would only have agreed to apportionments under the Old Regulations if they had satisfied themselves that the remaining employers would be able to fund the scheme. Accordingly, although this is a further formal stage which needs to be gone through in order to implement a Scheme Apportionment Arrangement, we do not think this should make a material difference in negotiations between an employer and trustees. Part II Supplementary Issues When can a Scheme Apportionment Arrangement be entered into? One of the main problems with the Old Regulations was that if the trustees entered into an apportionment arrangement after the employment cessation event, this could be treated as a compromise of a Section 75 Debt, and thereby prevent the scheme from being eligible to enter the Pension Protection Fund ( PPF ). The New Regulations have made the position much easier. As well as periods of grace (see page 6 above), the New Regulations expressly provide that Scheme Apportionment Arrangements can be entered into before, on, or after an employment cessation event. The New Regulations also amend the relevant provision of the rules governing PPF entry to make clear that the entry into a Scheme Apportionment Arrangement (including entering into it after the employment cessation event) will not prevent the scheme from being eligible for the PPF. 13 Lovells comment this development will make it much easier for employers and trustees to manage employment cessation events after they have occurred as the trustees need no longer be concerned about prejudicing the scheme s eligibility to enter the PPF. Whose agreement is needed for a Scheme Apportionment Arrangement? Under the Old Regulations, an apportionment arrangement could only be entered into if the scheme provided for such an arrangement. This usually meant that it could only be entered into if the scheme was specifically amended. Most scheme amendment powers require principal employer and trustee agreement, so usually an apportionment had to be agreed between the principal employer and the trustees. The New Regulations as initially drafted could have been interpreted as suggesting that trustees could implement a Scheme Apportionment Arrangement without the need for the employer s consent. However, emergency amending regulations 14 have now been passed which specify that: (a) if the Scheme Appointment Arrangement is apportioning a liability to the withdrawing employer that is greater than the withdrawing employer s Liability Share, then the consent of both the trustees and the withdrawing employer is required; and (b) if the Scheme Apportionment Arrangement is apportioning a liability to the withdrawing employer that is less than the withdrawing employer s Liability Share, and hence apportioning the balance to other employers, the consent of the trustees and the other employers to whom the balance is apportioned is required (but there is no requirement for the consent of the withdrawing employer). Lovells comment the emergency amendment removes the risk in the New Regulations that trustees could implement a Scheme Apportionment 13 Regulation 2(4) of the Pension Protection Fund (Entry Rules) Regulations The Occupational Pension Scheme (Employer Debt Apportionment Arrangements) (Amendment) Regulations

