Squire Sanders Hammonds: It pays to get the right advice
Defined benefit pension schemes are notoriously complex, with a host of legal issues to consider when managing down the risks. Catherine McKenna, partner at Squire Sanders Hammonds, explains how schemes can benefit from the advice of a specialist law firm, especially in light of the upcoming regulations around auto-enrolment.
What are the key legal issues in the bulk annuity buy-in and buy-out process?
Catherine McKenna: There are three main issues that you're going to face legally. Number one, both buy-in and buy-out involve an element of cross-subsidy. The second point is collateral - if the insurer you've transacted with goes bust, will you be able to strike a deal that puts you in a more advantageous position than their normal unsecured creditors? The third one would be the different protections that apply before and after a buy-out, which differ a lot in terms of their impact.
These are complex legal contracts, and your rights and obligations will be governed by them. So they're not the kind of thing you'll want to enter into without legal or actuarial advice. That's where a specialist law firm comes in.
What other strategies are open to finance directors looking to manage down the risks associated with defined benefit pension plans?
Aside from buy-ins and buy-outs and other forms of investment hedging, I'd say there are three main options. One of these is an enhanced transfer value exercise, where the corporate approaches its ex-employees and offers them an enhancement if they transfer their benefits elsewhere. This will almost certainly cost less than providing those benefits over the fullness of time.
Another option is to offer a similar deal to the people who are currently in receipt of the pension, reshaping it in such a way that they can have more cash today, but give up future increases on parts of it.
And then the third main strategy is to try to find something other than cash to fund the scheme, such as real estate, brands, receivables or trade debts. This gives the fund assets if the company's no longer there.
How should finance directors prepare for the extra costs involved in the auto-enrolment regime?
When auto-enrolment is ultimately rolled out across the UK, the average cost for a business with 5,000 heads will be around £2 million a year. We have a hit list of things that we think finance directors should be doing in order to minimise the impact.
Firstly, you can delay putting people into the pension plan and paying contributions for them for three months. Secondly, you can implement a salary sacrifice, which typically saves both employer and employee NI and can wipe out 15-20% of your extra costs.
Thirdly, you can implement a pay freeze, adjusting other employee benefits instead. Finally, you can employ more part-timers, because unless an employee earns more than £7,500 a year, they will not have to be auto-enrolled.
To what extent are pension deficit issues dictating outcomes in mergers and acquisitions?
M&A activity is slower than it has been, but where you get a pension deficit it's still a major issue. The two main risks that you face are firstly that you crystallise the shortfall in the pension plan and have to pay it, and secondly that, because of the way the deal is struck, the pension regulator expects you to re-open your deal.
The overall message is that if pension deficit issues are recognised and managed they won't get in the way of an M&A deal, but otherwise they can trip them up.
What were the main drivers behind your recognition as the European Pensions Law Team of the Year and Global Pensions Law Team of the Year at the European Pensions Awards 2011?
One driver is the critical mass of the UK team. We have about 60 specialist lawyers within our pensions practice, which is about the biggest in the industry. We also now have a global platform as a result of our recent merger with US firm Squire Sanders, which is represented in 17 countries.
And then the third one is a recognition that we're not just reactive lawyers - we're proactive. We have a role in many of the industry bodies, which gives us advance warning of developments and a chance to lobby for change.