Pension Funding

Most private sector pensions are funded. Assets need to be accumulated in advance to meet the ultimate liability to pay pensions. Some public sector schemes are unfunded, and they are paid for by taxation on an ongoing basis.

Prior to the pensions legislation in the mid-1990s, there were very few funding obligations. The contractual and trust duties provided in the trust deed are related contracts applied. However, if there was a failure to adequately fund pensions, there was no effective recourse left for pension beneficiaries. Unless the employer had substantial means and could be shown to be in breach of the contract.

From an employer’s perspective, it is better that the obligations accrued in respect of future pensions are funded on an ongoing basis over time. It is much better able to meet its liabilities and properly account for its real current profits on this basis. The trust documentation will make provisions for contributions by the employer and employee as the case may be. Commonly, the employee makes a fixed contribution, and the employer has a balancing contribution.

There is a critical distinction between final salary schemes, defined benefit, and defined contribution schemes. The risk of inadequate funding is particularly pointed in the case of final salary or the defined benefit schemes as they promise pensions referable to a final salary and not simply the pension that the available contributions can finance.

The Pensions Act 1995 provided statutory requirements to maintain the funding. It provided that the assets should be at least equal to the amount of the liabilities on the basis provided. This was the minimum funding requirement.

It required valuations every three years, a schedule of contributions payable on annual certification.

The MFO has been replaced from 2005 under the Pensions Act 2004 by a statutory funding objective. This is designed to allow the schemes to adopt a funding strategy appropriate to their circumstances. The statutory funding objectives apply to all defined benefits schemes, other than those exempted by regulation. The exemptions apply to certain public sector schemes, pay-as-you-go schemes, unregistered schemes with fewer than a hundred members, certain other schemes with fewer than a hundred members, a scheme with fewer than 12 members for all our trustees, and decisions on investment are to be made unanimously. The scheme in which death benefits are only provided, scheme that is being round up.

The overriding requirement is that the scheme has sufficient and appropriate assets to cover technical provisions. Technical provisions are the amounts actuarially calculated required to make provision for the liabilities of the scheme. This is based on actuarial assumptions of inflation, discount rates, life expectancy, and investment returns.

Trustees must prepare and review periodically a statement of funding principles. This is to ensure that the statutory funding objective is met on an ongoing basis.

Trustees must carry out an annual valuation, actuarial valuation, or obtain an annual actuarial report with an actuarial valuation every third year. The actuarial report should include developments affecting the scheme, practical provisions since the last valuation.

As part of the actuarial valuation process, the actuary must specify in its opinion the calculation of technical provisions as required by the funding regulations. The actuary must certify that the legal requirements have been met or must report the matter to the regulator within a reasonable period following receipt of the valuation, generally 10 days.

Where the funding requirement is not met, a recovery plan must be put in place to meet the statutory funding objective. The plan must be reviewed and, where necessary, adjusted.

In fixing the recovery plan, the trustees must take account of the assets and liabilities of the fund, risk profile, liquidity requirements, age and profile of members, recommendations of other parties who determine employer contribution rates.

Trustees should aim to remove the shortfall as quickly as possible. The underlying assumptions for the recovery plan must be appropriate. There is a range of matters to which the trustees are to have regard.

The recovery plan must set out the date by which the funding shortfall is to be eliminated. It should, where appropriate, provide for additional contributions to be made. The copy must be sent to the regulator within a reasonable period. Failure by the trust deed to take a few requisite steps may result in penalties.

Trustees must prepare and review periodically a schedule of contributions. This must be done within a certain period of the actuarial valuation. It must cover the five-year fund, the date of the certification, or the recovery period if longer.

The actuary certifies the schedule of conditions as required in accordance with the funding principles. He must certify that the scheme meets the statutory funding objective or can be expected to do so for the period of the schedule. Alternatively, that the scheme can be expected to meet the funding objective by the end of the period in the recovery plan.

If the actuary cannot give the relevant certificate, this must be notified to the regulator.

The schedule must be signed by the trustees and the employer to testify to his agreement to the matters in it.

Where the actuary determines that, because of significant changes in the value of scheme assets since the last valuation, he is unable to certify the schedule. He should modify the certificate, registering that the funding objective is not complied with, assets of the most recent actuarial valuation. The regulator must be notified. Failures to take reasonable steps to comply with the requirements relative to the schedule of contributions may be subject to administrative penalties.

Trustees are obliged to report late payments of contributions under a schedule of contributions to the regulator. Where they have reasonable cause to believe the failure to pay on time is likely to be of material significance on the exercise of the regulator, this would include fraudulent behaviour by the employee, systematic failures, signs of insolvency. Contributions that are unpaid are a debt due to the scheme by the employer. Civil penalties may be imposed, and administrative sanctions may be imposed on the employer if they fail without reasonable cause to make contributions.

There are equivalent obligations to disclose failures to contribute to a defined contribution scheme. Civil administrative sanctions apply for failure to make payments on the part of the employee.

The trustees introduce a statement of funding principles setting out the schedule of contributions within 15 months of the actuarial valuation, including if necessary provision of a funding plan.

Trustees must obtain records of all contributions, showing the contributions made on behalf of members, retired members, voluntary contributions, and employer contributions. They must set out the records of actions to recover contributions if not paid when due to recover any debt that has arisen.

The concept behind the 2004 Pensions Act is that the trustees and employer should work together to resolve funding issues, develop a funding strategy, and resolve funding issues. The trustees must obtain the consent of the employer in relation to certain key issues, including the content of the funding principles, recovery plans, schedule of contributions, functions regarding technical provisions.

The requirement for consent is inapplicable where the trustees have the power to set the contributions without the employer’s consent. Where this power exists, trustees are to consult with the employer only.

