In recent years we have seen some disturbing headlines in the media concerning large corporate failures and what affect this has had on the company’s pension scheme as a result. Not many people would have missed the media coverage of the losses to the BHS pension scheme when Philip Green sold the company. He later paid £363million in a deal with The Pensions Regulator to cover some of the losses.
However, while we read the headlines, what do we really know about the reality of what happens to a company’s pension scheme on its insolvency?
- What happens to a company pension scheme when it goes into insolvency?
- Does it matter what type of pension scheme the company has?
- What happens when a company goes into formal insolvency?
- The Pensions Regulator and powers to get money into the scheme
- How are unpaid employer or employee contributions to a pension scheme dealt with on insolvency?
What happens to a company pension scheme when it goes into insolvency?
The good news is that the pension assets do not form part of the company’s assets to be used for the benefit of all the company’s creditors. They sit apart in a separate ‘pot’ just for the pension scheme beneficiaries.
Does it matter what type of pension scheme the company has?
There are two types of pension scheme generally. A Defined Benefit scheme and a Defined Contribution Scheme. These are treated very differently in insolvency.
A Defined Benefit (DB) scheme is more commonly referred to as a final salary scheme. This means that the scheme is responsible for paying its pensioners an amount equivalent to their average final salary once they retire.
A Defined Contribution (DC) scheme (also known as a money purchase scheme) is where money paid in by the employee and employer is put into investments (such as shares) by the pension provider. The value of the pension depends on how much was put in, and on how the investments perform.
These schemes are treated differently on a company’s insolvency. The larger liability for a company will be a DB scheme, as the company will be responsible for paying its pensioners their final salary on retirement, even though there may not be sufficient funds in the pension scheme when the company goes into insolvency.
With a DC scheme, the pension is unlikely to be owed much, if any money. Only the value of unpaid contributions by the company if payments weren’t met for employees when due.
What happens when a company goes into formal insolvency?
If the company has a DB scheme, then the insolvency of that company triggers what is known as a s.75 debt (under the Pensions Act 1995, s.75). This means that the employer now owes a sum to that pension scheme sufficient to meet the amount needed to enable the fund to pay all its liabilities to pensioners under the scheme when they become due. In reality, this will usually amount to the cost of buying out the scheme’s liabilities to members by means of annuities.
This debt from the company into the scheme ranks as an ordinary unsecured debt in insolvency, which, as you can see in our previous article: Who gets paid first in liquidation, falls quite far down the list of creditors in terms of priority. So, it is unlikely to be paid in full, or even often in part, depending on the assets available and the number of creditors left behind in the insolvent company.
At the same time, the insolvency will trigger the start of an assessment by the Pensions Protection Fund (PPF) to check the eligibility of any DB scheme to fall into the PPF. The PPF was put in place to pay compensation to cover members' benefits, up to a certain level, if a company goes into insolvency and is unable to meet its full commitments to a DB pension scheme. The DB scheme must be eligible for the PPF by satisfying certain criteria, and this assessment can take up to two years.
If the scheme’s assets are insufficient to meet certain minimum statutory liabilities to members, then the PPF will take on the scheme, to ensure that pension members do not lose their final salary pension interests due to the failure of the company.
DC pension schemes are not eligible for entry into the PPF. It is likely that a DC pension scheme will be wound up following an insolvency event, as insolvency is generally a trigger for the winding up of the scheme. Assets will be dealt with in accordance with the terms of the scheme, and those responsible for the DC scheme's winding up, which are likely to be the Trustees and the Insolvency Practitioner involved in the insolvent company, must ensure they comply fully with the procedures set out in the scheme rules and pensions legislation.
The Pensions Regulator and powers to get money into the scheme
The Pensions Regulator (TPR) was created to protect occupational pension scheme members and the PPF, as well as to regulate pension trustee behaviour more generally. It has various regulatory powers available to recoup money back into DB pensions schemes to try to reduce the burden on the PPF when a company can’t meet these debts. These include:
- Imposing a Financial Support Direction (FSD) – this is where a company that is associated with the insolvent company, often a parent company or connected company which has benefitted financially from the insolvent company in the past, is ordered to financially support the DB scheme by the TPR.
- A Contribution Notice (CN) - this is where the TPR finds there has been a deliberate avoidance policy by the employer company or an entity or person associated with the employer company in order to avoid having to meet the full pension liability. If that is the case a CN can be ordered against that entity or person to put money back into the scheme to meet it’s liabilities (and reduce the burden on the PPF). A relevant example is that given earlier of Philip Green, who was accused of having sold BHS to Dominic Chappell deliberately to avoid the company’s retirement plan liability. He later agreed to put £363m into the pension fund (which had a deficit of approximately £571m).
How are unpaid employer or employee contributions to a pension scheme dealt with on insolvency?
Any money an employer has deducted from an employee’s benefits for the purposes of paying into their pension scheme in the 4 months before insolvency will rank as a preferential debt to be paid into the scheme through the insolvent company’s assets. Anything over 4 months will be an unsecured debt and sit further down the priority order but can ultimately be repaid if money is available.
Generally unpaid employer contributions will rank as an unsecured debt in the insolvency, due to the pension scheme.