As the economic downturn continues, employers are increasingly considering ways to reduce their pension costs to aid survival. Several organisations have recently announced plans to modify existing pension arrangements. In the coming months many other employers are expected to follow suit. So what are the options for employers who want to reduce future pensions costs and what are the legal issues that need to be considered?
Options for reducing future pensions costs
For employers with a defined-benefit occupational pension scheme, the primary options for reducing future pensions costs are:
- closing the scheme to future accrual and providing a money purchase scheme (such as a group personal pension plan) for the future;
- closing the scheme to new members (most employers with defined-benefit schemes have already done this);
- keeping the scheme open but reducing the rate of future accrual (for example, by reducing the accrual rate or replacing final salary benefits with career average benefits); and
- increasing the rate of members’ contributions towards the scheme.
Employers with a money purchase scheme can reduce future costs by:
- reducing the rate of employer contributions; or
- increasing the amount that members have to contribute to qualify for employer contributions.
Employers (and members) could also reduce national insurance contributions by introducing a salary sacrifice arrangement for the payment of members’ contributions.
Legal considerations
Before employers make changes to pension arrangements, there are several legal issues that need to be considered.
Power to amend schemes
The changes that an employer can make to its pension scheme in respect of future service may be restricted by the terms of the scheme’s amendment power. For example, in Lloyds Bank Pension Trust Corporation Ltd v Lloyds Bank plc[1996], the High Court held that a restriction in the amendment power of the Lloyds Bank Pension Scheme, which prohibited changes ‘decreasing the pecuniary benefits secured’ to or in respect of active members of the scheme, prevented changes being made to the scheme that would take away members’ past service benefits or promised future benefits.
An employer may also be required to obtain the consent of its scheme’s trustees before any changes can be made.
Consulting ‘affected members’
Employers with more than 50 employees have a statutory duty under s259 of the Pensions Act 2004 to consult ‘affected members’ before making certain so-called ‘listed changes’ to an occupational pension scheme. Listed changes include:
- closing a scheme to new members;
- ceasing future accrual;
- reducing future service benefits; and
- increasing members’ contributions.
Employers may also be required to consult with employees and trade unions under the Information and Consultation of Employees Regulations 2004 or under the terms of a collective bargaining agreement.
Do the changes constitute a variation of employees contractual terms?
If the change to a scheme would constitute a variation of an employee’s contract of employment that is not permitted by the contract, an employer will need to vary the terms of the contract by:
- seeking the employee’s express agreement to the new terms (either on an individual or collective basis);
- unilaterally imposing the change and relying on the employee’s conduct to establish implied agreement to the change; or
- terminating the employee’s employment and re-engaging them on the new terms.
Each of these options give rise to different legal issues that need to be addressed. However, in practice it should be possible to effect such a change where an employer can demonstrate a good business reason for doing so and where it acts reasonably and follows a proper procedure.
What about the past?
Section 67 of the Pensions Act 1995 prevents detrimental changes being made to members’ accrued benefits without the members’ consent. Most schemes’ rules also contain a similar restriction. This means that the scope for employers to reduce members’ accrued benefits is very limited. Having said that, in recent years some employers have sought to reduce past service liabilities and risk by:
- offering inducements to members to forego non-statutory pension increases;
- offering inducements to members to transfer benefits out of the scheme; or
- buying-out past service liabilities (although at present this option is likely to be too expensive for most employers).
Needless to say, there are several legal issues that need to be considered before any of these exercises are undertaken.
If you would like to find out more about these issues, Eversheds is running a series of seminars on scheme change throughout the country during July 2009. For more details e-mail timsmith@eversheds.com.
By Jeremy Goodwin, partner, Eversheds LLP. E-mail: jeremygoodwin@eversheds.com.