Every Defined Benefit pension scheme must produce an actuarial funding certificate every three years, which certifies the solvency of the scheme. The issue does not arise in relation to a Defined Contribution scheme as the benefits available are directly linked to the value available within the fund and there is no promise of a pension being calculated on the basis of the number of years of membership and final salary.
The solvency of the defined benefit fund is measured as if the scheme was going to be wound up on the date of the certificate. The fund is not technically solvent if its total assets are less than its total liabilities. The employer and trustees must arrange for a “funding proposal” to be prepared by an actuary, and presented to the Pensions Board. This proposal will set out how it is proposed to bring the fund back to solvency over a period of anything up to 10 years.
If they don’t submit a Funding Proposal, then either the Pensions Board can take action, and oblige the trustees to reduce the benefits being promised under the scheme, or the Trustees can submit an application to the Board under Section 50 of the Pensions Act, for permission to alter the benefit promise, i.e., to restructure the scheme.
The implication of restructuring depends upon the category of the scheme member. Existing pensioners will receive first priority over everything except Additional Voluntary Contributions (AVCs), and their pensions are protected; but a promise to pay future annual increases, normally based on some form of index, may well be withdrawn.
The trustees are obliged to consult with active members, deferred beneficiaries and pensioners in payment before making such a submission. Possibilities include future benefits being reduced, contributions being increased (for both the employee and employer), entry to the scheme being closed for new employees or the entire scheme being replaced by a new type of “hybrid” scheme, possibly involving a “cap” on the defined benefit promise and perhaps defined contribution provision in excess of the “cap”.