volume 80 may 2014 - ipebla · philip bennett, susan p. serota and b. bethune a. whiston workshop 9...

Volume 80 – May 2014

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Contents May 2014 – No 80

From the Editor... 3

From the Conference Chair… 4

Journal Production Schedule and Representatives 5

IPEBLA Steering Committee 2013-2015 6

Libby Slater Award 7

Tony Thurnham Award 8

Theme: 14th International IPEBLA Conference – Rome

The Impact of the Global Financial Crisis on the Retirement System

Workshop 4 Outline of Topics Discussed During the Workshop on the

Risks of Implementing a DC Plan 9

Philip Bennett, Susan P. Serota and B. Bethune A. Whiston

Workshop 9 Guarantee Funds: Policy, Politics and Practice 31

Jane Marshall and Fran Phillips Taft

Workshop 13 Convergence of Employee Benefits – Wrapping up other

benefits with the Pension Plan 38

Camilla Barry, Michael Beatty, Elise Laeremans and Martin

Rochett

Workshop 13 Convergence of Employee Benefits - Wrapping Other

Benefits up with the Pension Plan: View From the UK 43

Camilla Barry

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Workshop 22 The ‘Waterford Crystal Judgment’ and Solvency Relief

Measures in Ireland 52

Deborah McHugh

Workshop 24 Auto Arrangements in Pension Plans 57

Andrew Harrison and Jane Dale

Workshop 27 Severance Packages and Golden Parachutes: An Overview

of Severance Programs and Internal Revenue Code

Section 280g in the United States

62

Susan A. Wetzel

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From the Editor…

Dear Members,

I am very pleased to release the 2013 Rome Conference edition of the Journal. As is traditionally the

case this edition of the Journal is dedicated to publishing material from the conference, and in

particular, the workshops presented. The 2013 Rome Conference was hugely successfully and a vote

of thanks is certainly in order for Mitch Frazer and the Conference Committee.

Our congratulations are also extended to Grace Zulu, who was awarded the 2013 Libby Slater Award,

and Greg Winfield and Mark Firman who were awarded the 2013 Tony Thurnham Award.

This edition includes 7 articles covering 6 different workshop topics. The topics are wide ranging and

certainly reflect the complexity and diversity of topics covered at the conference. I particularly draw

attention to the article covering Workshop 4 as the authors have kindly provided an extensive table

setting out the background context and points of difference between the jurisdictions of the UK, USA

and Canada in respect of the plan structure of defined contribution plans, relevant terminology, and

applicable legal duties and rules.

This conference edition has had a long germination period, and I particularly thank the authors for their

contributions and patience in getting this edition to the published version.

With warmest regards,

Lisa

Dr Lisa Butler Beatty

Senior Legal Counsel

Commonwealth Bank of Australia

[email protected]

mailto:[email protected]

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From the Conference Chair…

Dear Colleagues,

The planning for the ome Conference tarte a mo t imme iate after we left Berlin. Over the

following two-year period, the conference committee succeeded in putting together an interesting

program. The theme of the conference was: the Impact of the Global Financial Crisis on the

Retirement System. Through plenaries and workshops, the participants discussed and debated

this theme using various lenses. Topics included: Should We Continue to Close our Eyes to the

Cost of Retirement?, Health Reform and Pension Fund Governance.

We were extremely fortunate to have had Professor Karel Van Hulle, the former Head of Insurance

and Pensions for the European Commission as our keynote speaker. His presentation provided us

with a thought provoking overview of the key issues facing pension plans as a result of the

financial crisis and laid the groundwork for the rest of the conference.

We were also fortunate to have Elsa Fornero, the former Minister of Labor, Social Policies and

Gender Equality for Italy as a lunch speaker. Hearing about her experiences as Minister, both from

a professional and personal perspective, brought a helpful context to our remaining conference

discussions.

The Rome Conference was the largest IPEBLA Biennial Conference yet. Over 145 delegates from

23 countries and 6 continents were in attendance. Some of the counties represented were

Argentina, Canada, France, Germany, Israel, Jamaica, South Africa, the USA & Zambia.

f co r e there was Rome itself. What a beautiful setting! The conference was held at the

Starhotels Metropole Rome Hotel. The social event on the first night was held at Taverna

De’Mercanti. The ga a event on the econ night wa he at the fab o Ca ina Va a ier. Thi

was one of the most beautiful settings any of us had ever seen.

By all measures, the Rome Conference was a huge success. There were so many people involved

in making this possible. I wanted to say a particular thanks to the conference committee including

vice-chairs, Luca Capone, Jonathan Mort and Jana Steele. Thanks to Managing Matters and

Taylor Weinstein for the great job in pulling the entire event together. Thanks as well to all the

participants.

I look forward to seeing you all very shortly in Chicago and next year in Brussels.

Regards,

Mitch

Mitch Frazer

Chair, 2013 Rome Conference

Partner, Torys LLP [email protected]


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Production Schedule

Quarter 2014 1st 2nd

3rd

4th

A Miscellany of Ideas

Governance & Conflicts of

Interest

Retirement Income

Policy and Reform

What’s New

Deadline for articles to country representatives / editor

In production July 2014 September

2014

December

2014

Country Representatives

Country Name E-mail

Australia Lisa Butler Beatty [email protected]

Belgium An Van Damme [email protected]

Canada Andrew Harrison [email protected]

Denmark Åse Kogsbøll [email protected]

Finland Minna Saarelainen [email protected]

Germany Bernd Klemm [email protected]

Hong Kong David Adams [email protected]

Ireland Michael Wolfe [email protected]

New Zealand Juliet Moses [email protected]

The Netherlands Kees-Pieter Dekker [email protected]

South Africa Jonathan Mort [email protected]

United Kingdom Peter Docking [email protected]

United States David Powell [email protected]

Please refer to the Member Directory for other contact details












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Steering Committee 2013 - 2015

Committee Member

Organisation

Country / City

Contact Details

Mitch Frazer

Chair

Partner

Torys LLP

Toronto

Canada

[email protected]

Lisa Butler Beatty

Deputy Chair

Journal / Comparative Survey

Senior Legal Counsel

Commonwealth Bank

Sydney

Australia

[email protected]

Kees-Pieter Dekker

Van Benthem & Keulen N.V.

Van Benthem & Keulen N.V.

Utrecht

The Netherlands

[email protected]

Brian Buggy

Secretary / Teleconferences

Partner

Matheson Ormsby Prentice

Dublin

Ireland

[email protected]

Judith Donnelly

Membership Partner

Clyde & Co

London

United Kingdom

[email protected]

Kobus Hanekom

Teleconferences Head: Strategy, Governance & Compliance,

Simeka Consultants & Actuaries

Cape Town

South Africa

[email protected]

Caroline Helbronner

Membership

Blake, Cassels & Graydon LLP

Toronto

Canada

[email protected]

Karla Small Dwyer

Website

Financial Services Commission

Kingston

Jamaica

[email protected]

Jana Steele

Brussels Conference Chair

Partner

Osler, Hoskin &

Harcourt LLP

Toronto

Canada

[email protected]

Carol Weiser

Membership

Partner

Sutherland Asbill & Brennan LLP

Washington

USA

[email protected]











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Libby Slater Award 2013

The Libby Slater Award is in the memory of Libby Slater, a leading Australian pension

or “super” lawyer who died when she was much too young, before her 40th birthday.

The award is made biennially and includes a complementary invitation to attend the

IPEBLA conference to which the award relates as well as associated travel costs. In

making the award the Steering Committee is looking for someone who has made or who

is making an outstanding contribution to pensions law in their country and who might

not otherwise attend the relevant IPEBLA conference.

Grace Zulu

Grace was awarded the 2013 Libby Slater Award at the 2013 Rome Conference.

Grace has been deeply involved in pensions and related fields in Zambia for many years, with a particular focus on trustee and corporate governance.

Board Secretary

Grace was Board Secretary of one of the largest Occupational Pension Schemes in Zambia – the Mukuba Pension Fund which is the Mining Industry Pension Fund.

The Board of Trustees was originally appointed by the Principal Employer. Grace managed the conversion of the governing structure of the pension to a member elected board of Trustee. This was the first conversion of this kind in Zambia, applying new legislation that permitted the change.

This was a landmark change in Zambia as it was the first ever election of member trustees to a Board of Trustees.

Pensions Consultancy

Grace is the Managing Director of a Pensions Consultancy Company.

The Consultancy offers consultancy and advice services to the government and other pension services institutions in Zambia and Ghana. More recently the Institute has begun to engage regulators on pension law review issues.

The Institute aims to:

bring international and local expertise to the improve corporate governance matters in Africa

improve the information provided in respect of the provision of indigenous pensions and employment

In respect of these aims the Consultancy is in the process of establishing the first African Pensions Institute. The Pensions Institute will be a non-profit organisation through which pension funds can access much needed information and global pensions experience. The governing structure of the Institute will be constituted by a combination of pension industry, labour and regulatory representatives.

Other

Grace has also been partner at a law firm in Zambia, been involved in law reform in through the Mukuba Pension Fund, and otherwise through the Tripartite Labour Council, and spoken at a number of international conferences.

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Tony Thurnham Award 2013

The Tony Thurnham Award is named after Tony Thurnham, one of the founding members of

IPEBLA as well as a past Chair of the Steering Committee and of the Conference Organising

Committee. The award is made for the article in the "International Pension Lawyer" considered

to be the best article published for the two year period between IPEBLA conferences (by the

Journal Editor).

At the 2013 Rome Conference Greg Winfield and Mark Firman were awarded the Tony

Thurnham Award for their article entitled “Canadian Employee Life and Health Trusts”.

Greg Winfield

McCarthy Tétrault LLP

Canada

Mark Firman

McCarthy Tétrault LLP

Canada

Canadian Employee Life and Health Trusts

(2011) 73 International Pension Lawyer 14

This article provides an overview of a new arrangement available under the Income Tax Act

(Canada) (the “Act”), called an “Employee Life and Health Trust” (ELHT), through which an

employer (or group of employers) can fund certain group health and life insurance benefits for

employees and retirees.

Part I of the article summarises the most salient aspects of the ELHT rules. These include the

criteria that an arrangement must meet in order to be considered an ELHT, restrictions on the

participation in an ELHT by high-earning employees, and the tax consequences of contributions

made by employers as well as payouts to employees and retirees.

