MONEY MATTERS
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When companies merge what happens to pension funds, and what must the trustees of each fund do to make sure their members get the best deal?
Amerger is announced: Bloggs Transport is buying Brown Transport No doubt sound business considerations underlie the deal, but what effect will it have on something the European Court clearly regards as "deferred pay"— namely companies' pension arrangements?
It depends on their type. If both companies have only private pension arrangements (whether or not the employer contributes) or Group Personal Pension Plans (in reality a cluster of individual personal pension schemes, often badged with the employer's name), then although Bloggs will probably have to contribute at the same level as Brown did, no major restructuring is required.
Occupational
It's more complex where there is an occupational pension scheme: a scheme set up with its own trustees and administered as a separate entity. An occupational scheme may be one of two types: • Money purchase (also known as defined contribution or DC); • Final salary (defined benefits or DB).
In a typical DC scheme, the level of employer and employee contributions is fixed and the benefits the pensioner receives depend on the sum available in his "pot" at retirement. This will buy benefits: usually a tax free lump sum and a pension for life provided by an annuity.
The annuity will often include other benefits such as widows' pensions and periodical pension increases which are mandatory when con
tributions have been made after April 1997.
The 1)B scheme is more complex. Retirement benefits depend on the individual's earnings in the last few years of his working life. They are built up over the whole period of the individual's membership of the scheme at a set rate; typically 1/60th or 1/80th per year. In a typical 1/80 scheme an employee with 40 years' membership of the scheme would be entitled, on retiring, to a pension of 40/80 (50%) of his average salary over the last three years of his employment For a 60th scheme it would be 40160(66%).
When a 25-year-old joins the scheme it is not possible to predict his salary at age 65. In the DB scheme the employee usually contributes a fixed percentage of his pay; the balance of the cost of providing the promised benefits is paid by the employer whose contribution rates are calculated by an actuary.
Each scheme must be valued at least every three years. If the actuary calculates that the scheme's assets are more than sufficient to meet its present and future liabilities, the scheme is in surplus; if the assets are insufficient it is in deficit.
Let's suppose that Bloggs and Brown both have DB pension schemes. Each scheme will have its own trustees and governing documentation. Administering pension funds can be expensive. As well as regular trustee meetings and three-yearly actuarial valuations, every scheme must produce annual audited accounts.
Merging the two schemes would obviously reduce these costs, but it not as easy as it sounds. Each group of trustees must discharge its duties. If not, it is likely to be called to account by a scheme member or by the Pensions Ombudsman. These duties are defined in case and statute law and in the documents governing the scheme.
In 1985 the mineworkers' pension fund was involved in a celebrated case. The trustees (some represented in court by Arthur Scargill) sought advice on their duties. Some of the trustees wanted the fund to place its money in ethical investments.
They were told their paramount duty was to act in the best financial interests of their beneficiaries: not only current members but also including pensioners, members with deferred benefits and widows.
This duty is wide-ranging. In a merger of schemes both sets of trustees must ensure the merger does not harm their members' interests, and the benefits already promised before the merger are as good or better in the new scheme. Unless they get consents from all the members (not usually practical) they must obtain an actuary's certificate to this effect.
Balance of powers
They will need to check the "balance of powers": the split between matters controlled by the trustees and those controlled by the employer. They will want to ensure that, where benefits and increases are discretionary, the new regime will be as generous as the old. Their duty is to get a good deal for their members—and trustees don't give things away, they trade them.
The trustees might well be able to block the merger. If so, they may seek to use this power for the benefit of the members. A surplus represents security: they are unlikely to agree that their fund (if in surplus) should be merged with a fund in deficit.
Many schemes lack the necessary power to merge. Section 67 of the Pensions Act 1995 means a scheme cannot be amended unless an actuary certifies members' rights will not be adversely affected. Even where the power to merge does exist, trustees must ensure their motives are correct the trustees of a scheme in the Hillsdown group, for example, were found to have exercised a perfectly valid power to merge "for a collateral purpose": to enable a surplus to be paid to the employer. The trustees were using their power for the wrong reasons and the Ombudsman and the High Court held that this meant the money paid (a seven-figure sum) had to be repaid.
A merger of pension schemes might bring advantages for all; not least the members. It is not, however, a straightforward undertaking and care must be taken to avoid legal pitfalls. LI by Ronald Graham Ronald Graham is a partner in the Manchester office of Eversheds, the national law firm.
• The UK is unusual in Europe: most British pension schemes are funded: money is collected and invested during the members working lives and used to pay their pensions On retirement Apart from Ireland and the Netherlands, other countries tend to rely on unfunded pension promises.
In a Defined Benefit Scheme employee and employer will usually contribute. The money is invested and substantial funds accumulate. Contribution rates vary with promised benefits and membership profiles.
A typical underlying rate might be 18%. If the member contributes 5% the employer meets 13%. But if the scheme investments are perform* well they provide a third source of income. In times of stock market growth this can mean that schemes become self-supporting. Employers (and, less frequently, employees) cease to contribute (by taking "pension holidays") and surpluses build up.
During an economic downturn the reverse effect applies:assets diminish and contribution rates for employers (occasionally for employees too) can rise sharply.
The Pensions Act 1995 requires employers to make good within defined timetables.