Section 75: Ticking time-bomb in need of reform, say lawyers

Section 75 of the Pensions Act 1995 refers to the debt payable by an employer that ceases to participate in a defined benefit scheme. The debt reflects the cost of buying out an employer’s portion of scheme liabilities.

In multi-employer DB schemes, this debt is supposed to stop sponsors from walking away from underfunded pensioner promises. But with the end of active membership triggering the debt, the legislation has left some employers unable to tackle their mounting pensions problem, and in extreme cases left a “last man standing” responsible for the liabilities of an entire scheme. 

There are also more typical uses of the act. In its 2019 annual report, the 627-member FirstGroup Pension Scheme announced that four employers had ceased to participate in the scheme in recent years, apportioning debts to different regional operators within FirstGroup.

A more high-profile case was that of Trinity College, Cambridge, which formally withdrew from the Universities Superannuation Scheme on May 31 2019. The college paid USS about 2 per cent of its total assets, saying it “removed the remote but existential risk to the college arising from continued participation in USS”.

This is a real threat for non-sectionalised, multi-employer schemes. If an employer exits either voluntarily or through insolvency and does not pay its own debt, then these liabilities become “orphan liabilities”, which are spread among the remaining employers.

Small plumbing businesses have been savagely hit by section 75 debts incurred under the Plumbing and Mechanical Services Industry Pension Scheme, forcing many of them to near bankruptcies.

Experts have said that the trigger for section 75, based on when the last member stops accruing benefits, can leave employers unable to manage their pension exposure.

Alistair Russell-Smith, head of corporate DB at Hymans Robertson, said: “As most employers in these types of scheme have a closed group of staff in the scheme, the section 75 debt is a ticking time-bomb for them, which will trigger when their last employee leaves pensionable service.”

Bulk transfers an alternative solution

A solution is emerging for employers who want to exit a multi-employer scheme, but are unable or unwilling to pay the section 75 debt triggered when they do exit.  

Mr Russell-Smith suggested that sponsors can bulk transfer their shares of assets and liabilities into their own scheme, affording them much more flexibility. 

“The employer can therefore fund the deficit over time in their own scheme without having to pay the section 75 debt upfront, and they are released from the ‘last man standing’ risk,” he said.

Another way for employers to manage section 75 debt risk is to use a flexible apportionment arrangement. These are often used by “associated schemes” – those where participating employers belong to a single parent group – and allow liabilities to be moved around the group.

Mr Russell-Smith explained: “It does require the trustees to be comfortable that the funding and covenant support for the scheme is no worse as a result of the apportionment. The employer also needs to find another employer willing to take on the liability.”

Finding a recipient is usually straightforward with associated schemes, but Mr Russell-Smith has also seen “cases of non-associated employers taking on the liability in exchange for a cash or asset payment outside of the pension scheme”.

Reforms urged

Without an agreement, an FAA cannot take place. Jeremy Harris, pensions lawyer at Fieldfisher, said this can limit their usefulness: “Unless some other way of apportioning or deferring the section 75 debt can be found, which is possible only in limited circumstances, where the leaving employer that is ceasing to participate in the scheme will be liable to an immediate section 75 debt.”

Trustees also need to notify the Pensions Regulator of any FAAs. According to Penny Cogher, partner at Irwin Mitchell, the watchdog has “become fairly relaxed on these, but with Covid-19, requests for apportionment arrangements will be scrutinised far more”.

The whole area is weighed down in arcane legislation. Indeed, Jane Kola, partner at Arc Pensions Law, stressed: “The rules for how employers transfer such liabilities to one another in the course of normal business are crying out for change, but in the past that has only resulted in tinkering around the edges, which has made the law more, not less, complex.”