Trustees in a UK pension scheme will have to determine the contribution rate that the employer pays into the scheme. This post discusses the things that they should to consider.
The duty of the trustees is act in accordance with Trust law, the Trust Deed and Rules for the scheme, and prevailing legislation. They should act prudently, in the best interests of all beneficiaries, seeking professional advice where necessary, and without seeking to profit from their duties.
The first port of call is therefore the Trust Deed and Rules and the Statement of Funding Principles. The Trust Deed and Rules will set out who determines the contribution rate, and the Statement of Funding Principles will set out how it has been agreed to fund the scheme. The trustees may be seeking to amend the Statement of Funding Principles as part of this exercise.
There are two main possibilities in the Trust Deed and Rules - that the trustees and employer decide on how the scheme should be funded together, or that the trustees decide on their own. Let us consider the case that trustees decide on their own first.
In this case, the trustees must determine exactly what the ability to set contribution requirements in the Trust Deed and Rules actually means. This will typically be something along the lines of "Contributions that are necessary to provide the benefits...". These wordings are ambiguous, because they do not state exactly how the benefits should be measured, under what scenarios the contributions required should be measured, under what timescale and shortfall or surplus should be amortised, and so on.
In an ideal world, the trustees look at this wording, and would interpret this purely based on the needs of the scheme, and the likelyhood of the employer being able to support the scheme in the future. So if a company was likely to be around indefinitely, the trustees would use an ongoing basis, with surplus or deficit amortised over the lifetime of members, and if the company was likely to be bust in few years, the trustees would target a solvency basis over the course of the expected lifetime of the company, and a continuum of possibilities in between these extremes. In making these assessment, the trustees should take legal advice, and actuarial advice. They should also consider the possible impact of forthcoming legislation.
In the real world, the trustees also need to consider the employer attitude to the scheme. This would include previous agreements, the position of the scheme in the remuneration strategy, advice that the employers are getting, how much they can afford to pay and whether they have any counter-proposals.
This consideration is required because there are also a number of possible concequences of the contribution demands. These concequences include the employer becoming uncooperative, refusing to pay contributions, closing down the scheme, winding up the scheme, or becoming sufficiently uncompetitive that they, and the scheme, became insolvent. The trustees will need to balance these concequences when considering how to act in the bests of all beneficiaries. In particular, they will need to examine the concequences of whether the employer has the ability to wind up the scheme, and if so, what funding requirements doing so would trigger.
If the trustees and employer decide how the scheme should be funded together, then similar considerations apply. However, there is now a default option if no agreement is reached. In the past, the default option was that the scheme was funded on the MFR basis; a basis which is weak by current standards. This meant that the employer had the strongest bargaining position - if the employer wasn't happy, then they could get a low rate largely automatically. Currently, with the introduction of the Pensions Regulator and the SFO the default position is moving towards the trustees side, with targets of 100% FRS or 75% solvency over 10 years being mooted.