14 Arrangement unilaterally. The amendment now makes clear that both trustee and employer consent will be required. Part B Withdrawal Arrangements Introduction The Pensions Regulator is clearance required for a Scheme Apportionment Arrangement? When the Old Regulations were in force, the Regulator was of the view that both the amending of a scheme s rules to introduce an apportionment rule and the exercise of that apportionment rule were Type A events, and so events in respect of which the employer should consider applying for clearance. The Regulator s updated clearance guidance (which came into effect just before the New Regulations) maintains that position. The amendment of a scheme s rules to allow for the entry into a Scheme Apportionment Arrangement, and the entry into the Scheme Apportionment Arrangement itself are, in the Regulator s opinion, both Type A events. 15 There are only three exceptions to this: (a) if the amount paid under the Scheme Apportionment Arrangement is more than the Liability Share; (b) if the amount paid is the actuary s best estimate of what the Liability Share is; or (c) if there is no net reduction in the employers combined covenant (for example if the apportionment is as a result of a group reorganisation). Lovells comment it is clear that the Regulator is still not particularly keen on schemes implementing Scheme Apportionment Arrangements. Unless one of the three conditions is met, we would normally advise that whenever a Scheme Apportionment Arrangement is entered into, the employer should apply for clearance. Withdrawal Arrangements are a wholly new type of arrangement for the payment of a Section 75 Debt. They are essentially a combination of parts of a Scheme Apportionment Arrangement and an Approved Withdrawal Arrangement. They are more prescriptive than Scheme Apportionment Arrangements, but are generally simpler and have fewer potential difficulties. In summary, a Withdrawal Arrangement requires the withdrawing employer to pay a Section 75 Debt calculated as his proportionate share of the scheme s deficit calculated on the scheme specific funding valuation method rather than the buy out method. This sum is termed Amount A. A further sum ( Amount B ) is guaranteed by a suitable guarantor. These points are examined in further detail below. Employer pays share of scheme deficit calculated on the scheme specific funding basis Under a Withdrawal Arrangement, the withdrawing employer has to pay the proportionate share of the scheme s deficit calculated on the scheme specific funding basis. Whilst this will typically be lower than the buy out basis, it is not possible under a Withdrawal Arrangement for the employer to pay an amount lower than this. If the scheme has not yet had a scheme specific valuation, the PPF valuation basis will apply. Guarantor must guarantee Amount B Under a Withdrawal Arrangement, a guarantor must guarantee Amount B. How Amount B is calculated is explained below. There are no formal requirements as to who can be the guarantor (for example the guarantor does not have to be a participating employer in the scheme, and could be an overseas parent company). 15 The Regulator considers the introduction or exercise of a Scheme Apportionment Arrangement power to be a scheme event. This means that it will be a Type A event regardless as to the funding position of the scheme see paragraphs 70 & 71 of The Pensions Regulator Clearance Guidance March

15 The only formal requirement is that the trustees must be satisfied, at the date the Withdrawal Arrangement is entered into, that the guarantor has sufficient resources to be likely to be able to pay Amount B. It is possible to have more than one guarantor. If there are multiple guarantors, the New Regulations specify that all the guarantors must have joint and several liability. 16 Conditions for payment of Amount B The New Regulations specify that Amount B must become payable when: (a) the scheme winds up; or (b) where the last remaining employer of the scheme becomes insolvent. 17 The guarantor may agree with the trustees that Amount B can also become payable in other circumstances. Calculation of Amount B is Amount B fixed or floating? The New Regulations provide that Amount B can either be fixed or floating. In other words, it can be calculated at the date the Withdrawal Arrangement takes place, and then a fixed sum becomes due from the guarantors. Alternatively, the calculation can be deferred until Amount B actually has to be paid. If Amount B is fixed, then Amount B is calculated as being the difference between the withdrawing employer s Liability Share (which is calculated on the buy out basis) and Amount A (the amount the withdrawing employer actually pays). The alternative method is where Amount B is floating. Precisely how much has to be paid under Amount B will not be known until the time comes for Amount B to be paid. However, when Amount B comes to be paid, it is not calculated in the same way as if Amount B is fixed. Instead, Amount B is calculated assuming that the withdrawing employer had in fact had an employment cessation event on the date Amount B has to be paid (rather than when the withdrawing employer actually had an employment cessation event). Amount B is therefore the withdrawing employer s Liability Share (calculated on the normal buy out basis) based on the funding position of the scheme at the date Amount B is actually paid, and Amount A is ignored in this situation. Lovells comment it will be interesting to see how this will operate in practice. It is not clear whether either a guarantor or the trustees would prefer Amount B to be fixed or floating. If Amount B is fixed, it provides the guarantor with certainty over what will become due. However, if the funding position of the scheme improves a fixed Amount B might actually be greater than the scheme s total Section 75 deficit and could lead to over-funding problems. On the other hand, if Amount B is floating, by the time it actually comes to be paid, if the funding position of the scheme has improved, Amount B may actually be very small or even non existent. Equally, if the funding position worsens, or if the buy out basis becomes more conservative, Amount B could be very much greater than it would have been if it had been fixed. Funding Test As with Scheme Apportionment Arrangements, the trustees can only enter into a Withdrawal Arrangement if, as well as being satisfied that the guarantor has sufficient assets to be able to pay Amount B, they are also satisfied that the first part of the Funding Test will be met. As set out on pages 9-10 above, the full Funding Test is a two part test. However, for a Withdrawal Arrangement, only part (a) applies the trustees do not need to confirm the part of the test set out in (b). Involvement of the Regulator A Withdrawal Arrangement does not formally need to be approved by the Regulator. In addition, the Regulator s updated clearance guidance states that [the Regulator] would not expect all Withdrawal 16 Paragraph 1(h) Schedule 1A of the New Regulations 17 Paragraph 3 Schedule 1A of the New Regulations 11

