How to insulate DC assets from insolvency risk

The troubles experienced by well known companies such as Kodak and La Senza have highlighted the vulnerability of pension assets, including defined contribution (DC) funds, when parent companies go insolvent.

DC scheme managers should familiarise themselves with scheme rules and seek legal advice if concerned about employer insolvency risk. 

In the event of an employer going insolvent, defined benefit (DB) schemes may enter the Pension Protection Fund (PPF) for compensation – but the organisation does not offer protection for DC schemes. 

Often, DC schemes do not get as much warning of employer insolvency as DB schemes, and DC members could face the risk of seeing their savings being used to pay off DB debts.

DC schemes concerned about employer insolvency have been called on by the Pensions Regulator to carry out a number of checks.

These included understanding the safeguards available for the different assets against losses arising from operational, fraud and insolvency failures.

The regulator also advised schemes to understand how tracing rules would apply for mixing DB and DC assets.

Changing definitions

The Supreme Court ruling in the Houldsworth v Bridge Trustees case – involving the Imperial Home Décor scheme – may mean more plans are defined as DC than previously thought.

This is a complex ruling and we are considering the implications carefully

This is because the courts gave a broad interpretation to relevant statutory provisions.

In response to this, the government is considering amending the law that affects the definition of money purchase schemes, the Financial Assistance Scheme (FAS) and the PPF to compensate members losing out in the event of insolvency.

Existing legislation in light of the Bridge case casts doubt on the status of a scheme, which, if it had become insolvent with a deficit, would conventionally have been considered a DB scheme and enjoyed the protection of the PPF or FAS.

A spokesperson for the Department for Work and Pensions said: "This is a complex ruling and we are considering the implications carefully as it is important to get the changes right.

"There is a lot of legislation to work through and we need to take particular care to understand how retrospection affects particular cases. We will be consulting formally later this year."

Hybrid schemes

Hybrid schemes may be particularly at risk, said Bob Scott, partner at Lane, Clark & Peacock, as it was unclear where responsibility lay. 

Schemes should ensure controls are in place to manage the risk of co-mingling of assets

He advised scheme managers and trustees to rigorously check scheme rules in the winding-up section and seek legal advice if they were concerned about the scheme’s liability. 

A spokesperson for the regulator said: "Schemes should ensure controls are in place to manage the risk of co-mingling of assets, which may become a significant problem in the event of an employer insolvency event.

"We expect DB and DC assets to be separately identifiable by the trustees so that they can be traced and identified." 

The regulator advised concerned scheme managers to discuss the rules with advisers before potential issues arose. Failing that, any fears should be escalated to the trustee board.

It also stressed schemes should understand how to treat members’ different entitlements in response to the statutory winding-up order and how it interacts with scheme rules.

When a DC scheme is liable 

In the event of an employer going insolvent, DC assets may be at risk if there are insufficient unallocated DB assets to pay levies, or the assets have been reduced as a result of fraud. 

Depending on the scheme rules, the DB scheme may be able to use the DC scheme assets to pay off debts. 

Mark Smith, partner at Taylor Wessing, said in some cases no further contributions would be paid to the scheme, or to the employer’s part of the scheme. The DB scheme would be wound up, subject to paying off debt due under section 75 of the 1995 Pensions Act.

“However, that will be the case only under the rules of certain schemes," he said. "For others, any cessation of contributions and winding-up will depend on whether the administration is for the purposes of reconstruction or amalgamation only.” 

He added that, for some, administration would not be enough to trigger a wind-up and a liquidation would be needed. For others, it would apply in the event of a company replacing the insolvent employer as principal or participating employer.