Defining your own benefits

LINDA BELL, pensions director at KPMG, reviews some of the cash-saving options for companies with defined benefit pension schemesFOR many companies with defined benefit (DB) pension schemes, their arrangements have become a significant “liability”.

LINDA BELL, pensions director at KPMG, reviews some of the cash-saving options for companies with defined benefit pension schemes

FOR many companies with defined benefit (DB) pension schemes, their arrangements have become a significant “liability”.

Not only can they be a massive cost to the business, with the scope to increase in the future, but the complexity in sponsoring these arrangements now requires significant management time in dealing with something that relates in no way to the core business. Every year, private companies with DB schemes are required to pay a compulsory levy to the Pension Protection Fund (PPF).

Whilst companies often start to think about this when the invoice arrives in the autumn, the levy is actually based on a snapshot taken at March 31, each year. For those businesses looking to reduce the 2011 levy that they will be expected to pay, action is needed before end March this year!

Most of the levy is based on an assessment of the risk that the scheme poses to the PPF ? the chance that the scheme will enter the PPF due to the company's insolvency, and how big a deficit it will have when it enters.

The risk of insolvency is based on a measure by Dun & Bradstreet (D&B), a score of 1 to 100, which gives the probability relative to other companies (for example, a D&B score of 90 means 10% of companies are less likely to fail.

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But there are things that can be done to reduce the assessed risk, thereby reducing the levy:

Improving the D&B rating is often relatively simple and can easily pay for itself; inexperience in understanding the D&B analysis means companies often miss opportunities.

A better rated company in the group can give a guarantee to the scheme, potentially an easy option if in practice the whole group stands behind the scheme.

Reducing the size of deficit on the PPF's Section 179 basis. Simply paying money into the scheme and letting the PPF know can reduce the levy. For companies which have cash available but low D&B scores, accelerating contributions can drive real cost savings. And of course, all other options to reduce the deficit help too.

Whilst challenging to achieve by March 31, liability management exercises and improved asset strategies could all help reduce the deficit next year.

What about future DB pension accrual? I am often asked: “Should I close to future accrual - it's creating extra risk for the company but it is important to my most loyal employees?”

It's a tough question to answer. Many companies have decided to bite the bullet while some have found modifying a DB pension more palatable, and possibly more cost effective, than switching to defined contribution.

Employers need to consider carefully what works best for them; following those making the headlines is not always the right answer.