Part II describes some of the advantages that a properly structured ELHT can provide to employers

(from a financial statements perspective) and employees and retirees (from a benefit security

perspective). In particular, Part II focuses on large employers with significant unionisation and

large, unfunded “other post-employment benefit” (OPEB) obligations. This part also discusses the

practical considerations that will have to be taken into account when settling an ELHT, including

strategies for negotiating with unions and retirees, how best to bind retirees and how to “paper”

the deal. While framed generally, much of the authors’ analysis is based on their experiences with

Canada’s first ELHT.

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Workshop 4

Outline of Topics Discussed During the Workshop on the Risks of Implementing

a DC Plan

Philip Bennett

Susan P. Serota

B. Bethune A. Whiston

Philip Bennett

Partner

Slaughter and May London, United Kingdom

[email protected]

Susan P. Serota,

Partner

Pillsbury Winthrop Shaw Pittman New York, USA

[email protected]

B. Bethune A. Whiston

Partner

Morneau Shepell Toronto, Canada

[email protected]

The driving force in many jurisdictions behind the shift in the private sector to DC plans has been the perception that DB plans present employers with greater funding risk. What many employers continue to ignore, however, is that while it may be true that DC plans have lower funding risk, they present an employer with greater legal risk, due to the potential legal duties owed to DC plan participants in the areas of contributions, investment of plan assets, fees charged, conversions from DB plans and communications. The DC Risks Workshop held during the IPEBLA Rome Conference provided a high level overview of the legal framework and administration of DC plans in Canada, the United States and the United Kingdom and in particular the common areas of risk related to these types of plans.

This article reflects the law as at 20 May 2013

Introduction

The Workshop was very well attended, with

approximately fifty people from the

following 12 jurisdictions: Belgium, Brazil,

Canada, Germany, Ireland, Jamaica, the

Netherlands, Portugal, South Africa,

Sweden, the United Kingdom and the

United States.

Some context for the discussion was

provided by describing some of the

differences in terminology used around

defined contribution or money purchase

plans in the different jurisdictions. The

fiduciary responsibilities of the different

stakeholders were described along with the

iffering ro e of the “tr tee” in Cana a

the United States and the United Kingdom.

An outline for the Workshop was distributed

to the participants at the conference which

(a) set out in some detail the rules in place

as at May 2013, in each jurisdiction under

discussion, whether legislative, best

practice or based in common law in a

number of relevant areas, and (b) included

a sample structure of a typical DC plan in

each of the three jurisdictions. A copy of

that outline is set out below.




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Position in Canada1 Position in USA Position in the UK

A. Typical DC Plan structure in legal terms2

1.1 Employer (Board of Directors) establishes DC plan.

1.2 Typically, in Canada, the primary fiduciary role lies with the p an “A mini trator” in accordance with the pension standards legislation of the particular jurisdiction. In the common law jurisdictions there are several choices as to who can be the Administrator. In most cases, the Administrator is the employer through its Board of Directors. In Quebec and Manitoba, for a typical plan, it must be the Pension Committee.

1.3 The Administrator has a fiduciary or a fiduciary-like duty. However, two of 11 jurisdictions also specify that the Administrator is a trustee for the employer, members and others with an interest in the plan.

1.4 Board resolutions or plan document will contemplate agreement with “tr tee”/f n ing agent an specify who will act as “A mini trator” of the p an. If the Administrator is the employer, the Board of Directors will typically delegate responsibility for administration of the plan and the fund to a Pension Committee. The Board legally retains a fiduciary obligation to monitor the Committee. Committee is also a fiduciary and typically

1.1 Employer establishes DC plan by Board of Directors adopting plan and authorizing trust agreement with bank or trust company, alternatively with an insurance company.

1.2 Board resolutions or plan document will authorise named fiduciaries for plan, including trustee and committee(s) for administration and investment of plan assets.

1.3 Recordkeeping can be done internally or with a third party record keeper.

1.4 Trust Agreement can provide trustee with discretion to select investments or, if no discretion, where the trustee is a “ irecte ” tr tee subject to investment manager instructions, committee instructions or participant instructions.

1.5 Employer reserves under plan document, right to amend or terminate plan, change contribution formula, cease contributions, or change trustee.

1.6 Plan committee can be comprised internally of company officers, although certain collectively bargained plans often have both employer and union representation on plan board.

1.7 ERISA Part 4 of Title I sets forth rules for fiduciaries of plans, including duty to act solely in interest of

1.1 Employer establishes DC plan by entering into Trust Deed with plan trustee (usually wholly owned subsidiary of sponsoring employer whose sole purpose is to act as DC plan trustee).

Note: In this outline,

references to a DC Plan for the UK are to an “occ pationa pen ion cheme” which provi e money purchase benefits. An occupational pension scheme is established in the UK by an employer. It is not to be confused with a personal pension scheme (or a so ca e “gro p” per ona pension scheme – just, in law, a personal pension scheme) established by an insurance company or other financial services provider. Personal pension schemes are outside the scope of this outline.

1.2 Trust Deed, in general, will set out all powers relating to holding of the trust assets, management of trust assets and keeping of retirement accounts for beneficiaries to trustee.

1.3 Trust Deed will usually give trustee powers to delegate:

(a) custody functions to a third party custodian, and

(b) retirement account record keeping function to a third party administrator.

1.4 Trust Deed will usually confer on trustee power to select a range of pooled investment vehicles in which plan members may direct that their

1 In Canada, pension standards legislation is adopted separately by the 10 provinces and the Federal

jurisdiction. There is also federal tax legislation in place respecting pensions. Each jurisdiction has different rules, and the Province of Quebec, being a civil law province, has significantly different rules. The highest number of pension plans is registered in the Province of Ontario, therefore, unless otherwise indicated, this chart specifies the rules in place in Ontario.

2 See Diagrams A1, A2 and A3 (attached) for typical structure showing legal relationships in Canada,

the USA and the UK.

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is responsible to monitor all agents or service providers, including the funding agent.

1.5 The Pension Committee is often comprised internally of company officers, although there is a move in Canada to encourage jointly sponsored and governed pension plans and independent committee members.

1.6 All employees of the company who help administer the plan and all “agent ” of the p an “A mini trator” are also held to a fiduciary standard of care.

1.7 Recordkeeping can be done internally or with a third party record keeper.

1.8 Employer reserves under plan document, right to amend or terminate plan.

participants and beneficiaries, prudent man standards, diversification of investments and the need to follow plan documents. ERISA also authorizes appointment of investment managers, delegation of fiduciary duties, personal liability for breach of fiduciary duties, prohibited transactions and statutory exemptions.

1.1 Potential criminal liability for failure to make required reportings and disclosures under ERISA. Other laws deal with fraud, etc.

retirement account balances may be invested by giving notice to that effect to the tr tee or the tr tee’ agent.

1.5 Employer reserves, under Trust Deed, right to terminate employer contribution or to reduce employer contributions or to wind-up plan. The employer will also reserve, under Trust Deed, the power to amend the plan (but, benefits derived from contributions up to the date the power of amendment is exercised will be protected (Section 67 of the UK Pensions Act 1995)). Exercise of power of amendment may also require trustee consent (depends on the terms on which the Trust Deed has been drafted).

1.6 Trustee company is, in most circumstances, required to ensure that at least

1/3

rd of the

board of directors of the trustee company are “member nominate irector ” n er Section 242 of the UK Pensions Act 2004.

1.7 Section 34 of the UK Pensions Act 1995 says that tr tee’ inve tment power may only be delegated to, in general, those authorised to undertake investment functions under UK Financial Services and Markets Act 2000.

1.8 It is a criminal offence for a trustee to take a day to day investment decision in relation to investments regulated by Financial Services and Markets Act 2000 unless the trustee falls within a safe harbour.

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B. Terminology: Divided by a common language

Topic: 1. Trustee

1.1 In Ontario, the Pension Benefits Act specifies that the “A mini trator” ha a duty to exercise the care, diligence and skill that a person of ordinary prudence would exercise in dealing with the property of another person, with the relevant knowledge and skill the person possesses or ought to possess.

1.2 Where it is reasonable and prudent the Administrator may employ one of more agents in the administration of the plan and the administration and investment of the fund.

1.3 No person other than a prescribed person may be a trustee of the pension fund.

1.4 The pension fund may be administered only by certain entities, including most commonly, an insurance company, or a trust in Canada governed by a written trust agreement with a trust company or three or more individuals.

1.5 The trust/custodial agreement typically provides for funding agent to take directions on investments from participants, investment manager or Pension Committee.

1.6 Please refer to Canadian Association of Pension Supervisory Authorities Guideline #5 on Fund Holder Arrangements in the various jurisdictions for further information.

1.1 Trustee holds plan assets and may have discretion over investment or may be a “ irecte tr tee” ( ee A.1.4)—sometimes referred

to a a “c to ian”. Whether trustee/custodian has discretion over investment will determine its status as an ERISA fiduciary.

1.2 Trustee must be a bank, trust company or individuals, depending on state law. Tax Code also permits plan assets to be held by an insurance company, e.g. in a deposit contract, annuity contract or separate account.

1.3 Plan administrator is a designation under the plan document required by ERISA. If no person or entity appointed as plan administrator, the employer is deemed to be the plan administrator. ERISA sets forth specific duties for the plan administrator, including making certain reports to the Department of Labor and certain disclosures to participants.

1.4 Plan document can provide for one or more committees with specific functions, i.e. plan administration, investment authority (appointment of investment managers), and review of participant claims and appeals.

1.5 Master trusts are typically trusts that cover more than one plan of an employer(s) all of whom are in the same controlled group (see B.2.1)

permitting aggregate investment of various plan ’ assets.

1.6 Group trusts are investment vehicles used by specific investment managers which are offered to unrelated plans and which are treated as a sub-tr t of the p an’ tr t. Similarly an insurance

1.1 As a general rule, all of the fiduciary functions for the DC plan established under trust are vested in the trustee of the DC plan with power to delegate.

1.2 The trustee of the DC plan is usually a wholly owned subsidiary of the sponsoring employer whose sole purpose is to act as trustee of the DC plan which acts through its board of directors.

1.3 The board of directors is, in general, sheltered by the corporate veil and an individual director is not, in general, considered as a trustee. In other words the duties and liabilities of the trustee company will derive from company law not trust law.