16 Arrangements to come to the Regulator for a clearance statement. the test for the Regulator approving an Approved Withdrawal Arrangement has been relaxed. Lovells comment there was a policy desire to have a safe harbour mechanism for Section 75 Debts which would not need the Regulator s involvement. It would appear that this is the function that Withdrawal Arrangements are intended to fulfil. We would not normally consider it necessary to involve the Regulator if it is proposed to enter into a Withdrawal Arrangement unless the Withdrawal Arrangement is part of a wider transaction which involves Type A events. PART C APPROVED WITHDRAWAL ARRANGEMENTS Introduction An Approved Withdrawal Arrangement is very similar to a Withdrawal Arrangement. The two key differences are that: (a) the withdrawing employer pays a Section 75 Debt which is less than Amount A; and (b) an Approved Withdrawal Arrangement has to be approved by the Regulator. These two points, and other relevant issues, are considered in more detail below. Withdrawing employer pays less than Amount A As with Scheme Apportionment Arrangements, there are no restrictions in the New Regulations as to the amount the withdrawing employer pays. Accordingly, the amount paid under an Approved Withdrawal Arrangement can be a purely nominal amount (for example 10). The amount paid however has to be less than Amount A (the Section 75 debt measured on the scheme specific funding basis). Approval by the Pensions Regulator An Approved Withdrawal Arrangement has to be approved by the Regulator. This is the same as applied under the Old Regulations. However, Test under the Old Regulations The test under the Old Regulations was that the Regulator could only approve an Approved Withdrawal Arrangement if the guarantor was more likely to be able to pay the total Section 75 Debt than the withdrawing employer. In practice this was interpreted as meaning that unless the withdrawing employer could not pay the full debt (for example it would become insolvent if the full debt was paid), an Approved Withdrawal Arrangement could not be approved by the Regulator. Test under the New Regulations The test under the New Regulations is much less prescriptive. The Regulator can now approve Approved Withdrawal Arrangements if the Regulator is satisfied that it is reasonable for it to do so. The New Regulations set out a non exhaustive list of factors that the Regulator should take into account (for example the financial strength of the guarantors, the amount the withdrawing employer is paying and the effect of the proposed arrangement on the security of members benefits). The Regulator essentially now has a wide discretion when considering Approved Withdrawal Arrangements. Lovells comment this is a very welcome development the test under the Old Regulations was very difficult to meet, and resulted in more regular use of apportionments than the Regulator felt comfortable with. Conditions for payment of Amount B Amount B is paid by the guarantor in the same circumstances as for a Withdrawal Arrangement (see above). In addition to these conditions, however, Amount B under an Approved Withdrawal Arrangement also becomes payable at any time that the Regulator directs. The Regulator may only demand payment of Amount B in this manner if it is reasonable for it to do so, and for this purpose the Regulator can take into 12

