The end of contracting out can bring challenges to schemes wanting to transfer. Mike Ramsey, Chief Executive, The Pensions Trust looks at how they can prepare.
The demise of contracting out can’t come quick enough for some people in the pensions industry.
Managing guaranteed minimum pensions (GMPs) is a thankless task that swallows disproportionate resource. While GMPs are set to rumble on a bit longer, at least the efforts required to keep on top of this will reduce in time.
That isn’t the end of the potential for corporate headaches, however, and many businesses may find themselves tripped up, particularly if they enter into any M&A activity.
When you buy or sell a company, the scheme will typically be transferred to the new owner. Transferring a scheme with GMPs and protected rights isn’t that much of a hassle in and of itself – you don’t even need a member’s consent provided the transfer is into a scheme that was set up to be contracted-out and that the member’s past benefit rights are protected. The transfer agreement will certify that the existing benefits are being transferred and that members will receive the same benefits as provided under the old scheme. The actuary of the ceding scheme also has to certify that the benefits of the members being transferred are not worse off post transfer.
If member benefits are not protected and the covenant strength of the new employer is not strong enough, the old trustees are never going to sign off the transfer.
But in order to be able to transfer a scheme with GMPs and protected rights liabilities, the receiving scheme must have been contracted-out.
When contracting out ends on 6 April 2016, new schemes won’t have the status of being formerly contracted-out and so won’t be able to accept transfers. This leaves business owners with two choices.
The first is to engage with all members and gain their consent to move the scheme into one that has never been contracted out. Now, member engagement is one of those tasks that many find very rewarding, yet rarely is it successful.
Encouraging any meaningful proportion of your membership to engage with you is very difficult and on a subject that deals with GMPs and protected rights that many in the industry will admit to have only a sketchy understanding of, well, you’ll need a lot of luck.
Unfortunately, there’s no knight on a white charger from the DWP. The department has decided that the rules governing schemes not being able to accept former contracted out benefits will remain in place.
It was proposed during the consultation last year that schemes not formerly contracted-out should be able to receive bulk transfers if sufficient safeguards and protections were put in place.
Encouragingly, the DWP considers this a reasonable suggestion, but that there simply isn’t time to draft protections in time for the end of contracting out, so it’s been put on the back burner for 2017.
The only other alternative is for businesses to find a suitable scheme that can hold their scheme, or to delay a transfer until the new regulations come out.
The good news is that such schemes do exist. Some schemes were set up to allow transfers in from multiple pension schemes, these are master-trusts. Typically associated with DC arrangements, DB master trusts such as The Pensions Trust also exist. Providing the master trust has formerly been contracted out they will be able to accept a bulk transfer of contracted out benefits.
Determining if a scheme is suitable couldn’t be simpler – all you have to do is ask for a scheme’s SCON. No, it’s not a request for a teatime treat, but the scheme’s contracting out number (SCON) that indicates its contracted out status.
The SCON allows schemes to Accept contracted out benefits. So, if you are involved with a company on the prowl for some M&A action, there are some simple steps to take.
First, determine whether there is a DB pension scheme.
The next question is was it contracted out and if so – it probably was – what the situation is concerning GMPs and protected rights.
You are right to think these will of course be picked up in the laxest of due diligence, but where we see problems – and corporate actions coming to a dead halt – are around the suitability of the receiving scheme.
Secondly, will the buyer need to take on pension liabilities as part of the M&A deal?
If you don’t have a scheme that can take on contracted out rights as part of a bulk transfer, you’ll have to find one. Due diligence doesn’t happen overnight and this will take time and cost money. Depending on how long it takes, it might even make that acquisition or disposal unappealing or impossible within a certain timeframe.
The answer is to be prepared. There’s no use complaining that the DWP has let you down, as nothing will happen for the next 12 months.
So, find a scheme with a SCON that will take your scheme, and if you give yourself sufficient time, you may find one on terms you find acceptable.