Home > News > 2003 > April 2003 > Wind-up Priorities
Wind-up Priorities
Julian Mainwood from the pensions administration department in Barnett Waddingham's Amersham office reports on the current inequalities that exist when a pension fund in deficit winds up.
Just recently pensions have come in for a bit of a rough ride in the media. It seems each day we hear of the closure of another final salary pension scheme, or a large funding deficit in a major pension fund.
Perhaps one of the most significant stories in recent months concerns the plight of some of the members of the Allied Steel & Wire Pension Scheme. This case highlights the potential inequalities that exist in the current winding up rules which mean the distribution of assets can work unfairly to the advantage of retired members at the expense of non-retired members.
Background
The current wind up rules are enshrined in the Pensions Act 1995 which for the first time legislated the order of priority for the allocation of scheme assets where a salary-related scheme (subject to the MFR) is being wound up. Prior to the Pensions Act 1995 the order of priority was largely established in the scheme's trust deed and rules.
On wind up the employer only has to fund (and settle any wind-up deficiency) up to the MFR level. Where a shortfall exists this then becomes a debt on the employer. The position is worsened where the employer is insolvent as the debt will rank alongside other creditors and may not be paid in full.
The problem is that even when the MFR level is reached the cost of buying annuities, particularly deferred annuities, is much greater than the MFR value and so there are rarely sufficient assets to provide members' benefits in full. Furthermore the cost of winding up a pension scheme can run into thousands with adviser and independent trustee fees having first call on the scheme's assets.
Once the numerous regulatory processes have been carried out what is left of the scheme assets can be distributed to members. The prescribed order as set out in the Pensions Act 1995 is:
- Pre April 1997 contracted out rights (i.e. GMPs and CEPs)*
- Post April 1997 benefits in respect of contracted-out employment*
- Refunds of contributions for members with less than two years service
Excluding increases in payment
As can be seen the list weighs heavily in favour of protecting the benefits of existing pensioners which is just and correct. However, the current high cost of securing pensions in payment means that existing pensioners have in many cases an overwhelming claim on the scheme assets leaving little for non-retired members (as is the case for Allied Steel & Wire).
The problem is highlighted when you consider that a pension scheme member (say in his early sixties) may have contributed to the scheme for over 40 years and still have little or no pension entitlement if the employer goes into insolvency and the scheme is in deficit when wound up. An equivalent fellow member, however, who is a few days older may have retired just before the crystallisation date (when members are allocated to their priority class), and will therefore receive full benefits. An area of concern is that there have been cases where top executives (armed with this knowledge) have taken early retirement before the crystallisation date, and hence they fall into the category of pensioner when the assets are distributed. This can have a large impact on the remaining fund available for distribution to non-retired members.
It is ironic that this part of the Pensions Act 1995 seems to lessen some members' pension security when most parts of that Act were intended to increase security following Professor Goode's report into the Maxwell affair. Clearly poor investment returns and diminishing asset values over recent years have made the situation much worse than may have been envisaged back then, and it is this that has brought the issue to the fore at the moment.
What next?
It was hoped that the recent government Green Paper would offer some solutions. It makes some suggestions such as changing the current priority order (to favour those with longer service) or a possible higher ranking for pension debts in insolvency but there is nothing really concrete. Another possibility might be for the priorities to be age-related, rather than just the crude distinction between pensioner and non-pensioner. The problem is if there is not enough money to go around then somebody will inevitably lose out. At present the system favours pensioners, however the alternative of reducing a pensioners' income is highly undesirable and should only be considered as a last resort.
Recently Frank Field MP drafted a private member's bill to change the priority order in pension scheme wind ups. The bill proposed four main aims:
- A new basis for sharing the scheme's assets such that if a scheme is underfunded then everyone's benefit will be reduced.
- Requiring the government to come up with proposals for an insurance scheme for funds so that any scheme winding up below a set level of funding would be topped-up.
- Limiting fees charged by advisors and Independent Trustees during wind-up.
- Permitting the Governement to fund a compensation scheme by making a limited levy against the vast amount of unclaimed assets from other schemes, some of which date back over hundreds of years.
The bill was due for a second reading on 7 March but due to time constraints and parliamentary procedures the bill has fallen by the wayside and will now disappear from view.
The bill did raise some interesting suggestions and certainly the idea of using unclaimed assets seems a good idea in principle but how this would be administered in practice is another matter.
It seems there is no immediate solution in sight but whilst pensions remain such a topical (and political) issue further such cases as Allied Steel & Wire are sure to demand change in the not too distant future.
Julian Mainwood, April 2003.