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Employer debt

This guide was last updated in August 2011.

When an employer leaves a multi-employer defined benefit pension scheme, that employer may have to pay more funds into the scheme. Understanding when such a liability can arise and how to deal with it is crucial to both the pension scheme and corporate activity.

Sufficient funding

When an employer leaves a pension scheme, there should be enough funds in the scheme to pay for the benefits of its employees. If there is not, then the departing employer will be responsible for its share of any underfunding. This is known as employer debt or 'section 75' debt, after the relevant provision of 1995's Pensions Act.

The amount of this debt is the difference between the assets relating to the particular employer and the cost of buying out the employer's share of the benefits with an insurance company. In many cases this cost is significant. The trustees of the pension scheme must ensure that any employer debt is paid within a reasonable period.

Triggering situations

Employer debt can be triggered in a number of different situations, such as on the sale of a subsidiary company or when the employer stops employing any contributing members.

In some internal group restructurings, no debt will arise as long as another employer in the scheme agrees to take on the leaving employer's liabilities. The restructuring must meet certain fairly narrow conditions, so the trustees and employers should take independent professional advice.

Dealing with debt

There are certain permitted ways of dealing with the debt which can help the employer.

The leaving employer can ask the trustees to allow it to pay a reduced amount if another company guarantees to pay the rest of the debt at a future date - usually when the scheme winds up or the last employer enrolled in the scheme becomes insolvent. This is known as a withdrawal arrangement. The trustees should only agree to the arrangement if the remaining employers can fund the pension scheme and the guarantor has sufficient financial resources to pay the outstanding debt when it is due.

Another option is to ask the trustees to agree to an arrangement in the scheme rules which allows the employer who is leaving to pay less - often only a nominal amount - than the full amount of its debt. Some or all of the other remaining employers must agree to pay the rest. This is known as an apportionment arrangement. The trustees will need to make sure that the remaining employers can fund the pension.

In both these cases, the trustees must first consider carefully whether it is in the best interests of the members to agree to the employer's request. Trustees need to understand the implications of the employer's departure on the ability of the remaining employers to support the scheme going forward. They may need to ask for additional financial support for the pension scheme. This is a complicated area, and trustees should seek independent professional advice.

An employer needs to be particularly careful if it employs very few contributing employees, as a debt may be payable if its last contributing employee leaves the scheme or dies. However, if the employer intends to offer membership to another employee within a year no debt will be payable. To take advantage of this, the employer must tell the trustees in writing within one month of its last employee leaving the scheme. Employers in this position should therefore have systems in place to monitor when the last employee leaves as it is very easy to miss this deadline.

Scheme closure

If the scheme is closed to all further benefits, no debt is payable immediately. However, the employers and trustees should check the rules to make sure that the scheme does not go into winding-up by mistake. An employer remains liable for its share of any underfunding if it becomes insolvent or if the scheme winds up at a later date.

Clearance

The Pensions Regulator, the UK regulator of work-based pension schemes, has powers to require other companies within the group to provide support. Employers can apply for confirmation from the Regulator that it will not use these powers. This is known as clearance.

Although neither a withdrawal arrangement nor an apportionment arrangement needs Regulator approval, the Regulator expects clearance to be sought in some cases.

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