In September 2005, the government introduced legislation which means an exit charge called a ‘section 75 employer debt’ becomes payable when a participating employer withdraws from a multi-employer pension scheme, such as the Industry Scheme.
Under section 75 of the Pensions Act 1995 as subsequently amended, participating employers become liable for what is known as a section 75 employer debt when they withdraw from the Scheme.
This debt is calculated on a ‘buy-out’ basis, which tests whether there would be sufficient assets in the Scheme to secure all the member benefits by buying annuity contracts from an insurance company.
Legislation requires a section 75 employer debt to be paid when a participating employer either:
- becomes insolvent;
- winds up;
- changes its legal status (for example following a business sale/transfer of all employees to a new entity or when a partnership or sole trader changes into a limited liability company); or
- ceases to have any active members in the Scheme while another participating employer continues to have active members (called an employment cessation event) and there is no expectation that new employees of the employer that ceases to have any active members will join the Scheme in the next 12 to 36 months.
The Employer Debt Regulations, which deal with employer departures and section 75 employer debts, have been around since 1995, but came into force on 6th April 1997. The Scheme was sufficiently well-funded on the basis that applied then, so that when an employer debt trigger occurred, no cash payment to the Scheme was required.
The legislation has changed several times since 1995. The current legislative requirements link section 75 employer debts to the ‘buy-out’ shortfall (based on the cost of buying annuities from an insurance company for all the members to match the Scheme’s benefits), which is much more expensive than the original legislation.
Until now, the Trustee has been unable to calculate section 75 employer debts because:
1. the legislation which the Trustee must follow when determining an appropriate approach to calculate debt payments is not easy to apply to very large non-associated multi-employer pension schemes like the Industry Scheme, and
2. it has not been possible to obtain all the data needed to carry out the calculations.
The Trustee has been in communication with the Pensions Regulator, the Department for Work and Pensions and its own professional advisors since the legislation changed to use the ‘buy-out’ shortfall. The Trustee had always hoped that a change in the law would be possible, or a special exemption granted from the legislation which is fair to employers and protects members.
A section 75 employer debt is equal to the departing employer’s share of the shortfall in the Scheme on a ‘buy-out’ basis. This includes an allowance for the estimated expenses that would be incurred in the hypothetical situation that the Scheme decided to wind up and buy annuities for all the members. The employer’s share of the shortfall is based on the benefits accrued by each member whilst employed by him.
The shortfall is calculated by comparing the Scheme’s assets against the Scheme Actuary’s estimate of the cost of securing all the Scheme’s benefits with an insurance company. The departing employer’s share of the shortfall includes its pro-rata share of the Scheme’s benefits that cannot be attributed to a given participating employer, otherwise known as “orphan” liabilities.
A section 75 employer debt can only be known for certain at the time the debt payment is triggered. This happens when a participating employer becomes insolvent, winds up, changes its legal status or ceases to have any active members in the Scheme while another participating employer continues to have some active members. It is extremely difficult to estimate in advance what an individual employer’s section 75 debt might be because the amount will vary depending on many factors including:
- The number of pension scheme members attributable to the departing employer, the ages of those members and the amount of pension benefits those members have built up (influenced by the size of each member’s earnings and the length of their pensionable service).
- The value of the Scheme’s assets on the calculation date.
- The assumptions the Scheme Actuary uses in her calculations (influenced by investment market conditions which change from day to day).
- The number of other participating employers in the Scheme.
- The value and appropriate share of “orphan” liabilities.
The section 75 employer debt could be a very large payment, even though the Scheme was fully funded on an ongoing ‘Technical Provisions’ basis at the latest formal actuarial valuation.
An employer debt only becomes payable when a participating employer winds up, becomes insolvent or ceases to have active members and there is no expectation that the employer will put new employees into the Scheme in the next 12 to 36 months.
If a departing employer tries to avoid paying an employer debt the Pensions Regulator has powers, known as anti-avoidance powers, which it can use if it is concerned that any alternative to full payment of the departing employer’s debt is being made to the Scheme.
The Pensions Regulator can also use its powers if a participating employer undertakes, for example, a corporate change or restructuring which is considered to be of material detriment to the Scheme, such that the employer debt recoverable was compromised or reduced.
In certain circumstances a departing employer may be able to reassign its liability to pay a section 75 employer debt to another participating company in the Scheme using an apportionment arrangement, such as a Flexible Apportionment Arrangement (FAA). For this to occur, another participating employer (or employers) must be willing to take on the departing employer’s liability, consent in writing to the apportionment and certain conditions must be met, including the Trustee’s agreement to the FAA. A statutory funding test must also be met to ensure that the employer or employers which take on the liability are financially able to do so. Further information is available here.
If you run an unincorporated business and are considering changing into a limited company please contact the Trustee before you make any changes because this could trigger an employer debt.
The Trustee would like to see the section 75 employer debt legislation reformed to make it fairer to employers participating in non-associated multi-employer pension schemes like the Scheme.
Since the introduction of the section 75 employer debt legislation, the Trustee has frequently advised the relevant Government departments and agencies of the difficulties that the employer debt regulations pose for the Scheme. The Scheme was established for employers whose only connection to each other is that they operate in the plumbing and mechanical services industry and the rules under which the Scheme was established did not envisage that, at any time, participating employers would be responsible for anything other than the contributions due to the Scheme in respect of their own employees. In spite of the Trustee’s representations on these matters, the legislation has continued to change in ways which have made it more difficult for the Scheme to operate in the way it was envisaged it would. One of the points the Trustee has highlighted as unfair is that the current legislation requires participating employers that cease to participate in the Scheme after the date on which the Regulations came into force to contribute towards the buy-out shortfall in relation to employees of employers (to whom there is no connection) who ceased to participate in the Scheme before the Regulations were introduced.
For information on an easement that may be available to companies to apportion a section 75 employer debt click below.
To see answers to frequently asked questions during the employer consultation and subsequently click below.
