Out-Law Analysis 4 min. read

Pensions risk transfer: a case study on final salary links


Trustees sometimes assume that winding up a pension scheme will sever a members’ right to continue obtaining benefits linked to their final salary, because it is not possible to insure benefits on a final salary linked basis, but this is not necessarily the case.

This is because benefits may have been bought out on a salary-linked basis.

One bulk annuity transaction that Pinsent Masons advised a sponsor company on highlighted some interesting issues around final salary linkage, the extent of trustees’ duties, and employer consultation law.

The example

The company closed its scheme to future accrual a few years ago, but following the Courage case of 1987, the scheme amendment power could not be used to break the link between members’ past accrual and their salaries while they remain in service. As a result, salary linkage continued under the scheme even though accrual of pensionable service had stopped.

The company wanted to buy-out the scheme and was prepared to provide additional funding so that the trustees could secure all benefits with a bulk policy and then wind the scheme up. But the company could only afford this if winding up would cut salary linkage for members still in service.


Read more on pensions risk transfer


Severing final salary linkage

There is a widely held view that winding up must sever salary linkage because it is not possible to insure benefits on a final salary linked basis. This is not in fact necessarily the case: benefits have been bought out on a salary linked basis, an example being the Denso Marston deal of 2012 in which Pinsent Masons acted.

In the recent bulk annuity transaction, we were able to advise the company that winding up would break the final salary link. It was possible to conclude that the principles in the Courage court judgment did not apply to the exercise of a winding-up power.

Fettering trustee discretions

The company’s objective was that the scheme would be wound up after the trustees had insured all liabilities. To make that happen, the company was prepared to inject additional funding.

There was a barrier to achieving the desired outcome: the winding-up mechanism under the scheme’s rules. Under those provisions, the company was obliged to give notice to the trustees that it was terminating its contributions to the scheme. Upon receipt of that notice, the trustees could exercise their discretion to wind up the scheme. However, the trustees could not be forced to wind up the scheme under the scheme’s rules. They could, if they wished, choose to continue the scheme as a frozen scheme – an outcome that the company did not want.

To address this, the company wanted the trustees to enter into a legally binding agreement. Under the agreement, on receipt of the additional funding, the trustees would:

  • use their investment power to purchase the buy in policy that had been selected by the company’s advisers; and then
  • definitely exercise their discretion to trigger wind up of the scheme upon receipt from the company of the contribution termination notice.

However, there was a question over whether the trustees could enter into such an agreement, given their general duty under to trust law not to ‘fetter’ their discretion.

On the basis of the relevant case law and of the terms of the proposed agreement, we were able to advise the company that the agreement would not infringe the trustees’ general duty not to fetter their discretion. The crucial point in this regard was that the trustees would be getting something substantial – the funding injection – in return for entering into the agreement. This meant that it would be an appropriate contractual agreement for them to enter into for the benefit of their members.

Employer consultation

A further issue to navigate concerned the sponsor’s obligations under the employer consultation regulations.

The company did not wish to communicate with affected members about its plans until the trustees had entered into the agreement and secured the buy in policy. However, if consultation was required, the regulations required that the company consult with affected employees before any agreement with the trustees and before the trustees had bought the buy in policy. In this scenario, however, it was conceivable that the company would go through consultation, decide to proceed, and then find that it could not obtain acceptable buy in terms and therefore have to announce to its members that its plans were off.

The question in this case was whether a decision to wind up the scheme, thereby cutting the salary link, would require the employer to consult with affected employees before taking it. The answer boiled down to whether the employees who benefited from salary linkage were active members for the purposes of the regulations: if they were active members, then consultation would be required.

Whilst the point is not straightforward, in this case, it was concluded that the members under the scheme who benefited from salary linkage were not active members for the purposes of the employer consultation regulations. The company was not required to consult under the employer consultation regulations and, consequently, it could communicate with members at the point that it wished to – i.e. after the trustees had entered into the legally binding agreement and secured the buy in policy.

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