Mergers & Acquisitions: The DC pension choices

If you read nothing else, read this…

  • There is no single right answer on what do about DC pensions provision following a merger or acquisition.
  • Some employers will launch a brand new scheme for all staff, others will extend existing plan and others will do nothing.
  • Employers must consider factors such contribution levels and governance.

Case study: E.On empowered by national pension scheme

E.On is a diverse business with a long history of mergers and acquisitions. In the UK, most staff belong to one of three pension plans: career average and final salary arrangements that are closed to new staff, and an open defined contribution (DC) plan.

Ant Donaldson, senior specialist, employee benefits at E.On, says harmonising pensions was helped by the fact that the whole industry is part of the national Electricity Supply Pension Scheme (ESPS), a final salary scheme. “Whenever there is a merger or acquisition involving ESPS members, they are generally moved from one section of the ESPS to another,” he says.

Eight years ago, E.On closed membership of ESPS to new joiners and set up its own career average pension scheme. This was subsequently closed to new members two years ago, when E.On launched a contract-based DC scheme.

There have been some acquisitions that fell outside ESPS. “We have allowed schemes to run on where we felt this was the most sensible course of action,” says Donaldson. “Where appropriate, we have offered members of those schemes the choice to move to whichever of our main three plans was open at the time.”

Employers have several options on DC pensions after a merger, says Sarah Coles

There is no single right answer when it comes to deciding what to do with pensions after a merger. Some employers find the best solution is to do nothing at all, keeping all the schemes going. Others have a policy of continuous acquisition and simply roll each new employee into one existing pension. And some take the opportunity to start afresh and build a brand new pension scheme for all staff.

Tony Pugh, UK head of Mercer’s defined contribution (DC) consulting business, says doing nothing is a powerful option. “I know of one company with 91 pension funds,” he says. “Some conglomerates with active acquisition strategies have an approach of leaving well alone. If the acquired company is a distinct part of the business, then they may not need to harmonise the schemes.”

But for many, the aim is to bring pensions together. Roger Mattingley, head of client relationship management at JLT Benefit Solutions, says: “There is a real corporate desire in most organisations to harmonise and get some consistency. The utopian position for [employers] is to offer the same core benefits for everyone.”

By far the most common option is to run a DC pension scheme – either offering an existing plan to the rest of the M&A parties, or starting a new one. Often, organisations with at least one trust-based DC scheme will expand it to the wider business. For example, when Lucent and Alcatel merged in 2008, Lucent’s stakeholder pension scheme was closed to new members and Alcatel’s trust-based DC plan was opened to all staff. With trust based schemes, it is more usual to extend one scheme than to close both and start afresh. Pugh says: “If employers can reduce the number of staff affected by the change, that may well prove the easiest option.”

If employers have two DC contract-based schemes, they can still extend an existing plan to new staff. With a contract-based scheme, employees must choose to transfer into it themselves. In 2010, for example, Computer share Investor Services opened its group personal pension (GPP) to staff who joined the business after it acquired HBOS Employee Equity Solutions. The legacy DC and DB schemes were closed and staff were invited to enrol in Computer share’s GPP.

Employers with contract-based DC plans have an easier job than those with trust based DC plans if they want to start a new scheme for the whole business. Philip Baker, senior consultant at Towers Watson, says: “Employers may be in a greenfield situation where what they consider to be right for the workforce is not already on offer at any of the merger parties. This is an opportunity to refresh the benefits strategy.”

Transfer existing benefits

If employers set up a new DC scheme, they need to enable employees to transfer their existing pension benefits and need to wind up the old schemes. Then it is just a question of establishing the right governance, contribution levels and communications.

Robin Ellison, head of strategic development for pensions at law firm Pinsent Masons, says: “The Pensions Regulator is issuing streams of advice and regulations that make running DC almost as complicated as DB, so a governance system is increasingly worth considering.”

Employers also need to look at contribution levels, particularly if merging staff received different contributions in their previous schemes. Employers may have to choose between levelling up or down. When Live Nation Entertainment merged with Ticketmaster in 2007, it levelled up, and some staff saw their contributions rise. JLT’s Mattingley says: “When harmonising benefits, it is easier to sell to staff if employers level the mup, but the overriding commercial desire is to keep costs neutral.”

But there are risks in increasing benefits to the highest level of the old schemes. Baker says: “Levelling up is expensive and it increases expectations for all aspects of reward, so most businesses try to keep changes to remuneration cost-neutral.” So there will be winners and losers, which makes it hard to satisfy all staff. Rather than trying to hide any negative effects of the changes, the key is communication. Take employees along, so they know this is not brutal cost-cutting, but is done for solid reasons and the good of the workforce.

Baker adds: “At the outset, employers may not be able to communicate what the new deal looks like, so they may need to tell staff about the principles they will employ, such as keeping overall benefit costs the same, to help manage expectations. If [employers] run a consultation process, they need to support it with communications. If decisions need to be made, staff need to understand the options available.”

A third option is to offer a pension through a flexible benefits plan. “This helps harmonise benefits without encouraging cherry-picking,” says Baker.

When accountancy firm Grant Thornton merged with Robson Rhodes in 2007, it was faced with two very different DC pension schemes: one offering a contribution of 6% for staff who contributed 4%, and the other offering age-based contributions. Its new stakeholder scheme, launched in 2008 through a flex plan, offered to match staff contributions between 3%and 8%. So, although there is no right answer in terms of how pensions are harmonised, the solution will need to combine careful analysis and open communications.

Auto-enrolment considerations

The impact of auto-enrolment must be considered in any harmonisation process. One element is cost: if a scheme is being introduced or rolled out more widely, employers must consider not just the cost of providing benefits to current pension members, but the potential overall cost if every single eligible employee is automatically enrolled.

Robin Ellison, head of strategic development for pensions at Pinsents Mason, says: “DC [provision] is going to get more complex because of Nest [the national employment savings trust] coming online. Employers have to consider whether the scheme they are intending to roll out to employees meets the new rules, because there is no point changing everything now and then changing again a year down the line.”

Auto-enrolment poses additional challenges in an already complex process, but it also offers an opportunity. Tony Pugh, UK head of Mercer’s DC consulting business, says: “With auto-enrolment, the removal of the default retirement age and the change in the state pension age, the landscape is completely changing. So much change gives employers an added rationale for entering a harmonisation process, which will leave them with a scheme suitable for a modern workforce and the current environment.”

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