Businesses often have complex corporate structures where employees of multiple group companies may participate as members of a group wide defined benefit pension scheme. 

Should one of those companies stop having any employees as members in the pension scheme, the consequence can be significant, resulting in an unexpected and legally enforceable cash call on that employer from the Trustees of the pension scheme.

A large number of businesses seem unaware and unprepared for this eventuality.  With most defined benefit pension schemes now closed to new entrants, companies are in danger of finding their last member retiring, leaving their employment or even dying suddenly triggering this debt.  A typical example is a holding company with a few executives in the group wide pension scheme.  As they retire or leave they may be replaced with executives not in the pension scheme so that the last member leaving triggers a debt.

Putting this is in more technical terms, under Section 75 of the Pensions Act 1995, when a Participating Employer ceases to participate in a multi-employer defined benefit pension scheme, a debt on that Participating Employer is triggered based on its share of the total liabilities of the scheme.

The crystallisation of a debt on an exiting Participating Employer can have a very significant impact on the finances of a business.  When the legislation was first introduced, the debt was calculated on the now defunct MFR basis.  Since September 2005, the debt calculation has been based on the much more stringent and expensive buy-out measure, i.e. the cost of securing scheme benefits in full with an insurance company. 

The exiting Participating Employer’s share of the total liabilities of the scheme includes benefits accrued to its former employees (i.e. deferred pensioners and pensioners) as well as its current employees.  Where liabilities relate to a member who worked for an employer that previously participated in the scheme but exited some time age, this so called “orphan” debt is allocated between the remaining Participating Employers.  The allocation is done in proportion to the exiting Participating Employer’s share of the liabilities which have been allocated.  The same principle applies where there is insufficient membership data is available to attribute all of the past members to a current Participating Employer.

It is also worth noting that the apportionment to the exiting Participating Employer is calculated by the Scheme Actuary after consultation with the Trustees.  There is a certain amount of Trustee discretion as to how the apportionment is carried out where the origin of historic liabilities is not completely clear and this can result in a higher debt than a sponsoring employer might expect.

So the potential debt levels are high and the allocation uncertain and difficult to calculate.  Many business groups and Trustees have never undertaken an exercise to understand the likely magnitude of debts that could fall on the group companies or take advice how to plan around this issue. 

We believe it is important to take action in advance of a debt triggering as a business group may be able to mitigate the risk of such an occurrence by ensuring that relevant senior managers (e.g. the FD and HRD) are aware of the potential debt issue.  In the event of a corporate re-structuring, those key managers would be in a position to check for any potential issues and ensure that a debt is not triggered, subject to legal advice, by keeping active scheme members in the employment of each Participating Employer. 

Managers can also ensure, subject to legal advice, that each Participating Employer has at least a handful of active members at all times to ensure that one employee leaving the employment of a Participating Employer can’t inadvertently trigger a debt.  Where the number of active members falls over a period of time, it may be possible for a company to switch the contracts of employment of other members between Participating Employers to retain a buffer against such an occurrence.  In addition business groups can consider approaching the Trustees to see whether changes could be made to the Trust Deed in order to specify the way liabilities are allocated to provide a more manageable outcome for the group, but the Trustee may require a price to be paid to agree to any such changes.

If you would like further information on this topic or have a specific query please contact David Cule (020 7533 1871) or Richard Jones (020 7533 6967).