Avoid being the “last man standing”
25 Jul 2019
Despite the hype around DB consolidation, there’s actually a situation where the exact opposite – de-consolidation – may be the better option.
This can be the case if you’re an employer of a non-sectionalised multi-employer scheme – quite common in the third sector. In this scenario, you’re at risk of picking up the costs of being the “last man standing”.
What do we mean by the “last man standing”?
If an employer in a multi-employer scheme leaves the scheme or becomes insolvent, all their liabilities become “orphan liabilities”. These liabilities must be supported by the remaining employers in the scheme, i.e. the “last man standing”.
As a result, some employers may want to exit these schemes but often can’t, or don’t want to, pay the Section 75 debt required to exit.
How can you manage “last man standing” risk?
There is a range of ways to exit these schemes now without necessarily having to pay the full Section 75 debt upfront. Here, we explore 4 different solutions:
- Bulk transfers
Your share of the DB assets and liabilities is transferred out of the multi-employer scheme into your own scheme. By taking the deficit with you, you don’t have to pay the Section 75 debt and can instead fund the deficit in your own scheme over time.
The recent evolution of DB Master Trusts, which crucially are sectionalised and therefore don’t have “last man standing” risk, can be a helpful new home for these transfers. We did one of the first of these transfers in 2013 with the Girls’ Day School Trust, and last year we completed a bulk transfer which enabled our client to successfully raise more capital from investors who had previously been put off by the last man standing risk.
- Apportionment arrangements
The DB liability can be apportioned to another employer in the multi-employer scheme. Some employers are fully committed to remaining in these schemes, in which case they do not actually expect the Section 75 debt to trigger. They may then be willing to take on further DB liabilities for a cash payment, as this gives them an upfront cash windfall for taking on a liability they don’t expect to trigger. Last year, we helped one employer exit a multi-employer scheme at a lower cost than Section 75 by taking this approach.
- Trigger the Section 75 debt when market conditions are favourable
If you do exit by paying the Section 75 debt, you still face the problem of having no certainty on what the debt will be, as this is only known for certain after the debt is triggered. Some of these schemes have volatile funding positions meaning debt amounts can move around materially with changes in market conditions.
Last year, we helped an employer artificially trigger 99% of their Section 75 debt early in July 2018 which locked in a low debt when market conditions were favourable. They then paid the remaining 1% when their last employee left earlier this year. Their debt would have been 20% higher if they had let it all trigger in 2019.
- Commercial consolidation
The development of these new vehicles gives a solution for getting a clean break from your DB liabilities at a lower cost than the Section 75 debt. This is because the cash injection required to transfer your liabilities into the commercial consolidator is lower than the Section 75 debt payable to get a clean break from the scheme.
If the transfer is to Clara Pensions, the transferring members would be expected to be in the insurance regime within 5-10 years. In many cases, this is far sooner than if you were to pay the Section 75 debt, where your members would remain in the multi-employer scheme rather than being insured.
If you’re worried about “last man standing” risk, and think you’re trapped without a cost-effective exit plan, consider one of the options above and please get in touch if you’d like to discuss further.