The Debate: Winding up final salary schemes

THE ARGUMENT FOR WINDING UP

By Michael Rudge

Many company final salary schemes have closed their doors to new entrants over the past few years and while this trend shows no signs of slowing, companies should consider opening their minds to winding up their final salary scheme rather than closure.

A closed scheme might reduce costs and risks in the longer term, but there are a number of factors working against this. Future benefits, for example, still need to be funded for existing members, while changing experience (such as people living longer) can not only increase the cost of benefits currently being earned but also impact on the whole fund built up to date. In addition the contribution rate will rise as the average age of the membership rises and costs are still incurred in managing the scheme.

This list is by no means exhaustive and ignores those issues the employer will face in having employees with different benefits. A successful wind up on the other hand does mean that the scheme, along with costs and risks, will end.

Many businesses are put off by wind up fearing it is too complicated and long-winded. But this is simply not true, it might be a lengthy process but it is not as complicated and long-winded as is often thought.

The wind up process can take around three years although many schemes have been in wind up for much longer. This is often due to businesses not thinking through the process before it starts which means that trustees and employers are often at loggerheads on how to deal with contentious issues. This slows down the process but thorough preparatory work can save much time and aggravation later.

Many schemes are wary of winding up due to the deficits they carry after three years of negative equity performance. However, these debts exist and regardless of which course of action is taken will need to be funded at some point. Closing the scheme and hoping the equity markets bounce could be considered a high risk strategy for many.

• Michael Rudge is director of Hazell Carr

DILEMMA OF FINAL SALARY SCHEME
By Alex Waite

Following three bad years on the stock market, many companies are looking at the deficits in their final salary pension funds and wishing for a way to make them vanish. A common response is to open a money purchase scheme for new employees, shifting the stock market risk onto employees themselves. However, while this contains future risks, it does nothing to change the existing shortfall. Faced with this position, should the final salary scheme be wound up?

The reason that final salary schemes cost so much is that they provide a relatively high level of pension benefit. Typically, alternative money purchase pension schemes incur higher administrative expenses while investing in lower yielding asset classes. Only as the coming generation of money purchase scheme members retire will the pension gap be fully understood.

Even if their scheme has past its ‘best before date’, winding up a pension scheme is a long, tortuous and bureaucratic process. Members are left feeling helpless and are furious when the deficit means they don’t receive the benefits they were expecting.

Winding up a final salary scheme alienates employees while taking away a key incentive to stay – it’s hard to imagine a course of action more likely to encourage people to look for jobs elsewhere. The high contributions required to maintain a final salary scheme are not money down the drain – they provide a correspondingly highly valued employee benefit.

The recent market falls, and new requirements to provide money purchase scheme members with realistic projections of their benefits, are making members increasingly aware of the value of pension benefits and of the relative safety and security of final salary schemes. Those employers that have kept their final salary plans open are seeing that it helps to attract and retain key staff in competitive markets.

If you were choosing between two finance director posts would you be more inclined to join the company offering a final salary scheme or the one with a weak money purchase alternative?

• Alex Waite is an actuary and partner of Lane Clark & Peacock.