1.4 However, the wholly owned subsidiary company, when acting as trustee, will be subject to the usual trust law duties and liabilities (subject to the extent these may be modified by the terms of the Trust Deed or by overriding legislation).

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company separate account can be used for a single plan’ inve tment or a an investment vehicle available to more than one plan. Both group trusts and separate accounts must be limited to investors which are tax qualified retirement plans, IRAs and government pension plans.

1.7 Collective trusts are a type of group trust sponsored by a bank for investment of assets of more than one plan.

Topic: 2. Multi-employer plans/ singular employer plans/ control group employer plans

2.1 When someone refers to a single employer pension plan in Canada, this can include a plan with more than one participating employer, but where all participating employers are part of a related group of companies.

2.2 Except to the extent that a related company participates in the plan, there is generally no concept of “contro gro p iabi it ” in Cana a.

2.3 Definitions of a multi-employer plan differ between the Canadian jurisdictions and also under the Income Tax Act. Recent changes to pension standards legislation in many of the provinces have also introduced new plan designs. Please refer to the Summary of Pension Legislation Charts related to Multi-Employer and Shared Risk Plans.

2.1 US Internal Revenue Code (IRC) and ERISA establish concept of controlled group of companies, typically an 80% ownership group. All members of the controlled group regardless of whether their employees are covered by the plan, are subject to joint and several liability for minimum funding requirements and termination liability of DB plans, withdrawal liability from a multi-employer plan and certain excise taxes.

2.2 A multi-employer plan is a plan which is covered by one or more a collective bargaining agreement to which unrelated employers (not members of the same controlled group) contribute. These plans are usually subject to special labor law rules, i.e Taft Hartley plans.

2.3 A number of DC plans are available through a master or prototype plan offered by a mutual fund family, insurance company, trade group, etc. This permits the same plan document to be used for more than one employer.

2.1 Prior to 6th April, 2006, tax legislation meant that, if a DC plan had more than one employer participating in a plan, the other employers would, in broad terms, all have to be in the same corporate group as the “principa emp o er” an the Trust Deed would have to make provision for a participating employer and its employees to cease to be eligible to contribute to the DC plan if that participating employer left the principal employer’ gro p.

2.2 From 6th April, 2006 the tax requirement for employers to be in the same group in a plan with 2 or more participating employers was abolished.

2.3 However, where the plan is set up by a company for its own employees then, in general, it will arrange for the Trust Deed to contain similar provisions to those required for tax purposes prior to 6th April, 2006 so that if a participating employer ceased to be in the same group as the principal employer, then it would have to cease to participate.

2.4 However, there are now DC p an (“Master Trusts”)

established by insurance companies and other financial product providers where there is no requirement that the employers who participate should be in the same group

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as the insurance company or other financial services provider establishing the Master Trust. In the case of a Master Trust, the trustee would usually be an independent trustee company (whose business is to act, for a fee, as the trustee of occupational pension schemes).

C. Legal duties (and associated legal risks) owed to Plan members in connection with (i) conversion of past service DB benefits into DC benefits, and (b) retaining past service DB

benefits but moving to future service DC benefits

1. Decision to convert DB plan is a plan sponsor/employer decision (subject to collective bargaining requirements, if applicable). The decision is not subject to fiduciary duties.

2. In most jurisdictions there is little guidance in the legislation respecting the rules related to conversions. In Ontario and several of the other jurisdictions, the regulators have developed policies respecting how a plan sponsor may convert a registered pension plan.

3. It is not permissible in about half of the jurisdictions to require a plan member to convert their past service from a defined benefit to a money purchase or defined contribution benefit (these terms can be used interchangeably in Canada – DC is most common). The other jurisdictions will allow it but there are usually conditions attached.

4. In many jurisdictions salary projection will be required if the plan requires it, and ancillary benefits must be accounted for.

5. Generally speaking, when a plan is converted for future service, the plan continues to have one registration number for both the DB and DC components, and the DB component may continue even though future service may be frozen.

6. The process of conversion requires a lot of

1. Decision to convert DB plan is a plan sponsor/employer decision not subject to fiduciary duties..

2. Conversion of DB plan to a DC plan is treated as a termination of the DB plan and requires vesting of all accrued benefits under DB plan. Future service can be covered under a DC plan. Special notice with detailed disclosure is required to be given to participants prior to conversion.

3. Need to consider age discrimination law implications.

4. Money purchase plans and profit sharing plans, e.g. 401(k) plans, are defined contribution plans having individual accounts for each participant and beneficiary. Contributions to a money purchase plan (a) cannot be discretionary and cannot be limited by profits of the employer (s) and (b) are subject to the Code and ERISA minimum funding requirements. Also a money purchase plan must provide a qualified joint and survivor as the normal form of benefit under the plan.

1. The effect of Section 67 of the UK Pensions Act 1995 (which

protects accrued rights) is that conversion of past service defined benefit benefits into money purchase benefits is only permissible with the informed consent of the member. See, for example, HR Trustees Limited v German a

decision of the High Court on 10

th November, 2009 [2009]

EWHC 2785 (Ch) for an example where such a past service conversion exercise (which took place prior to the effective date of the protection conferred by Section 67 of the UK Pensions Act 1995 came into force, was litigated).

Note: In the UK money

purchase benefits or defined contribution benefits or DC benefits are used interchangeably (as are money purchase scheme or plan and defined contribution scheme or plan, or DC scheme or plan).

2. Past service conversions usually end up being structured a what are ca e “enhance tran fer va e exerci e ” where the member is given the opportunity to transfer his defined benefit benefits to a new money purchase plan (usually a personal pension plan provided by an insurance company in return for an enhancement in his statutory transfer value (or a cash inducement) (or both)).

3. The ability to change defined benefit plan benefits for future service into money purchase

15


communication with plan members and this increases the chance for misstatements and misunderstandings.

7. Litigation may be brought over conversions. Historically, this has occurred after plan members have retired and seen the impact that the conversion has had on their benefits. The lapse of time makes it difficult for an employer to defend itself as it will need to locate old records and witnesses may no longer be available. To date, limitations statutes have been of very limited help in countering these claims.

8. There may be an open-ended potential for liability owing to future changes in regulatory practices and case law. For example, in a 2010 case out of Alberta, the regulator undid a plan amendment that froze earnings levels under the closed DB provision of a converted plan, despite having registered the amendment three years earlier.

benefits for future service is a f nction of the p an’ power of amendment (coupled with any reserved right to the employer under the plan to terminate, without winding-up the plan, the future service accrual of defined benefit benefits in the plan).

Comment: For a case where

the power of amendment prevented the change to the p an’ efine benefit benefit for future service, see Lloyds Bank Pension Trust Corporation Ltd v Lloyds Bank Plc [1996] Pens. L.R. 263.

4. Where the p an’ power of amendment is adequate to allow the change, it is still necessary to check employment contracts to see whether the employment contract has committed the employer to provide a defined benefit benefit and, accordingly, has restricted the emp o er’ abi it to exerci e any reserved power of amendment of the plan.

5. However, the fallback position is to go through the process of terminating, on due notice and after consultation, the employment contracts of the employees, coupled with an offer of re-employment on identical terms, except as to pension benefits, once the contractual notice period has expired.

Note 1: It is necessary to

proceed with care, as employees have rights under the UK Employment Rights Act 1996 not to be “ nfair i mi e ” an o an appropriate due process needs to be followed.

Note 2: The fact that the

employer may go down this route can be a useful way of persuading a plan trustee to agree to exercise the power of amendment to allow future service benefits to be changed from defined benefit to money purchase (in a plan where the power of amendment is a joint power held by the employer

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and the trustee) – but without the employer breaching the implied duty of mutual trust and confidence.

6. If the future service contribution rate for the defined contribution plan is age-related, then it is necessary to establish whether age-related contributions would infringe age discrimination legislation. See, for example, the A vocate Genera ’ opinion issued on 7

th February, 2013 in

relation to Kristensen v Experian A/S [C-476/11], which said that age-related contributions could be permissible. A decision of the ECJ in this case is awaited (as at 7

th May, 2013).

D. Legal duties owed (and associated legal risks) to members and level of contributions made to the DC plan (will the resulting retirement income level satisfy the purpose of plan?)

1. In accordance with the Federal Income Tax Act, the employer must contribute at least 1% of payroll to a DC plan. Employee contributions are frequently required by the plan provisions, but not always. The plan terms may also permit employees to make optional contributions on top of the required contributions, and these may or may not be partially or wholly matched.

2. The Income Tax Act restricts the amount that may be contributed to a DC registered pension plan for an individual. In 2013, the limit is the lesser of 18% of compensation and $24,270.

3. It is permissible to have different contribution rates for different classes of employees. If contributions are linked to age, plan sponsors are often careful to also incorporate another component, like service, into the formula to avoid human rights issues.

4. Typically, in Canada, DC plans contemplate total contributions of somewhere between 4% and 12% of compensation, whereas estimates of what is an appropriate rate range between 10% and 20% of

1. 401(k) plans and most other DC plans are not subject to minimum funding or contribution rules. (Money purchase plans are treated differently.) See C.4.

2. Pre-tax, after-tax and employer matching contributions are subject to testing to assure no discrimination in favour of highly compensated employees. Safe harbour testing arrangement available for certain 401(k) plans, as well as automatic enrolment features.

1. UK “a to-enro ment” legislation, which is in the course of coming into force over a transitional period, lays down, for a DC plan, minimum levels of employer and employee contributions. Employees may elect to opt-o t of ch “a to-enro ment” but, in summary, would have to be “re-enro e ” once ever 3 years.

2, So ong a the member’ money purchase benefits are directly related to the way in which the contributions of the employer and, if applicable, the member, are credited to the member’ retirement account or invested, there are no minimum funding requirements and no minimum guaranteed return requirements (and no capital protection guarantee).

Note 1: If the plan offered a

guarantee, then it would, in effect be treate a a “ efine benefit” p an for f n ing purposes and would then be within the funding regime for defined benefit plans.

Note 2: This means that any

guarantees are offered in the investment product, and if the investment product does not perform (e.g. the provider

17


annual income.

5. Higher contribution rates, however, may be inappropriate for lower income workers. These workers may not benefit from the tax credit for pension plan contributions and may have their social security benefits clawed back because of their pension income.

