Let’s talk about problems with defined benefit pension schemes. I know – where do we start? Some have been foisted upon us by legislation but it’s fair to say some are of the industry’s own making.
For closed defined benefit (DB) pension schemes, it seems likely that the vast majority of these will end up in one of two homes – an insurance company or the Pension Protection Fund (PPF). Although this may be far in the distance for some and imminent for others, what is common in both is something that needs action now – namely rectifying pension scheme data and making sure the scheme is being administered in accordance with the rules. Sounds easy? Not so, but well worth doing, to avoid a whole world of pain when the end point of the scheme arrives.
So what is the problem? Many schemes are not getting the basics of pension scheme administration right. An administrator’s mantra is “pay the right benefit to the right person at the right time”.
In order to do this, you firstly need a complete data set so that you can calculate the correct benefit entitlement when a member becomes deferred, retires or dies. This seemingly simple process can rely on multiple pieces of information covering various salary definitions, service history, part time working hours, transferred in benefits to name but a few. In terms of historical administration records, it is also prudent to check a sample of records to verify that past calculations are correct and, if not, take the appropriate action.
Secondly, you need to ensure that the rules are “valid” and that they are being implemented correctly. Common problems relate to sex equalisation – resulting from the Barber judgement which saw retirement ages for males and females aligned, implementation of pension in payment increases, the effectiveness of scheme closures and the breaking of the link between accrued benefits and final salary. If any of these issues have not been dealt with properly, there is a serious risk that a scheme could be building up unexpected additional liabilities on a daily basis until these problems are fixed.
In our experience of taking schemes through the wind up process, and through the assessment process for entry to the PPF, almost all schemes suffer from one or more of the above afflictions.
Taking the above action will allow the production of a clean set of governing documents for the scheme and a detailed benefit specification upon which the administrator can calculate the benefits due to members in an unambiguous way. This will lead to significant improvements in the administration of schemes – full automation, better service levels and substantial cost savings.
So why act now? Two reasons – firstly, the problem will not just “disappear”. It will come out eventually and prior to the scheme winding-up, the benefits will need to be corrected, potentially at huge cost.
Secondly, Section 67 of the Pensions Act 1995 means that accrued benefits cannot be reduced, without individual member consent. As such, each day that an additional benefit accrues, it cannot be removed and the additional liability has therefore crystallised. Also, pension overpayments are very difficult to reclaim, both legally and morally, especially if the scheme has contributed to the errors.
Recent cases such as the Gleeds pension scheme, where the employer is facing £45 million of additional liability, and the Honda Uk pension scheme, where the employer’s additional liability may reach £70 million, illustrate the potential scale of these issues. We are also of aware of schemes where a buyout had seemed affordable to an employer only for historic issues to scupper the well laid plans. In many of these cases, an earlier identification of the problems would have significantly reduced future costs.
Finally, with the end of contracting-out looming in April 2016, schemes with contracted out liabilities, in the form of Guaranteed Minimum Pensions, should act now to tie up the scheme records with those held by the DWP. Delaying this necessary project will only cost further time and money as the disparity between data sets grows and the level of support from DWP to assist schemes dwindles.
So, it may well pay off to have a peek in the closet, even if there is a skeleton or two.
