Pensions World

As more employers contemplate closing their DB schemes, how do lawyers see the pensions endgame panning out? James Thomas surveys the legal scene

A glance at a pensions lawyer’s in tray is as useful an indicator as any of the current state of occupational provision and of its future direction. And such a glimpse suggests that the trend among pension schemes towards focusing on liabilities – which our annual lawyers’ survey has seen accelerate in recent years – has continued in the aftermath of the financial crisis. For example, respondents to this year’s survey reported a surge of interest in the use of contingent assets to reduce employer cash contributions and in scheme restructuring and redesign projects, particularly as the funding challenge facing schemes has been compounded by the downturn.

TABLE 1 - Pension lawyers - their clients and their practices

More generally, with minds now focused sharply on the volatility of scheme deficits, lawyers have noticed that the endgame has become a principal concern for many employer sponsored defined benefit (DB) schemes. As David Pollard, Freshfields, explains, schemes are wondering, with varying degrees of urgency: “What happens if it all goes wrong?”

“We’ve seen a significant increase in advice relating to failure of the employer covenant – trustees needing to understand, get involved in and ultimately support debt restructurings of their employers done on a distress basis and, worse, negotiating full compromises of pension liabilities with a view to schemes then entering the PPF,” he says. “But even for other schemes where the urgency is not so immediate, there is contingency planning to be done to ensure that trustees and employers are prepared for ‘if’ becoming ‘when’.”

Cash flows

Indeed, as the crisis has drawn financial directors’ and chief executive officers’ attentions ever more towards what were already eye-watering pension scheme liabilities, joined up thinking around the sharing of risk between trustees and employers has come to the fore. Notably, the use of contingent assets to reduce employer liabilities has brought with it a host of new considerations for lawyers advising in this area.

“While the contingent asset and associated exotic funding arena is getting really interesting now, I do worry that there will be a backlash from Parliament if one of these structures collapses with the company,” warns Däna Burstow, Allen & Overy. “The Regulator is already expressing reservations and there is a very fine balance between structuring cash flows reasonably to reduce the risk of surplus getting stuck and the sort of overly employer dependent investment which originally led to the employer related investment laws.”

With employers increasingly looking to offload risk, lawyers have also noticed signs of a revival of interest in the buyouts market, which according to some reports has been flagging over the past 12 months. Jane Samsworth, Hogan Lovells, believes that, as soon as market conditions are favourable, there will be an increase in such deals. Indeed, François Barker, Hammonds, suggests that the trend towards buyouts has in fact increased over the past year, with those schemes that cannot or do not yet wish to consider a buyout showing interest in partial buyins instead. “The key issues for trustees in considering these deals are certainty of the benefits to be secured, preparation and auditing of data and ensuring how to crystallise any benefit features they have at their discretion,” he adds.

Although much-hyped, there are mixed views on the potential popularity of longevity swaps as a means to de-risk. Ms Samsworth feels that the time horizons “are so distant that it is hard to judge how robust they really are” and, consequently, clients have shown less interest in the approach than might have been expected. Mr Barker, however, offer replacement arrangements that may well be inadequate,” suggests Paul Stannard of Travers Smith. “This has now gone past the point of no return and means that individuals will increasingly have to fend for themselves.”

Anna Rogers, Mayer Brown, feels that some corporates may in time regret having lost their DB scheme as an HR tool. “Research shows that retirement poverty is a risk to an employer’s reputation,” she argues. “Pension schemes don’t just exist out of generosity to employees, they exist for business reasons, although the costs have got so out of control that those business reasons appear to have been lost. While I understand the commercial pressures on employers, employers will find managing employees and an ageing workforce much more difficult if they only have in place a relatively modest defined contribution (DC) scheme which transfers all of the risk to the employee. Employers are going to lose something for the money they save by moving to DC.”

TABLE 2 - FEES

Although some of Mayer Brown’s clients have shown interest in replacing DB schemes with career average revalued earnings (CARE) structures, Ms Rogers reports that it is more common for employers to “go the whole hog” and opt for DC. “Although many of our clients are trying to shave benefits off the DB promise and reduce costs in more modest ways while retaining the core benefit, I think the tide towards DC is unstoppable now and that most employers will stop future accrual in their DB schemes and opt for untrammelled DC rather than any ‘third way’ of risk sharing,” she adds.