6. There are issues with offering auto escalation for contribution rates in Canada.

becomes insolvent), then that would automatically flow through to reduce the value of the member’ retirement account.

3. Apart from provisions relating to the minimum contributions deriving from the auto-enrolment requirements (see the UK Pensions Act 2008), there is no positive legal duty on a UK employer to ensure that an employee achieves any particular level of retirement income.

4. However, it is not permissible under the Equality Act 2010

(which is the current UK legislation which contains the transition of various EU Directives on equality) to retire compulsorily an employee on attaining a specified retirement age (unless this can be objectively justified). So, there is an incentive on employers, looking to the longer term, to try to ensure that the employee has an adequate level of retirement income in order to be able to afford to retire.

5. Contribution levels need to be non-discriminatory on grounds of sex, age, etc.

6. However, there is a current safe harbour for age-related contributions where the purpose of the age-related contributions is to aim to make the retirement income generated by the contribution the same or nearly equal as between a younger employee and an older employee doing like work. See, for example, the Equality Act (Age Exceptions) Order 2010, Schedule 1, Paragraph 4.

Note: This reflects the fact

that the younger employee has a longer period of time for the contributions to be invested.

18


E. Legal duties owed to plan members (and associated legal risks) in relation to investment choices offered (including number of investment options and default options and whether regard should be had to behavioural psychology/ behavioural economic theory in deciding

those choices in discharging the duty owed to the plan members)

1. There is no safe harbor yet in Canada respecting investment choices offered to DC plan members. One jurisdiction has drafted legislation that would permit a limited form of safe harbor but it is not yet in force.

2. With a few exceptions, Canadian law is principles-based (prudent person rule) rather than rules-based as regards plan investments.

3. There is some disagreement as to whether it is less risky for the plan sponsor to select the plan investments on a global basis or permit members to have a choice of a platform of investments selected by the plan sponsor.

4. Where member choice is permitted, an unlimited range of options is not recommended. Rather, the number of options may range from 8 to 12 on average.

5. Cana a’ pen ion ec ritie and insurance regulators have collectively adopted Guidelines for Capital Accumulation Plans (the CAP Guidelines), which describe recommended practices in the administration of investment options under member-directed DC plans. These Guidelines are not law, but are likely to be considered appropriate industry practice by a decision-maker.

6. There are additional obligations of the administrator under member-directed DC plans, including additional communications; the selection of an appropriate range of investment options and “ efa t f n ” an the preparation and distribution of member educational materials and decision-making tools. In contrast to a DC plan under which the administrator retains responsibility for investments,

1. Where participants can choose investment option for their accounts, ERISA provides that a plan fiduciary is not re pon ib e for participant ’ choices (404(c) plans). However, if a menu of investment funds or options are chosen by the plan fiduciary, the fiduciary is required to choose the menu under fiduciary standards.

2. 404(c) requires certain diversity of investment options to be available to participants, specific disclosure re choices and fees/expenses and disclaimer of fiduciary responsibility by plan fiduciaries.

3. Certain types of investment options (e.g. a balanced fund) may qua if a a “q a ifie efa t inve tment a ternative” (QDIA) used where the participant does not make a pro-active investment decision.

Note: Money market and

stable value funds do not qualify as a QDIA.

1. In ofar a it i the emp o er’ responsibility for the design of the investment options (or the structure of the plan documentation within which the investment options operate), it is likely that the employer will owe a duty of care to the employees, unless disclaimed.

2. That duty of care, if it can be established, would require the employer to use reasonable skill and care in relation to this aspect of the plan design.

3. However, it would be seem to follow that, if the employer, not being an investment expert, relies on the advice of an investment consultant who is, prima facie, competent, then the employer will have i charge the emp o er’ duty of care (and the claim may then be against the investment consultant).

4. There is a Pensions Ombudsman decision on 10

th

November, 1998 in Brown v Perot Systems Europe Limited, as Trustee of the Perot Systems Europe Retirement Benefit Scheme (F00785) in which it was decided that the employer had been in breach of a duty to the employee in establishing a plan which invested in insurance products where there were heavy early termination penalties, if the employee who was a plan member, ceased to have contributions paid in respect of him (e.g. on leaving employment).

5. In this case, the nature of the emp o er’ workforce wa that turnover was relatively high, and so, almost by definition, most employees would suffer an early termination penalty in respect of the insurance products in which the amounts credited to their retirement

19


there are more avenues for the administrator to make mistakes or misstatements.

7. Existing case law shows that liability will flow even if mistakes or misstatements are inadvertent and innocent.

8. There is no requirement to have regard to behavioral psychology in determining what investment options to offer members, however, the CAP Guidelines recommend that the plan sponsor should ensure a range of investment options is made available taking into consideration the purpose of the CAP. The CAP Guidelines also suggest the factors a CAP sponsor should consider when choosing investment options The factors include:

(a) any default option that may be selected by the CAP sponsor;

(b) the purpose of the CAP;

(c) the number of investment options to be made available;

(d) the fees associated with the investment options;

(e) the CAP pon or’ abi it to periodically review the options;

(f) the diversity and demographics of CAP members;

(g) the degree of diversification among the investment options to be made available to members;

(h) the liquidity of the investment options; and,

(i) the level of risk associated with the investment options.

9. Plan sponsors in Canada have moved, over the last 20 years, from offering a money market default fund, to offering a balanced fund as a default and more recently to offering a target-date or life-cycle fund as a default.

accounts had been invested.

6. It is relatively rare, in the UK, for large DC plans to allow the plan member to choose how to invest the plan assets backing his retirement account amongst an unlimited range of bonds and shares listed on a recognised stock exchange.

7. Accordingly, the more usual plan design is that the member is allowed to direct the investment of the plan assets backing his retirement account from a menu.

8. The menu may, in part, be limited by the terms of the Trust Deed (i.e. an employer plan design decision – partly linked to legal risk management).

9. The trustee then has a prudent person duty, within the powers available under the terms of the Trust Deed, in selecting the pooled investment vehicles to include on the plan menu, in terms of:

(a) asset class,

(b) management style (active versus passive), and

(c) having regard to the costs of the investment vehicle in question.

10. It is an open issue as to whether the employer or the plan trustee is under a duty to take account of behavioural finance theory.

Note: The UK Financial

Conduct Authority has expressly stated that behavioural economics is a factor it considers relevant in assessing financial product design, marketing and sales processes (see Speech by Martin Wheatley, Chief Executive of the UK Financial Conduct Authority on 10

th

April, 2013) (http://www.fca.uk/news/speeches/human-face-of-regulation)

11. However, it is certainly not impossible that, in looking at the way which plan investment options have been designed and presented, the following

http://www.fca.uk/news/speeches/human-face-of-regulation

http://www.fca.uk/news/speeches/human-face-of-regulation

20


findings could be made by an English court:

(a) in offering the ABC pension plan to an offer to an employee, the employer owes an implied duty to offer a pension plan that is rea onab “fit for p rpo e”.

(b) “fit for p rpo e” might embrace the following:

(i) the charging structure of the investment options under the plan,

Comment: Each £1

of future retirement income is potentially at least £1 (i.e. once adjusted for compounding the effect of charges in reducing retirement income can be significant) off future retirement income.

(ii) to offer a reasonable range of investment options,

(iii) to aim to have reasonably competent investment managers of the investment option in question (or to go down the index tracking/passive route), and

(iv) in determining the number of choices available and the way they are presented, to “n ge” emp o ee towards making better decisions (as supported by well established research in behavioural finance theory).

Comment: That said,

there are clearly causation issues to establish and link to loss alleged to be suffered.

12. The UK Pensions Regulator is currently consulting on a draft code of practice in relation to

21


DC schemes, on which the “high eve ” me age i that DC plans should focus on “goo member o tt rn ”.

Note: The consultation closed

on 28th March, 2013, and the

final Code of Practice is awaited.

13. In relation to default investment options, there is no exp icit “ afe harbo r” for an particular default investment option.

14. Rather, the general principles referred to in 1, 2, 3, 7, 8 and 9 above in relation to

investment options will apply to the default investment option.

15. This means that the inve tment con tant’ standard default investment options should not be blindly adopted by the trustee or the employer.

16. Rather, there should be some analysis of the plan membership and those who are likely to end up in the default investment option.

17. For example, if plan members have a low capacity to bear adverse investment outturns (e.g. if they are mainly low paid employees), then the default investment option may be more appropriate if it is capital protected (so, the downside is protected, although the upside is limited).

Note 1: See paper “ n the

Risk of Stocks in the Long n” b Profe or Zvi Bo i (Financial Analysts Journal, May-June, 1995, pages 18-22) as an example of the analysis here. (Cited, for example, in “A e ing Defa t Inve tment Strategies in Defined Contrib tion Pen ion P an ” OECD Working Papers on Finance, Insurance and Private Pensions No. 2 June, 2010 – Pablo Antolin, Stephanie Payet and Juan Yermo).

Note 2: Under the auto-

enrolment provisions of the UK Pensions Act 2008, a plan member cannot be required to

22


make a choice of investment option as a condition of becoming a plan member.

F. Legal duties owed (and associated legal risks) in connection with investment choices made by plan members (is there a duty to second guess the member’s investment choice).

Note: I it a to exc e (or tr to exc e) the “pr ent per on” t when investing to prevent having

to econ g e the member’ inve tment choice?

1. In Canada, it is good practice to request reports from the third party plan administrator respecting the number of members who remain in the default fund, and in particular, if possible to ascertain the members who defaulted to that fund rather than actively selected it.

2. If there are a large percentage of members in the default fund, it is good practice to send a special communication out to plan members advising of the risks of not actively selecting investments based on a member’ partic ar circumstances and risk profile.

3. It remains rare for a plan sponsor in Canada to offer members investment advice rather than just investment information, and there appears to be a lot of apathy in plan member groups respecting selecting their own investment options.

See E.1 and E.2 above. 1. Section 34 of the UK Pensions Act 2004 gives the trustee of a UK occupational pension plan the same powers of investment as if the trustee were the beneficial owner of the assets of the pension plan, subject to any restriction on those powers contained in the p an’ Tr t Dee .

2. In the case of a defined benefit pension plan, it is usual for the plan trustee to be given very wide powers of investment (which are then delegated to specialist investment managers to invest in a wide range of different asset classes).