17 account the guarantor s financial circumstances and whether it has complied with the terms of the Approved Withdrawal Arrangement. 18 The Regulator may also give notice that the Approved Withdrawal Arrangement is no longer required (and hence the guarantor is no longer liable to pay Amount B). Calculation of Amount B Amount B for an Approved Withdrawal Arrangement is calculated in the same way as for a Withdrawal Arrangement (see above). In other words, Amount B for an Approved Withdrawal Arrangement can also be either fixed or floating. Part D Regulated Apportionment Arrangements This is the fourth category of apportionment arrangement. A Regulated Apportionment Arrangement is similar to a Scheme Apportionment Arrangement. There is no guarantor necessary, the amount of liabilities apportioned to the withdrawing employer is specified, and the difference between that amount and the withdrawing employer s Liability Share is apportioned to one or more of the other employers. There are two key differences between a Regulated Apportionment Arrangement and a Scheme Apportionment Arrangement: Lovells comment we anticipate that Regulated Apportionment Arrangements will be used less often given that they only apply to distress situations. However, there is no legal restriction on a scheme in a distressed state (ie either in a PPF assessment period or likely to enter one within the next 12 months) from using any of the other methods under the New Regulations as an alternative to a Regulated Apportionment Arrangement. Alternative methods of calculating Section 75 Debts Summary Lovells comment the New Regulations now provide four different options for calculating and managing Section 75 Debts other than the default Liability Share. The best option will very much depend upon the circumstances at the time. Our advice is that it seems that the Regulator will expect an employer first to consider a Withdrawal Arrangement. If the employer decides ultimately that he prefers one of the other options, he will need to explain to the trustees and the Regulator why he is not proposing a Withdrawal Arrangement. The table on the following page briefly sets out the key features of the different arrangements so that they can be compared. Given that a Regulated Apportionment Arrangement can only be used in situations of distress, we have excluded that from the table. (a) a Regulated Apportionment Arrangement can only be used when a scheme is in a PPF assessment period, or if the trustees believe that the scheme will enter a PPF assessment period within the next 12 months; and (b) a Regulated Apportionment Arrangement must be approved by the Regulator, and the PPF must confirm that it does not object to the entry into the Regulated Apportionment Arrangement. 18 Regulations 7(8) & (9) of the New Regulations 13

18 TABLE OF OPTIONS UNDER EMPLOYER DEBT REGULATIONS 19 LIABILITY SHARE SCHEME APPORTIONMENT ARRANGEMENT WITHDRAWAL ARRANGEMENT APPROVED WITHDRAWAL ARRANGEMENT Is trustee agreement necessary? No this is the statutory default and will apply if none of the other options apply. Yes Yes Yes Is employer agreement necessary? No this is the statutory default and will apply if none of the other options apply. Yes - although either the agreement of the withdrawing employer or the others depending on the circumstances. Yes Yes What Section 75 Debt is payable? The withdrawing employer s share of the scheme s deficit calculated on the buy out basis (the Liability Share ). Any amount (which can be higher or lower than the Liability Share). The withdrawing employer s share of the scheme deficit calculated on the scheme specific funding basis. Any amount, but must be less than the withdrawing employer s share of the scheme s deficit on the scheme specific funding basis. Can the withdrawing employer pay a nominal debt (eg 10)? No Yes No Yes Is a guarantor required? No No but balance of the Liability Share must be apportioned to one or more of the other employers. Yes Yes Does the Regulator need to be involved? No Yes - not formally necessary but the employer is recommended to apply for clearance. No not formally involved and it will usually not be necessary to apply for clearance. Yes the Regulator must formally approve the arrangement. Do the trustees have to confirm that the Funding test has been met? No Yes Yes Yes 19 Excluding Regulated Apportionment Arrangements 14