Saving a savings culture

Against this background of declining DB pension provision – and the concern that DC replacements may be inadequate – the Coalition government faces some stern challenges in promoting pensions saving. What steps, then, should Pensions Minister Steve Webb be considering to encourage continued workplace pension provision and healthy uptake by employees?

The lawyers surveyed were unanimous that any initiative to promote pension saving should have education at its heart. “Regulation has not worked, and nor have moves towards ‘simplification’. The main weapon that needs to be deployed is education,” believes CMS Cameron McKenna’s Neil Smith. “The government will need to continue to work to ensure that employees are under no illusion that if they do not save, there may be no meaningful safety net for them at retirement age.”

And such moves should be part of a wider initiative to encourage a general savings culture, according to David Thompson, Shoosmiths. “People in their early twenties are starting work in debt, which means that saving for an event which will occur in 40 years’ time is not at the forefront of their minds,” he argues. The value of pensions should be emphasised in the schoolroom, with education continuing into the workplace. Auto-enrolment could then be viewed as an opportunity to further reinforce changes in attitudes towards saving.

“Alongside an auto-enrolment regime that is simple to understand and easy to administer, employers should be encouraged to establish governance committees for their contract-based DC arrangements with responsibility for promoting workplace pensions and member investment choice,” suggests Mr Barker. “It should also be made easy for employers to take advantage of self-certification of existing schemes that already exceed the requirements of Nest by simplifying the band earnings and tests.”

Initiating this type of cultural change is no mean feat. As Anna Rogers notes, employees on the whole are not particularly well informed about DC issues, despite the fact that there is currently a lot of information available about pensions “for those who seek it”. “The problem is getting employees to engage with pensions and get their heads around the issues, because, despite tax simplification, it can still be a very complicated and dull subject for them, with deferred gratification,” she explains. “Apparently people spend longer each year arranging their holiday than they do on arranging their retirement provision.”

If pensions saving is to be encouraged, then education must be supplemented with employer incentives. According to Alastair Meeks, Pinsent Masons: “The government needs to find a way to encourage schemes to offer a middle way between DB and DC provision. In the meantime, it could offer better tax incentives to encourage higher pension contributions to DC schemes and perhaps tax incentives to employers based on the numbers of employees who join their pension schemes. This would have to be done carefully as it may not be financially advantageous for lower earners to join a DC scheme.”

Accelerated demise

Unfortunately, the complexity of pensions continues to prove a hurdle both to employee uptake and employer provision; the irony being that successive rounds of legislation aimed at protecting pensions have in fact accelerated the demise of DB. It is a source of frustration to the legal community. As Jane Samsworth suggests: “Pension provision is voluntary so it is difficult to understand why those who do choose to provide pensions have to be so highly regulated. I’d take a scythe to much legislation on the basis that it’s unnecessary; and some of it is just wrong-headed. For example, whatever the original purpose of s251, its effect has been to impose further costs on already struggling DB schemes. And the apparent s75 easements given to employers who conduct internal reorganisations are laughable – far too narrow to be of any practical use.”

TABLE 3 - Top Performers

But despite the steady decline in DB schemes – which have provided the bread and butter of lawyers’ work for years – there are few concerns amongst the legal community that the volume of pensions related work will tail off any time soon. The same complexity that lawyers bemoan will, of course, ensure a high demand for legal advice, while scheme restructures, closures and the like will keep legal professionals busy for some time. Meanwhile, a retooling among pensions lawyers is already under way, prompted by the new demands of the current liability driven environment, in which, for example, an increasing awareness of alternative asset classes has resulted in trustees requiring advice from those expert on such matters as swaps contracts, hedge fund investments and general de-risking and longevity mitigation strategies. According to Ian Pittaway, Sackers: “With trustee boards run increasingly like a full-blown business, the role of the pensions lawyer has also moved on. For example, a very positive development in my view is that I am increasingly involved in more governance related work, such as sitting on trustee selection panels. This gives me an even greater understanding of the immense pressure on hardworking trustees.”

There seems little doubt that lawyers’ in-trays – albeit differently composed – will continue to bulge.

James Thomas is a financial journalist; jamesthomasworks@yahoo.co.uk