3. In the case of a DC plan, the trustee, in general, cannot take a day to day investment decision itself without committing a criminal offence.

4. Furthermore, the trustee, before taking any investment decision in relation to specific investments, will, generally, need to have obtained “proper a vice” from a suitably qualified investment adviser.

5. Given those constraints, this means that the Trust Deed needs to be structured so that:

5.1 Option 1: The trustee is

required to follow the member’ in tr ction as to the way in which the plan assets which are to be credited to the member’ inve tment account are to be invested within the range of investments which are permitted by the plan Trust Deed (usually, specifically,

23


limited for legal risk management purposes), and for the particular investment vehicles to be chosen by the trustee on the advice of a suitably qualified investment adviser.

5.2 Option 2: For the

member to be permitted to link the return on his investment account to a range of investment options on the menu. The trustee then puts in place arrangements to match the member’ choice of how he would like his retirement account linked to arrange for the plan assets to be invested in a manner which delivers the return that flows from the link chosen by the trustee.

Note: This is similar to

the drafting approach in a unit-linked life policy issued by an insurance company.

6. In other words, the drafting approach seeks to preclude the argument that the trustee is required to look at each member’ partic ar circumstances and then invest in a manner which is appropriate, in terms of risk/ reward tolerance, for the member in question.

Note 1: Consider the

example where a plan member’ inve tment acco nt has been invested in a cash option for 10 years (where the capital is protected, but the rate of return after allowing for inflation is seriously negative).

Note 2: In that situation, does

the trustee owe a duty to second-guess the member or to inform the member that the member should think further about his investment decision?

24


G. Legal duties in connection with fees charged to members’ retirement accounts (including duty to ensure adequate disclosure)

Note: Can trustees or employers just pass on investment information, particularly associated cost

disclosures received by a trustee/employer from the investment provider or does the employer or trustee have a duty to review the material passed on to plan members?

1. There is little guidance respecting disclosure related to fees, beyond the general requirements of the a mini trator’ fiduciary, which requires openness and candor with beneficiaries. The CAP Guidelines provide that The CAP sponsor should provide CAP members with the description and amount of all fees, expenses and penalties relating to the plan that are borne by the members.

2. Where appropriate, these fees, expenses and penalties may be disclosed on an aggregate basis, provided the nature of the fees, expenses and penalties is disclosed. Where fees, expenses and penalties are incurred by members by virtue of member choices (e.g., transfer fees, additional investment information or tools, etc.) such fees, expenses and penalties should not be aggregated.

3. It appears that there are a lot of hidden fees that may not be disclosed by third party service providers and there is serious concern about the high fee levels charged on mutual fund products in Canada.

4. It is good governance for plan sponsors to review the information on fees being provided to their plan members and question the amount of information provided, and how it is provided (i.e., as a percentage versus as a numerical example), and to regularly review whether there is any opportunity to negotiate for lower fees.

In 2012, DOL finalized regulations providing all plan service providers to disclose fees/expenses charged to plan. Plan fiduciary must review to determine whether service provider disclosed all required information and then distribute to participants in a 401(k) plan.

1. In order for a plan member to make an informed choice as to how to direct the investment amounts credited to his retirement account within the range of investment options available under the plan, the member needs to be given adequate information about the charges that are levied on the investment option in question (so, not just the investment manager’ fee b t the “tota expen e ratio” having regar to custody fees, brokerage fees etc.).

2. The starting presumption is that, under UK Financial Services legislation, the investment product provider would be required to include adequate disclosure of the charges within the promotional literature relating to the investment option in question.

3. If the investment product provider has done so and the trustee/employer just passes on (or provides access to a website where) the information about the investment options, including charges, is available, then the employer/trustee duties would have been discharged.

4. On the other hand, if the investment product provider has not adequately disclosed the charges, the question arises as to whether simply passing on the information without review would be sufficient for the trustee/ employer to discharge its legal duties.

5. That said, in the selection of the investment options in the first place, the investment consultant should have looked at, among other things, the total expense ratio for the investment option in

25


question (and that would be part of the ongoing monitoring exercise of the investment option).

6. A possible approach is to include a suitable disclaimer from the employer and the trustee, to the effect that they have not separately checked whether the information about the investment option provided by the investment product provider is correct (as well as to seek a representation and/or indemnity from the investment provider about adequately disclosure).

7. From a “goo o tt rn” point of view, part of the process of selecting an investment option may include some sample checking of whether the product provider does appear to be complying with the disclosure of cost information in a transparent manner.

H. Legal duties owed by trustees and employers to plan members in connection with member communications.

Note: Should these communications explain to plan members (i) the legal nature of the investment

product, and (ii) what would happen if the investment product provider were to become insolvent?

1. There is little guidance in the legislation, however, the CAP Guidelines indicate that the administrator should provide CAP members with sufficient detail about the investment options available in the plan so they can make informed investment decisions.

2. The CAP Guidelines specify that for each investment fund that is an investment option available in the plan, the administrator should provide CAP members with the following information:

the name of the investment fund;

names of all investment management companies responsible for the day-to-day

management of fund assets;

the investment objective of the fund;

1. Legal nature of investment product (trust, mutual fund, hedge fund, separate account) subject to disclosure under DOL regs.

2. Consequences of investment product provider becoming insolvent is not required at the time of investment.

1. No specific requirement to disclosure the legal nature of an investment product imposed by legislation on a trustee or employer.

2. However, where the trustee is dealing with the proper discharge of its prudent person duties, the test will be whether the disclosure of the legal nature of the investment vehicle was material information that should have been disclosed.

3. As a practical matter, the legal nature of an investment vehicle only ever becomes material in an insolvency situation where the investment product provider becomes insolvent (e.g. Lehman and AIG).

4. It is sensible, therefore, to include this disclosure, including what happens on insolvency and details of any

26


the types of investments the fund may hold;

a description of the risks associated with investing in the fund;

where a member can obtain more information abo t the f n ’ portfo io holdings, and other detailed disclosure about the fund, etc

3. There are also recommended disclosures where employer securities are offered as investment options and where other types of investments are offered.

4. There is no requirement for a plan administrator to advise members of what the consequences might be if the investment product provider were to become insolvent. It has been a rare occurrence in Canada and there are some insurance protections available.

compensation scheme, in the information about the investment product.

I. Does the employer or person responsible for the governance or operation of the plan have a duty to ensure that the de-accumulation (or retirement) income options are structured and

operated so as to optimise the level of retirement income or should the plan member be left to make his own investigation?

1. There is no duty on the plan sponsor or administrator to assist with the de-accumulation phase apart from some basic disclosures on the member’ option form as to the main choices available to them.

2. The Ontario regulator has information posted on its website to assist members in understanding their options, and this is the case in some other jurisdictions as well.

3. Opportunities to unlock pension monies significantly increased in the last few years across Canada, and this trend may continue in the future.

Employer is not required to ensure adequacy of retirement income provided by a DC plan.

1. In the UK, it is usual, at least at the moment, for a member with DC plan benefits to, at retirement:

1.1 take the maximum amount that he may take as tax-free cash (in summary, 25% of his retirement account, subject to a maximum of one-quarter of the available lifetime allowance (£375,000 reducing to one-quarter of £1.4 million on 6

th

April, 2014 subject to certain grandfathering provisions)), and

1.2 to purchase an annuity with the balance of his retirement account.

2. Where the administration of the plan is provided by an insurance company, it is usual for the insurance company to send out an annuity quotation to the

27


member in the run-up to his retirement.

3. It is a requirement of the Finance Act 2004 that the member is informed that he ha an “open market option” under which he can require the trustee of the plan to purchase an annuity for the member in the member’ own name with an insurance company chosen by the member and with the annuity having particular attributes chosen by the member, but otherwise permitted by the tax legislation (e.g. a level annuity or an annuity which increases each year in line with inflation or a fixed percentage (or inflation capped by a fixed percentage)).

4. However, surveys have shown that a large number of members do not exercise their open market options and, in consequence, end up with annuities which are, potentially, 30% lower than the member could have obtained had he exercised his open market option.

5. There is UK Pensions Regulator Guidance on “Member etirement ption . Occupational DC Schemes – Good Practice in Member Retirement Options and the pen Market ption” (Ma 2008, as updated), which encourages trustees to be pro-active in educating members about the need to exercise their open market option (or at least to investigate it carefully). However, there is a question as to whether the trustee has a positive legal duty to take further action.

20 May 2013

31

Workshop 9

Guarantee Funds: Policy, Politics and Practice

Jane Marshall

Fran Phillips Taft

Jane Marshall

Macfarlanes LLP London, United Kingdom

[email protected]

Frances Phillips Taft

GE Oil & Gas, Inc Florence, Italy

[email protected]

This article is based on a workshop given by Jane Marshall and Frances Phillips Taft at the IPEBLA Rome Conference on Monday 27 May 2013. It explores a number of issues in connection with national pension guarantee schemes including their potential application to defined contribution schemes, the issue of moral hazard and the future of pension protection.

This article reflects the law as at the date of the 2013 Rome Conference (27-29 May 2013)

What are guarantee funds?

For the purposes of this paper, we have

used the term to include:

• formal guarantee funds such as the

US Pension Benefit Guarantee

Corporation (PBGC) or the UK

Pension Protection Fund (PPF).

These are arrangements which take

on the assets of qualifying pension

plans, and pay compensation to plan

members. Typically, levies are

imposed on ongoing pension plans

to finance the guarantee fund. The

amount of the levy may be

determined in various ways, such as

by fund size or to reflect the risk

characteristics of the particular plan.

The levy is therefore analogous to

an insurance premium.

Compensation levels are prescribed

and do not usually provide full

compensation for the totality of plan

benefits. There may or may not be

an explicit State guarantee (see

below); and

• insurance based systems which

provide pensions protection, for

example the German PSV, which

operates a mutual insurance

association, buying out benefits

with insurance companies and

collecting the necessary

contributions to meet these

liabilities.

In a European context, pension

protection on insolvency is required

under the Insolvency Directive.1 The

extent of the obligations imposed by the

Insolvency Directive has been

discussed in Robins v Secretary of

State for Work and Pensions (2007) 2

CMLR 13 and, most recently, in Hogan

and Others v Ireland (Decision handed

down 25 April 2013). The latter case in

1 Directive 2008/94/EC (Articles 1 and 8); Council Directive 80/987/EEC (Article 8).

32

particular has ramifications in a number

of EU member states, where it is by no

means clear that their guarantee

systems fully embody the protection

which the Court of Justice of the

European Union has held is necessary

to f fi member tate ’ ob igation

(broadly protection of more than 49% of

the va e of the member’ pen ion).