19 Transitional Provisions Introduction The Government recognised that many schemes had set up processes to manage Section 75 Debts under the Old Regulations. In light of this, and the fact that the New Regulations were only published in final form shortly before they came into force, the New Regulations contain some transitional provisions. Section 75 Debts arising before 6 April 2008 Lovells comment this transitional protection is sensible, as the New Regulations were only published in final form very shortly before they came into force, and employers and trustees may have completed long negotiations (perhaps involving a contribution to the scheme) on the basis of the Old Regulations. This transitional provision helps to reduce the chances of that effort being wasted and any contribution being paid in vain. The Old Regulations will apply to any Section 75 Debt that arose as a result of an insolvency of an employer, the winding-up of a scheme, or an employment-cessation event that occurred before 6 April Section 75 Debts anticipated before 6 April 2008 but due to be triggered after 6 April 2008 The Old Regulations may also continue to apply for Section 75 Debts which are triggered after 6 April 2008, but which were anticipated before 6 April There are relatively strict qualifying conditions for this protection. However, in general terms, employers and trustees can use an apportionment arrangement under the Old Regulations until 5 April 2009 (ie for 12 months after the New Regulations came into force), if they entered into the apportionment arrangement before 6 April 2008, and the transaction to which the expected Section 75 Debt related (for example a sale of a subsidiary resulting in an employment cessation event) occurs before 5 April 2009, but was considered by the employer s board of directors before 6 April

20 Miscellaneous Amendments Defined Contribution employers Under the Old Regulations, the provisions concerning employment cessation events did not fit very well with employers who only employed defined contribution ( DC ) members. For example, suppose a scheme was unsegregated and had both defined benefit ( DB ) members and DC members. Employer A employs only the DB members, and Employer B employs only the DC members. If Employer A ceased to employ any active members, this would constitute an employment cessation event, because after he ceases to have any active members, Employer B still has active members (even though they are only DC members). Under the New Regulations, if an employer has only employed DC members, that employer is not counted for the purposes of Section 75 Debts. This means that in the example cited above, for Section 75 purposes the scheme would be treated as a single employer scheme, and Employer A as the only employer. Consequently, when Employer A ceases to employ active members, as he is counted as being the only (and therefore last) employer, no Section 75 Debt arises at this point. sections) then the New Regulations apply to each of those segregated sections separately, as if each section was an independent scheme. Former Employers The general position under the Old Regulations was that an employer would not be discharged from further liability to a scheme unless either no Section 75 Debt was due when it ceased to employ active members or it paid a Section 75 Debt. Hence some schemes have former employers who are still employers for purposes of the legislation. The New Regulations essentially maintain this basic position. However, some of the precise drafting has added confusion concerning when former employers may or may not be discharged without actually having to pay a Section 75 Debt. Lovells comment these provisions are very technical and are beyond the scope of this note. We can discuss these problems on an individual basis with our clients should they arise in practice. In any event, it is possible that the provisions may be further amended. Lovells comment precisely how this change will operate in practice depends on the individual facts in each circumstance. However, it is probable that this change will be helpful as DC-only employers ought not really to be considered when looking at Section 75 Debts which only apply to DB liabilities. Sectionalised Schemes The New Regulations maintain, but slightly tighten up, the provisions of the Old Regulations concerning sectionalisation. If a scheme is divided into separate segregated sections (ie where the assets of the scheme are formally segregated and held apart from each other as opposed to simply having different benefit Transfers out The New Regulations contain provisions which provide that if an employment-cessation event is accompanied by a transfer-out of liabilities, the Section 75 Debt will be reduced to take account of the transfer-out of liabilities. The situations being dealt with here is when, for example, an employer participating in a multi employer scheme is sold to another company. The withdrawing employer undergoes an employment cessation event and hence triggers a Section 75 Debt. The Section 75 Debt is calculated at the time of the employment cessation event. 16

21 However, the employer may be going to participate in a pension scheme run by the buyer, and may have negotiated a bulk-transfer, whereby the past service liabilities of some or all of his employees are transferring from the seller s scheme to the buyer s. If this transfer is anticipated, it would not seem fair for the withdrawing employer to pay a full Section 75 Debt to the seller s scheme, when the seller s scheme s liabilities are going to be reduced, perhaps substantially, by a bulk transfer-out. The New Regulations therefore contain provisions for taking this bulk transfer into account when calculating the Section 75 Debt. Lovells comment this is a helpful development. Although similar provisions existed in the Old Regulations, they only applied to Approved Withdrawal Arrangements. The New Regulations now give this a more general applicability. 17

22 Notes

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