Where the scheme rules provide for a contribution rate to be determined by a third party, such as the scheme actuary, or without the agreement of the employer, the trustee must take account of the recommendations of that person on the assumption and their calculation. In this case, trustees are only obliged to consult with the employer.

Where the scheme actuary has the power to determine a contribution rate without the agreement of the employer, the trustees determine the rate with the consent of the employer, and the scheme actuary may certify the schedule of contributions if they are no less than they would have been had the actuary determined the rate.

Where the employer’s consent is necessary but is not forthcoming, the trustees may determine a modified rate of accrual with the employer’s consent. They must report the failure to agree to the regulator who has powers to intervene.

Where the modification of future accrual is involved, the trustees may fix contributions while consulting the employer. Modifications must not affect subsisting vested rights. They must be in writing and notified to active members.

The trustees must obtain the advice of an actuary before making decisions regarding methods and assumptions in calculating scheme technical provisions, preparing or revising a statement of funding principles, preparing or revising a schedule plan, and preparing or revising a schedule of contribution upon a five-year scheme with the employer.

The regulator has powers to ensure or seek compliance with the funding standards. It may modify future funding benefits and may impose the schedule of contributions, statement of funding principles, or other recovery plans where the trustees fail to comply with their statutory obligations. The regulator’s code of practice sets out the steps which the trustees are required to take in order to reach agreement with the employer before reporting a failure to agree to the regulator.

If trustees and employers have not been able to reach an agreement on issues, the regulator will require details of negotiations and the reasons for non-agreement. It may require them to undertake alternative dispute resolution mechanisms. If the regulator’s intervention does not resolve the matter, the regulator may exercise the above powers, including the imposition of a funding schedule of contributions.

Schemes with fewer than 100 members with no cross-border elements are not required to obtain annual actuarial reports or funding statements between their triennial valuations every third year. The obligation will be triggered if the number of employees exceeds 100.

There are more stringent requirements in respect of cross-border schemes. The IORPS directive requires that such schemes must be fully funded at all times. They must have an annual actuarial valuation. Each valuation must be signed by an actuary within a year.

The regulator authorizes cross-border schemes.

Where the pension scheme itself covers risks related to death, guarantees on investment performance, or guarantees defined benefits, it must comply with certain own fund requirements in addition to the standards requirement. An actuarial valuation is required annually, and the statement of funding principles must set out the policy of complying with the regulatory owned funds requirements. If it is not met at the current date, trustees must ensure that it is met within three years and furnish the regulator with reports and the steps required to do this. The regulator may modify the future accruals of benefits and give directions.

The regulatory owned funds requirement does not apply to certain schemes, similar to those exempted in respect of the exemption in respect of scheme funding regulations referred to above.

The actuarial report must be furnished to the regulator if he is unable to certify that the technical provisions calculation is undertaken in accordance with the funding regulations. He must report if he is unable to certify the schedule of contributions.

The trustees must furnish a copy of the recovery plan together with information. Certain information in the actuarial evaluation.

Where the statutory funding objective has not been achieved on the effective date of the evaluation, the trustees must send the copy of the schedule of contribution. Trustees must report failure to pay in accordance with the schedule of contributions. They must report failure to agree matters with the employer.

The funding regime requires disclosure of certain documents to members, potential members, spouses, and civil partners, recognized trade unions.

The trustees must disclose within two months of request the latest valuation report, the latest statement of investment principles, statement of funding principles, recovery plan, actuarial valuation, schedule of contributions, and payment schedule.

The trustees must send an annual funding statement to all members and beneficiaries of schemes which are subject to the statutory funding objective.

The statement must include a summary based on the most recent valuation of the term to which assets cover technical provisions. Explanation of change in funding provision. Actuaries estimate of solvency in the latest valuation certificate summary of recovery plan. Whether the scheme has been modified at the direction of the regulator.

See separate chapters in relation to winding up of schemes in deficits. Schemes in deficit have obligations to notify certain events to the regulator. They must notify certain employer-related events.

Where funds are in surplus relative to their obligations, complex issues may arise. Monies are not necessarily available for additional benefits. Technically they belong to the employer on the principle of a resulting trust. They may be reduced by a reduction in the employer’s contribution for a period.

The question arises as to whether the surplus has arisen from excess employer contributions or employee contributions. The trust deeds and rules may set out the position. They expressly provide or may create a legitimate expectation that surplus funds will be used for additional benefits.

The rules will set out what happens to excess assets in the winding up.

As legislation restricts to the extent tax advantage is to register schemes to the extent of the surplus by way of a position of a 35 percent charge.

The Pensions Act 2004 provided certain conditions applicable to the repayment of a surplus. It included notice to be given to members and an increase in pensions by a certain percentage.

Where the deed provides payment to the employer out of funds, it may only be exercised by the trustees. It may be exercised only if the trustees have obtained a written valuation signed by an actuary. There is a certificate in force that it meets the prescribed requirements and specifies the maximum that may be paid. Payment does not exceed the maximum. Trustees are satisfied with the interest of the members that the power is properly exercised. Notices have been given to the members in a prescribed form. This is to set out the payment decision.

If a registered scheme commences winding up, the power to distribute surplus assets to the employer cannot be exercised unless certain statutory requirements are followed. The scheme’s liabilities must be fully discharged. If there are powers to distribute funds to another third party, this must be positively exercised or not exercised. Notice must be given to the scheme members in a prescribed manner. The notice must set out the estimate of the value of the assets remaining and the persons or class of persons to whom and in what proportions it is to be distributed. Invite representations within two months and advise the members that no assets would be distributed for at least three months after the second notice is given.

The second part of the notice must be given after the representation period has expired. The distribution takes place if no notice is received from the regulator for the requisite period.