Feature – Focus on pensions: A-day shifts pension goalposts

Accounting standard FRS 17 has completely changed the pensions landscape and new rules mean employers must be even more member vigilant, says Ceri Jones

If you read nothing else, read this …

Employers cannot change their pension scheme without consulting members from April 2006.

Check the wording of employment contracts so that any pension promise is not broken.

Bring unions into discussions early on.

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The closure of final salary pension schemes has gathered pace this year as costs rise in line with increased life expectancy and companies grapple with the impact of accounting standard FRS 17, which puts pension liabilities on the balance sheet.

According to the Government Actuary’s department, about three-quarters of final salary schemes in the private sector are now closed to new members. A step further is now being taken with some final salary schemes being closed to any future accruals.

In December, Rentokil Initial became the first FTSE 100 firm to announce the closure of its defined benefit (DB) plan to future accruals. Others, such as Royal & SunAlliance and the Co-op, have altered their scheme structures to an average earnings basis, while Provident Financial has introduced a cash balance system, which guarantees 20% of each employee’s salary will be credited to their pension fund per year.

The restructuring procedure for a scheme will largely be governed by its trust deed and rules, which usually vest power of amendment in the employer and trustees. If the employer simply gives notice that it is stopping contributions to the scheme, in most cases this will precipitate a wind-up.

Under current law, if a solvent company wants to wind up a final salary scheme it has to ensure that the pensions promised are paid on a full buy-out basis, which will be much more expensive than keeping the scheme going. But because wind-up is advantageous to members, the trustees may try to force it through.

Under the new Occupational and Personal Pension Schemes (Consultation by Employers and Miscellaneous Amendment) Regulations 2006, employers will no longer be able to make major changes to their pension scheme without first consulting members.

Such changes include closing a scheme to new members, changing the accrual rate, changing a defined benefit scheme to a money purchase arrangement, reducing employer contributions and increasing member contributions. These requirements will affect employers with more than 150 employees from 6 April 2006, those with over 100 staff from 6 April 2007 while those with 50-100 employees will have to ensure compliance from 6 April 2008.

Bringing a union representative into the proceedings early is sensible to explain the rationale, the legal and actuarial advice received and the treatment of any scheme shortfalls.

Steve Yeo, senior consultant at Watson Wyatt, says: "Employers underestimate the huge amount of effort that goes into communications and the length of time the whole process will take." There may also be conflicts of interest for directors who are also trustees of the scheme and they may be best advised to step down from one of the two boards.

Where scheme changes are mooted the main task will be to check whether any pension arrangement is mentioned in employment contracts, which may vary across the business. If a contract merely mentions the availability of a pension scheme, a stakeholder may suffice, but breach of contract may arise where contracts specify a scheme or benefit level.

Employers who tamper with accrued benefits may be open to legal challenge if the basis on which the pension is calculated is subsequently weakened, such as to an average-of-years basis, particularly if the sponsor has recently enjoyed a contribution holiday. Clive Walker, director at actuaries Hughes Price Walker, says: "Remember, one determined man and a good lawyer can win a case."

Any replacement scheme will impact employees differently. Transferring to a career average scheme, for instance, makes little difference to those whose salaries rise with inflation.

However, any accrued benefits in a closed DB scheme will be linked to rises in the retail price index. This will hit staff in the middle of the age and pay ranges with the greatest prospect of a major promotion ahead, alienating the very group of employees that most firms would like to retain.