Department for Work and Pensions (“DWP”) issues guidance to scheme employers on risk sharing

13 April 2010

Summary
The trend amongst employers to close defined benefit (“DB”) in favour of defined contribution (“DC”) schemes has been widely reported within the media. In an attempt to slow the closure of DB schemes, a new guide entitled Risk Sharing: information for employers considering making changes to Defined Benefit pension schemes (the “Guide”) has been produced by the DWP. This INSIGHT considers the Guide, provides a brief summary of its contents and discusses some issues that employers, trustees and members of schemes may find helpful to address in dealing with changes to occupational pension schemes (“schemes”).

What is risk sharing?
Broadly speaking, most DB pension schemes place the risks on the employer. In DC schemes, risks associated with investment returns and longevity fall on individual scheme members. Risk sharing attempts to find a more balanced way of sharing the risk between employers and members in schemes.

Are there any examples of how it is done?
There are a variety of risk sharing schemes: cash balance, hybrid, career average schemes are samples of the many schemes available. The Guide suggests that instead of closing their DB scheme, employers consider options, for example, the “longevity adjusted DB scheme”. This last example is where a scheme can adjust benefits to take account of changes in longevity, for future accruals only. An alternative is a “hybrid scheme” where the employer and employee contributions go into a DC “pot”, but the employer provides some DB benefits as an “underpin”. The Guide is helpful that it also contains some practical case studies showing the issues that employers need to consider when making changes to their DB scheme.

What are the issues that employers should consider when introducing risk sharing schemes?
The following list of points to note which we have set out below is not comprehensive. However, it provides some salient points to note when considering introducing any of the changes suggested by the Guide.

Member consultation
Employers are obliged to consult with prospective and active pension scheme members before making significant changes to future pension arrangements. A statutory framework exists to ensure that this occurs and is undertaken in accordance with legislation.

Power of amendment: scheme rules, statutory and contractual restrictions
There may be restrictions relating to the amendment power in the scheme rules that stop or limit the alteration of a scheme. In addition to the power of amendment within the scheme rules, section 67 of the Pensions Act 1995, protects the value of pension benefits promised in schemes. Employees sometimes have contractual rights to be a member of a pension scheme. Employees may be able to raise a contractual objection to increasing employee contributions or to cessation of future accruals in the pension scheme.

For the further consideration of employers and members ...
We would suggest that scheme sponsoring employers, who are considering introducing risk sharing schemes seek our professional advice on the changes they are considering at an early stage of their deliberations.

Click here to view the full text of the Guide >>