Guarantee funds share a number of

common features:

• they provide protection principally for

members of defined benefit

schemes where the pension promise

may not be matched with sufficient

assets to pay for it (the PBGC, the

PPF, the Ontario Pension Benefit

Guarantee Fund (PBGF) and the

Irish Pension Insurance Protection

Scheme (PIPS) exclusively protect

defined benefit schemes);

they may also be used where

defined contribution funds contain a

guarantee. (Defined contribution

guarantees may be of an absolute

rate of return, such as exists in the

Belgian, Czech and Swiss systems)

in different forms, or relative rate of

return guarantees, as in Hungary,

Poland or Denmark2 or in cases

where member ’ right are not

matched by any direct assets (as in

book reserve or unfunded schemes);

• they provide protection where the

employer sponsor becomes

insolvent;

• they are often implemented because

of political pressure following

corporate failures (e.g. the

establishment of PBGC following

2 Guarantees – counting the cost of guaranteeing defined contribution pensions by the World Bank Pension Reform Primer.

failures such as Studebaker auto

company); and

• in the EU they must also have

regard to obligations under the

Insolvency Directive.

Are DC schemes irrelevant to the

consideration of guarantee funds?

Many guarantee funds are, as noted

above, only relevant to defined benefit

plans. A pure money purchase plan

wi on the emp o er’ in o venc

contain no element of underfunding

ince the member’ right epen on

the value of his pension account.

(There may be unpaid employer

contributions to collect, which are often

given priority in general insolvency

law.) Clearly, in cases where rate of

return guarantees have been given

which cannot be met by the fund,

protection may be afforded by

guarantee funds. Examples of this kind

of protection are the central pension

guarantee pension funds established in

Hungary and Poland backed by the

State.

The Insolvency Directive (Article 8)

provides that:

‘Member states shall ensure that

necessary measures are taken to

protect the interests of employees and

of persons having already left the

employer’s undertaking or business at

the date of the onset of the employer’s

insolvency in respect of rights

conferring on them immediate or

prospective entitlement to old-age

benefits, including survivor’s benefits,

under supplementary occupational or

inter-occupational pension schemes

outside the national statutory social

security schemes.’

While the Directive is wide enough to

require protection of member rights

33

under defined contribution plans, pure

money purchase plans will not normally

need to be subjected to any particular

protective mea re a member ’

benefits will be unaffected by the

emp o er’ in o venc . For thi rea on

the UK Government expressly excluded

the ability of money purchase schemes

to enter into the PPF (s.126(1)(a) of the

Pensions Act 2004). It is also the

reason that the UK government is

desperately trying to resolve the

question of what constitute money

purchase benefits following the

decision in Houldsworth v Bridge

Trustees [2011] Pens LR 313. Any

uncertainty could mean that certain

benefit designs would be brought within

the ambit both of the Insolvency

Directive and the funding provisions of

the IORP Directive.

What is moral hazard?

In economics, the term is defined as

the lack of any incentive to guard

against a risk which one is protected

against (as by insurance). In pensions

usage, it highlights the possibility that

some sponsors and/or plan trustees

may behave less prudently in the

funding, investment or administration of

their schemes in the knowledge that

member benefits are protected by an

insurance or guarantee fund.

Ultimately, well run schemes of good

employers help to bale out the

employees of companies which have

been reckless, as well as those which

have merely been unlucky. In the UK,

moral hazard is often used to refer to

the raft of anti-avoidance provisions

introduced by the Pensions Act 2004,

which give the Pensions Regulator the

power in certain circumstances to

recover under-funding from group

companies of the sponsor. These

powers are directly linked to one of the

eg ator’ tat tor objective – the

need to reduce the risk of calls being

made on the PPF.

Many guarantee systems contain

measures to try and mitigate the

possibility of moral hazard. Indeed, this

is essential given the potential conflict

with other established legal principles.

Companies are required, for example,

to promote the success of their own

shareholders, not those of their

competitors. Among measures

designed to reduce the risk of moral

hazard are regulatory intervention, strict

funding rules, and the calculation of

levies or insurance premiums on a

basis which tries to reflect the risk

posed by a particular scheme. In a UK

context, 80% of PPF levies are broadly

determined on a risk basis having

regard to the funding and investment

strategy of the particular plan and also

the credit worthiness of the sponsor.

The relevant factors in determining risk

are the level of under-funding and the

risk of the employer becoming insolvent

in that year.

The original policy intention – protection

for employees whose employer is

unable to honour the pension promises

it has made because of insolvency – is

straightforward, and provided the

guarantee system contains measure

such as those referred to above, moral

hazard can probably be contained. The

policy objective becomes less clear,

and moral hazard a much greater

issue, in those cases where an

employer is not actually insolvent but

would have a much better business if it

were shorn of its pensions obligations.

The reasons for employers which have

given guarantees, such as those

embodied in defined benefit schemes,

wishing to rid themselves of their

obligations are many and various.

34

Increased obligations unilaterally

imposed by government, unforeseen

additional costs associated with

increasing longevity, lower than

anticipated investment returns, a

ownt rn in the compan ’ b ine

falling short of insolvency or historic

liabilities which are perceived to have

no direct connection with the current

business – any of these may contribute.

Whatever the rea on the emp o er’

premise is usually that the viability of

the entire business is at risk if it has to

deliver the benefits it has promised.

Someone else must therefore fill the

gap. This of course raises difficult

issues of equity and commercial

advantage between employers who

may seek to shift the burden of their

pension obligations in this way and

those who do not. These difficult issues

are compounded by the financing of

guarantee funds, which, as noted

above, often depend on levies or

contributions from other employers and

the schemes they sponsor.

Investment is an often quoted example

of the existence of a guarantee fund

potentially changing behaviour. If

members are generally protected by a

safety net, what incentive is there to run

a prudent investment policy, particularly

where a high risk strategy may be the

only way of closing a funding gap that

the emp o er can’t otherwi e pa ? The

issue has been considered by the UK

courts. In ITS v Hope (Independent

Trustee Services Limited (in its capacity

as trustee of the Ilford Pension

Scheme) v Hope and others (2009)

EWHC 2810) the employer entered

administrative receivership with no

assets available to fill the scheme

funding gap (in the UK the pension

scheme ranks as an unsecured

creditor). The compensation limits of

the PPF meant that some members

who had retired early with substantial

entitlements would have been very

materially affected on entry into the

PPF. The trustee wanted to buy out

annuities in excess of PPF

compensation limits, ensuring that

members received full benefits through

a combination of the annuities and PPF

compensation; the assets available for

transfer to the PPF would be

accordingly reduced. The Court

rejecte the tr tee ’ propo a . It held

that the trustees could not take into

account PPF compensation in deciding

to allocate a disproportionate amount of

the available assets to secure top up

benefits. The Court stopped short of

saying that trustees could never take

into account the existence of the PPF,

but made it clear that it expected its

rea oning to be fo owe ‘in an

instance where trustees seek to take

advantage of the existence of the PPF

as a justification for acting in a way

which would otherwise be improper’.

It is also possible to envisage

circumstances where action (or

inaction) occurs in order to allow higher

levels of compensation to be paid – so

ca e ‘priorit rift’. In the UK PPF, the

benefits of those who have reached

normal retirement date are better

protected than those under that age,

irrespective of whether or not the

individual member is in receipt of his

pension. A pensioner who is above

normal pension age and entitled to a

pension in payment at the date the

scheme enters into an assessment

period is entitled to 100% of his

pension (Schedule 7 to the Pensions

Act 2004). A member who has not

reached normal pension age (in

accordance with the relevant rules)

when the scheme enters into an

35

assessment period has his

compensation capped at 90% (save in

relation to an early payment on the

grounds of ill health).

The most obvious examples of moral

hazard are, however, those outlined in

paragraph 9 above. Prepacks are a

particular object of scrutiny, where a

restructuring is designed so as to

trigger the transfer of the pension plan

to the guarantee fund but leaves

essentially the same business carrying

on. In one sense, the business has

nfair ‘ mpe ’ it iabi itie on to

someone else. In another, the business

has been able to avoid the job losses

and other economic disruption which

would otherwise have occurred in

addition to the transfer of pension

liabilities to the guarantee fund. Which

side of the argument one comes down

on may depend (in the UK anyway) on

the view one take of a ‘har ’

guarantee of buy out annuities being

imposed retrospectively by

government. In any event, such cases

are likely to attract regulatory scrutiny.

Some UK examples include the

following:

Heath Lambert

The first controversial case under the

2004 Pensions Act regime arose when

the scheme of insurance broker Heath

Lambert received approval from the

Pensions Regulator for the transfer of

its scheme to the PPF in return for a

30% stake in the continuing company.

Silentnight

Silentnight was purchased out of

administration by private equity firm

HIG Capital. An associated company of

HIG Capital had previously purchased

the senior debt of Silentnight, and using

the powers it had acquired as a result

had placed the company into

administration. The scheme entered

into a PPF assessment period. HIG

Capital then bought the business.

The Pensions Regulator has recently

suggested that it is minded to exercise

its regulatory powers in relation to the

Silentnight structure.

What risks are there in guarantee

funds?

Investment

For guarantee funds such as the PPF

and PBGC, which take over scheme

assets, the investment of those funds is

crucial to the security of the

compensation members are promised.

This is so since many guarantee funds

do not enjoy an explicit State

guarantee. There has for example been

much discussion over the years about

the solvency of the PBGC. A 2011

paper by Charles Blahous noted that

the PBGC’ ate t ann a report

showed a net negative financial

position of more than $23 billion, falling

just short of the record deficit in 2004

and 2003.3 Concerns in the UK have

frequently been expressed about the

abi it of ome arge cheme to ‘ ink’

the PPF were they to fail, with the

inevitable call for a State guarantee. In

2008, the UK Society of Pension

Consultants wrote to ministers calling

for “a commitment from the government

to stand behind the PPF financially in a

similar form to the guarantees now

commonp ace in the banking ector…”

In Canada, the PBGF has on several

occasions received state funding.

