16th January 2018 Closing Defined Benefit Pension Scheme at BA highlights liabilities
British Airways’ decision to close the New Airways Pension Scheme (NAPS) raises the risk of defined benefit pension liabilities and highlights the problems with a focus on dividend policy, warns Partner Anne-Marie Winton.
With some rather unseasonal timing, in mid December 2017, British Airways announced the bad news to staff of the planned closure of its defined benefits pension scheme (the New Airways Pension Scheme, known as NAPS) to future accrual in April 2018, with a view to addressing the £2.8bn deficit in the scheme.
Future benefits will be provided on a defined contribution basis, exposing only those employees who are members of the replacement scheme, not BA, to the investment risk in the underlying assets.
As required by law, a period of prior consultation took place with affected employees (and their unions) before the decision to close NAPS was made, and this resulted in sufficient improvements being made to the replacement pension benefits to hold off industrial action.
The consent of the NAPS trustees is still needed to amend the scheme to stop benefits building up, but if BA argues that this means that accrued benefits will be better secured, this would generally be enough to get the trustees on side.
The materials sent to NAPS members in the consultation explained that the past service benefits built up to the date of closure would be protected by law (including inflation proofing- which has been the subject of a separate dispute in 2017 between BA and the trustees of its other defined benefits scheme).
BA must continue to pay contributions into NAPS to fund these accrued benefits at an estimated cost of between £300m and £450m a year to 2027.
So while closure to accrual is an effective corporate risk reducing exercise, it by no means operates to eliminate all risk associated with the scheme. Defined benefits pensions liabilities can lurk underneath the surface of a company’s accounts, with the potential to damage or sink the business.
This is because this type of pensions scheme remains a contingent liability of all the current and former employers participating in the scheme until it winds up, with the size of that liability being the difference between the scheme’s assets and liabilities at any time.
That deficit can be highly volatile as the difference between two large numbers (the NAPS assets are around £16bn, for example), and for a scheme that is closed to accrual of benefits (as most are), responsibility for meeting the deficit over time rests solely with the employers.
The Pensions Protection Fund has access to data on the composition of almost all defined benefits pension schemes in the UK, which it publishes in the Pensions Universe Risk Profile (the Purple Book (http://www.pensionprotectionfund.org.uk/Pages/ThePurpleBook.aspx), currently in its 12th edition.
Between 2006 and 2017 the percentage of schemes open to new members dropped from 43% to 12% and, in the same period, the percentage of schemes closed to future benefit accrual increased from 12% to 39%. Total active members are now around 1.3m within 5,600 schemes. The trend is towards closure and cessation of accrual, so the question that sponsoring employers face is really one of when, not if.
Pensions was identified early on as a key corporate risk within threatened to derail the merger of BA with Iberia in 2009. At the time, BA was believed to have one of the ten most underfunded pension schemes in the UK (others included BT and the Royal Mail).
It appears that the funding deal agreed then with the NAPS trustees forms the basis for the contributions still being paid by BA years later.
Part of the funding deal agreement between BA and the trustees put a system in place to enable the company to pay dividends to its parent, International Airlines Group if certain Triggers are met.
In connection with the most recent 2015 NAPS actuarial valuation, it was agreed that if BA pays a dividend to IAG higher than 35% of its profits it will either provide the NAPS trustees with a guarantee for 100% of the amount above 35% or contribute 50% of that amount in cash to the scheme.
This focus on dividend policy reflects the attention given to fairness between stakeholders articulated by The Pensions Regulator in June 2017.
At that time, the Regulator said: ‘We are not against companies paying out dividends but employers must strike the right balance between the interests of the scheme and that of its shareholders.’
In short, if a company wants to pay dividends to avoid the risk of regulatory scrutiny, it must also treat its defined benefits scheme fairly.
Anne-Marie Winton, Partner
This article was published in CCH Daily
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.