How to control costs through DB scheme mergers

The main drivers for merging pension schemes are, typically, to reduce the burden on management, make cost savings from economies of scale, and eliminate duplication in areas such as administration.

Schemes and employers will hope to save on professional legal, actuarial, auditing and accounting fees, and any professional trustee charges. There may also be better investment opportunities with a larger merged fund. 

A merger is typically considered alongside corporate reorganisation, where a group which has previously taken over companies wishes to rationalise pension provision across its various businesses.

Who needs to be involved with a merger?

The principal companies of the schemes need to approve the merger, although this is often a formality if they have proposed it. 

The schemes will need to carefully review the proposals, take professional advice on whether to approve the merger, and whether their approval should be subject to any conditions, for example an additional payment into the merged scheme to boost funding levels. 

The members of the scheme will also be involved in the process to a lesser or greater extent, depending on whether the transferring scheme's rules require member consent. In either case communication will be critical.

How should it be done?

Mergers should be carefully planned to avoid or manage conflicts of interest between the trustees and the company, by forming a sub-committee of non-conflicted trustees, or ensuring conflicted trustees withdraw from meetings or voting dealing with merger issues.

The parties to a merger will also require separate legal advice as the employer and trustees have differing considerations and different memberships to consider.

The schemes must contain a power to merge either in the form of a specific merger power or relevant powers to make and receive bulk transfers.

The transferring parties should ensure the documentation implementing the merger does not inadvertently trigger a wind-up of the scheme and hence a significant statutory debt on the transferring employers.

The schemes’ main balance of powers between employer and trustee should be compared, as they may differ, to the detriment of members. 

For example, the transferring trustees may have the power to set employer contributions, amend or wind-up the scheme, or to veto certain benefit amendments.

They may then be reluctant to transfer members to a scheme where these powers are vested in the employer, without some form of mitigation such as accelerated funding or the grant of security.

To merge or not to merge?

The transferring scheme will want to ensure that the employer covenant in the merged scheme is equal to or better than that in the transferring scheme, and if not, whether there is anything else in the merger proposal which will compensate for this.

This will include the willingness of the sponsoring employer of the transferee scheme to continue to fund accrual. 

A well-funded scheme would need to consider very carefully whether to merge with a poorly-funded scheme and thereby dilute the funding level of its members’ benefits. 

However, isolated current funding levels can be misleading and are not the only consideration. The size of the respective funds and the nature of investments may be relevant.

Merging into a large fund that is currently 100% funded on an ongoing basis may at first appear attractive. However, if the fund is heavily invested in equities or other volatile investments, the level of funding could reduce significantly in a short time period.

The composition of the trustee board may require review and, if appropriate, new employer or member representatives added. 

The employers will need to consult with affected employees prior to merger as, on a plain reading, the cessation of future benefit accrual in the transferring scheme – notwithstanding that benefits may be replicated in the receiving scheme – would constitute a “listed change” and trigger a statutory 60-day consultation period.

If there is to be a change to future benefit accrual in the merged scheme, will past service defined benefits continue to be linked to future salary growth in the merged scheme?

It may also be worth scrutinising the actuarial factors used in each scheme, in case there are significant differences, for example commutation factors and early retirement reduction factors.

The receiving scheme documentation will need to be updated by legal advisers to accommodate, replicate, or mirror the past, and if relevant, future service benefits applicable to transferring members.

The transferring trustees are likely to seek an indemnity from the employer or trustees of the merged scheme, in relation to any claims or transferring scheme liabilities that may arise after the merger is complete.

Ginevra Gatrell is an associate at DLA Piper.