3 Working paper: The Other Pensions Crisis: options for avoiding a taxpayer bailout of the PBGC by Charles Blahous of George Mason University.

36

The UK PPF maintains a panel of

external managers covering different

assets/classes, from global bonds and

equities to alternative credit and real

estate. It also maintains a panel of

transition managers. The PPF

publishes its overall investment

strategy (the latest being its Statement

of Investment Principles in November

2012). In some other systems,

investment risk is avoided by the

immediate purchase of insurance

annuities, as in the German system.

Governance

The UK PPF was established in

Pensions Act 2004. It is run by the

Board of the PPF, a statutory

corporation. There is a small number of

executive members, with a larger

number of non-executive members.

Possible changes in benefits/political

interference

Guarantee funds do not always provide

absolute levels of compensation, which

can often be altered. Such changes

would, again, be politically difficult but

might be necessary.

Who guarantees the guarantor?

Currently there is no explicit taxpayer

guarantee for the PPF in the UK,

although there have been many calls

for this and there is a perception that it

would be politically difficult not to

rescue it (although perhaps unfair to

those that have not been lucky enough

to be given final salary pensions). The

same applies to the PBGC.

Contrast the position with the Ontario

fund where there has been a

requirement for taxpayer backing. For

example in 2010 when Nortel moved

into administration, the PBGF could not

meet its liabilities and it required $500

million of state funding.

What next?

The global financial and economic

crisis has once again focused attention

on the place of guarantees and

additional security within private

pensions systems, particularly given

the wholesale retreat from defined

benefit schemes into a largely defined

contribution environment. In a

European context, IORP II has raised

the possibility of additional funding

buffers in defined contribution

schemes, to provide protection against

administration failures, fraud and so on.

In some countries, such as the UK,

there has also been discussion about

the use of minimum return guarantees

in efine contrib tion or ‘ efine

ambition’ cheme a a wa of

connecting with and gaining the

confidence of those who may be

undertaking pension savings for the

first time. It is fair to say that there is

little enthusiasm from employers for

any such guarantee. And of course

there has been considerable debate

about the difficulties posed by the

increasing cost of annuities.

At the same time, discussions about

fairness, moral hazard and burden

sharing crop up across all sorts of

policy areas, not least in relation to

banking policy. Using taxpayer money

to bail out the banks may have averted

‘the wor t financia cri i ince 1931’

according to Jochen Sanio in 2007,

then German ’ top financia

supervisor. However, the resentment of

the man in the street at the shock to the

system as a result has led in many

countries to the impossibility of any

rea i tic i c ion abo t banker ’ pa

37

taxation policy, public spending or

welfare.

The potential for similar disquiet also

exists with regard to any State

n erwriting of emp o er ’ pen ion

promises. Why should a taxpayer who

may not have much of a pension

himself be compelled to contribute to

omeone e e’ pen ion? This is so

particularly when the taxpayer is also

compelled to meet what are often

relatively generous pension

entitlements of employees in the public

sector – central and local government,

police, fire and health employees for

example.

However, guarantees are likely to be on

the agenda in the EU for some time

following the Hogan and Others v

Ireland decision. There was particular

discussion during the workshop on the

possible responses that could be

expected from the Irish government. It

was noted that the fact that there was

no eq iva ent of a ‘ ection 75 ebt’ (the

provision of the Pensions Act 2004

which prevents UK companies from

abandoning their defined benefit

schemes) made it difficult to implement

a guarantee fund, at least without a

section 75 equivalent being introduced.

One problem that authorities face is

that many companies with defined

benefit schemes will be subsidiaries of

overseas parent companies. Where the

employer subsidiary fails, interesting

questions arise as to the extent to

which the overseas parent can or

should be pursued. The current dispute

between the PBGC and the Japanese

company Asahi Tec Corporation was

discussed at the workshop and this is a

dispute to be followed with interest.

With the difficulties of extra-territorial

enforcement in mind, it was interesting

to discuss the possibility of an EU wide

guarantee fund. It will be interesting to

see whether guarantee funds form part

of an EU-wide policy response

although, as is clear from the schemes

mentioned in this article, pension

scheme systems in EU States are

currently far from harmonised.

38

Workshop 13

Convergence of Employee Benefits – Wrapping up other benefits with

the Pension Plan

Camilla Barry

Michael Beatty

Elise Laeremans

Martin Rochett

Camilla Barry

Partner, Macfarlanes LLP, London, United Kingdom

Michael Beatty

International Consultant, Maida Vale

Fiduciary Services Sydney, Australia

Elise Laeremans

Partner, Younity Lawyers Belgium

Martin Rochett

Senior Partner, Norton Rose, Canada


Introduction

Our session canvassed the jurisdictions

of Belgium, Canada (Québec),

Singapore and the United Kingdom in

the context of the inclusion of other

benefits offered in addition to a

traditional pension plan. While some

benefits are supplementary benefits

included within a pension plan, in other

jurisdictions similar benefits are offered

as part of the overall employment

package yet separate from the pension

plan structure.

Due to challenges of government

taxation and regulation pensions are

often segregated from other products

and not offered in conjunction with

other benefits. However,

administratively the various benefits

may appear as one umbrella plan to the

members.

Although the method of delivering other

employee benefits varied between the

jurisdictions, there seems to be a

consistent policy aspiration to assist

citizens with retirement, risk related

insurance benefits, death (and

survivorship benefits), healthcare,

housing and flexible (cafeteria)

benefits.

Belgium

The Belgium pension system contains

the traditional three pillar system with a

government pension, an occupational

pension and individual savings.

Occupational pension plans include

company and industry wide plans.

Collective and individual pension

arrangements are available.

39

The European Union dictates that

benefits resulting from a pension plan

m t be imite to “retirement benefit

related operations and activities arising

therefrom”. In genera thi inc e

retirement benefits, death benefits and

disability benefits.

For salaried employees retirement

benefits do not permit pay-out before

age 60. One exception to this restriction

(if explicitly provided for in the plan

rules) is the use of pension plan for real

estate purposes in order to pledge the

pension rights and/or an advance of a

part of the retirement benefit. This

exception is subject to certain

limitations however.

Be gi m a o ha “Socia ” pen ion

plans. A social pension plan has two

components retirement benefit and

social benefits. The social benefits

must be chosen from a menu that is

determined by law.

Examples of social benefits include:

continuation of the funding of the

retirement benefit during certain

periods: temporary or involuntary

unemployment, disability, parental

leave, until 6 months after

bankruptcy of the employer;

payment of an annuity in the event

of permanent disability less than

66% to 25,000 Euros on a yearly

basis;

payment of an annuity in the event

of death in service (limited to 20,000

Euros);

payment of funeral expenses; and

increase of current retirement

annuities (for example and

indexation).

The advantages of social plans is that

the social benefits are not taken into

account for any salary freeze

calculations and no 4.4% insurance tax

must be paid on the premiums (social

benefits must however be at least 4.4%

of the pension premium).

Belgium also has flexible or cafeteria

type plans which can include, but are

not limited to benefits such as eco

vouchers, ironing services, magazine

subscriptions, personal discounts, profit

participation, child care and fuel cards.

However, as soon as a pension plan is

one of the benefits that is wrapped up

in the cafeteria plan, the list of other

benefits that may be included is very

short. Other possible benefits include: a

supplement to the legal benefits paid in

the event of a disability or a death;

compensation for cost of hospitalisation

day-case care and palliative care,

compensation for costs

(physical/mental) dependence, annuity

in ca e of “ erio i ne ”; an other

personal insurance that are a

supplement to legal social security

benefits and only provide benefits in the

course of employment.

Canada (Québec)

The Canadian pension benefits system

has three pillars including a

combination of public, occupational and

private arrangements. The occupation

pension system in Canada and Québec

is not mandatory and employers are not

obligated to provide pension benefits to

their employees.

Pension and employee benefit

arrangements include insurance plans

(life, health etc.), income replacement

plans and other miscellaneous benefits.

The public system includes the Old Age

Security (OAS) which provides

universal pension payments to retirees

over age 65. This covers 99% of the

40

Canadian population and has 1.3

million beneficiaries in Québec.

Occupational pension are provided by

the Canada Pension Plan (CPP) and

the Québec Pension Plan (QPP). The

QPP has 4 million workers covered and

1.5 million retirement pension

beneficiaries.

Private initiates include supplemental

pension plans and personal savings

which cover 2.1 million workers in

Québec who participate in some form

of group savings.

In addition to supplemental pension

plans and personal savings, private

initiates also include several types of

retirement pension vehicles such as

group registered retirement savings

plans (RRSPs) and deferred profit

sharing plans (DPSP).

At retirement and age 65 a goal of the

combination of QPP, OAS and private

initiatives is projected to provide a

replacement income of roughly 60% of

an annual salary of $50,000 CDN.

Other income replacement products

inc e worker ’ compen ation

automobile accident insurance and

government social welfare.

Private schemes may include short and

long term disability insurance.

Both pensions and insurance in

Canada are highly regulated and

segregated. However, pension plan

benefits may also include death and

disability benefits.

Canada also permits first time

homebuyers to withdraw funds from a

RRSP to buy or build a home up to a

prescribed amount in a calendar year.

The amounts may be paid back into the

RRSP over a period of 15 years.

Singapore

In 1955 Singapore established the

Singaporean Central Provident Fund

(“CPF”) a a retirement scheme.

Singapore’ CPF i a man ator

employer/employee scheme which

requires employer and contributions.

There is both a minimum amount and

maximum monthly amount for

contributions. Total contributions as a

percentage of wages vary depending

on the emp o ee’ age b t range

between 11.5% and 36% of the

emp o ee’ month wage. With ome

exceptions benefits within the members

account are preserved until age 55.

Contributions are tax deductible to

employers as a business expense, tax

relief is permitted to employees,

account balances and gains accrue tax

free and retirement income from an

annuity or monthly income is not taxed.

Shortly after independence of

Singapore in 1968 the government of

Singapore permitted members to

purchase residential real estate using

the CPF as financing. Singapore had

an expanding economy and needed a

larger population. The government felt

that encouraging real estate purchases

assisted with the permanent settlement

of employees. The CPF has continued

to evolve to offer other employee

benefit . Man benefit are in the “be t

intere t ” of the nation a we a the

members. The government is able to

influence social and economic policy

considerably via the CPF.

The mi ion of the CFP i “[T]o enab e

Singaporeans to have a secure

retirement through lifelong income,

healthcare financing and home

financing.

The CPF now includes additional

benefits such as: medical insurance,

advances from the members account

41

for full or partial property payment or

ongoing payments to service monthly

mortgage obligations, mortgage

protection insurance, insurance for

death/disability, payment of local post

secondary school fees, direct payment

of hospital charges and the purchase of

life annuities.

The CPF directs contribution amounts

and percentages into different account

epen ing on the member’ age. For

example, below age 35 most of the

contributions are allocated to an

account commonly used for housing.

Conversely, at age 60 plus the majority

of the members account is allocated

towards the medical account

(Medisave).

As the Singaporean system is

government pon ore the member’

are able to obtain group insurance

benefits and change employment with

no disruption in their employee

benefits.

As the members funds are all deposited

into one “pen ion pot” there i a

ignificant amo nt of oca “b in” to

the scheme.

United Kingdom

In the UK, what benefits can be

wrapped up in a pension plan is

restricted by UK regulatory and tax

legislation and by European legislation.

European law in particular restricts

activitie of pen ion p an to “retirement

benefit operation and activities arising

therefrom”. Funding of capital for

housing and provision of medical care

of education are therefore not

permitted.

In addition, as a matter of national tax

policy, payments out of tax favoured

pension plans are tightly restricted as to

form and purpose. Early access rights

are largely limited to disability and

survivorship although from a certain

minimum pension age pension rights

can be provided which arguably

constitute protection for loss of

employment or forced early retirement.

Life assurance benefits are permitted

as part of occupational pension

provision.

These restrictions have left the UK with

a difficulty regarding the

unattractiveness to young savers of

locking up substantial funds for a very

long period: age 55 is unimaginably old

to a 25 year old. In addition, social

provision for medical care and basic

provision provides basic security so

that pension saving is not seen as

critical.

Also, housing costs are a significant

and a key priority in the UK. This and

other spending cost such as private

education often seen as desirable,

compete with pensions. So far the

policy remains not to allow access to

pension savings for other purposes or

before age 55 even though it is

recognised that this may be a break on

pension savings.

One exception stands out: the tax free

lump sum of 25% of the savers pot

available on retirement and often used

to clear mortgage debt or secure

housing at the start of retirement or to

support children accessing the property

market.

The development of discrimination law

in Europe including age discrimination

rules and the increasing cost of pension

provision have also led employers to

ook at combining benefit on a ‘pick

an mix’ ba i a o known a ‘cafeteria

benefit ’. Thi app ie for the pre-

42

retirement phase. Pensions can be

included within this alongside life

assurance, nursery vouchers, train

ticket loans, gym memberships and

medical insurance. Cafeteria benefits

effectively wrap the pension plan up

with other benefits from the perspective

of the employment even though for tax

and regulatory reasons the pension

plan will stand apart and minimum

allocations to pensions are required to

comply with the new auto-enrolment

legislation.

In the post retirement phase, pensions

are generally only linked to life

assurance benefits either by dual

annuities, provision of dependant

pen ion from an emp o er’ pen ion

or transfer of a remaining n pent ‘pot’.

[Ed note: for further information on the UK

position see the article by Camilla Barry

that directly follows]

43

Workshop 13

Convergence of Employee Benefits - Wrapping Other Benefits up with the Pension

Plan: View from the UK

Camilla Barry

Macfarlanes LLP, London, United Kingdom

[email protected]


Introduction

Pensions are special. Are they too

special?

Traditionally, in the UK, pensions have

been provided through special purpose

trust vehicles or under special contracts

issued by regulated insurance

companies. They have a separate tax

regime, indeed several separate tax

regimes, and separate regulation.

Because pensions are very special.

And yet there is a well-noted failure by

the general population to embrace

pensions. People seem to need a lot of

persuading to lock up significant

proportions of their earnings in

something they may not touch for a

quarter of a century or more and which

they may not live to enjoy. The young

find it hard to believe they will ever

grow old.

Employers have no interest in providing

an expensive benefit if it is not

appreciated. And yet, they know that

pensions are needed and appreciated

by some. Even where tax rules and

regulation do not make this easy,

employers are keen on wrapping

pensions up with other benefits.

This paper looks at the traditional UK

pension design and provision of other

linked benefits, the rules that dictate the

special treatment of pensions and the

current trends in benefit packages

wrapping p pen ion in ‘f ex

package ’.

UK traditional pension model

The traditional UK pension model is a

trust-based occupational pension

scheme. One might add that these

were typically defined benefit of the

final salary model although defined

contribution occupational pension

schemes could be found. What was

wrapped up with the pension scheme

wa on a m ch a the UK’ In an

Revenue (now HMRC) would allow to

be provided from the tax-favoured

pension scheme. The tax rules were


44

revised in 2004 but remain broadly the

similar as to the type of benefits that

can be paid without tax penalties.

There has also been a marked shift

towards defined contribution provision

in recent years.

UK tax rules for pensions have always

allowed death benefits and early

retirement pension benefits as well as

some lump sum benefits to be provided

through the pension scheme. No other

early access rights have been

permitte . The ti aren’t.

In fact, contribution refunds that had

always been permitted before full

vesting have been gradually restricted

as vesting rules have tightened and the

Government is not looking at banning

all refunds; a few decades ago, a 5

year vesting period applied.

Pen ion cheme fo ow the taxman’

view of what a pension scheme is for:

essentially, it was there primarily to

provide life-long income for those too

old to work.

Disability (income protection) benefits

By extension, pensions can be

provided for those who become

permanently infirmed and unable to

work before reaching old age. So

disability benefits have long been

wrapped up with the pension plan.

These disability benefits were often far

more generous than the old age benefit

in that they might provide for the

expected old age benefit that might

have been earned over a full career to

become immediately payable, and

payable for life, from the time of the

disability retirement. A 30 year old

could receive a pension for life based

not on the pension value he had earned

to date but based on the pension he

might have earned assuming he

continued working for his employer till

old age (defined as normal retirement

age for these purposes) and based on

his current salary. This is known as a

‘pro pective ervice pen ion’. The 30

year old, struck down with a disability

having joined the pension scheme at

25, would then receive an income for

life from 30 based on the service he

had completed as a member of the

pension scheme (5 years) and the

service he might have completed to

normal retirement age (say 65 or 35

years).

Not all pension schemes are as

generous and many might only provide

early access on an unreduced basis; in

effect the pension that has already

been earned but paid for a much longer

period (i.e. with some material

enhancement to value but not as great

as the prospective service pension).

While the benefit looks similar to the old

age pension, particularly as it is

expressed as early access to a pension

calculated using the same formula as

the old age pension or at least a similar

formula, it is in fact very different. The

old age pension is one that most

employees are expected to receive and

draw for an average number of years

with some pooling of life risk. The

disability pension is a risk benefit that

very few employees are expected to

receive. The benefit is affordable to the

employer only because the 30 year old

who becomes permanently disabled is

expected to be so rare. The moral or

social return on provision of this benefit,

in terms of its impact on employee

relations, even before any employee

falls ill is assumed to be high compared

to the expected financial cost. The

benefit is often not prefunded but, in the

45

golden age of pension scheme

surpluses, might be funded from the

general funds in the pension scheme.

Redundancy or employment

termination benefits

As a further extension, traditional final

salary pension schemes might provide

for pensions to come into payment

before old age in the event of

re n anc or at the emp o er’

discretion or even at the emp o ee’

option provided the employee has

reached a minimum age (then 50 and

now 55, although lower ages might be

permitted for some careers). The status

of early retirement benefits is far more

ambiguous and contentious.

Early access to an old age pension in

some cases does not change the

character of the benefit at all. For

practical reasons, a defined benefit

scheme has to have a normal

retirement age, i.e. a reference age to

determine the value of the basic benefit

and an age at which the benefit

becomes payable as of right. But old

age is not fixed. Some may be able to

work longer than others and some may

choose to work longer than others.

If there is no enhancement to value on

early retirement, early access is not an

additional benefit and it may arguably

not detract from the benefit being an

old age benefit if the reason for the

pension commencing to be paid is that

the employee has reached the end of

his working life, a little earlier than

others.

On the other hand, particularly where

there is a material enhancement to

value or early access is linked to

redundancy or termination of

emp o ment at the emp o er’ initiative

the benefit may look far more like a

redundancy benefit or even

compensation for the employer forcing

early termination of the emp o ee’

career.

The distinction is one that is

contentious because of the different

legal treatment afforded to old age

benefits and benefits that are deemed

not to be old age benefits under the

European Acquired Rights Directive

and the UK implementing legislation

(the Transfer of Undertakings

(Protection of Employment)

eg ation or ‘TUPE’). The European

Court of Justice has held in Beckmann

v Dynamco Whicheloe Macfarlane, that

early retirement benefits and benefits

payable on redundancy are not old age

benefits and therefore continue to

accrue and be payable after a business

transfer, whereas the old age benefits

do not.

Wealth management

The UK tax rules have recently been

restricted to allow early access only

from age 55 rather than age 50 (except

in cases of ill-health). The taxman’

interest is that early retirement

provisions, particularly if at the

member’ option ook more ike wea th

management than provision for old age.

Life assurance

Further conventional benefits included

in the pension plan are death benefits,

both in lump sum form and in pension

form.

As with the disability benefit, a spouse

or epen ant’ pen ion might be ba e

on prospective service so that it is a

high value, low-cost risk benefit similar

in its formulation to the emplo ee’ own

retirement pension benefit but falling

rather than increasing in value as the

46

employee ages. In other schemes, it

might simply be a fraction of the

member’ own accr e benefit; it

value might still be greater if the

member dies early or leaving a young

spouse.

Typical lump sum death benefits might

be a fixed multiple of salary at death in

the pre-retirement phase and a 5 year

guarantee in the post-retirement period.

The one is a free-standing risk benefit.

The other is about protecting the value

each employee (and his dependants)

gets from his old age benefit.

The pension commencement lump sum

– a concession to wealth management

or housing costs?

One of the most valued and

contentious benefits permitted under

the UK tax r e i the ‘pension

commencement mp m’. This may

be paid automatically in some schemes

or it may be paid by commutation of

pen ion right or app ication of the ‘pot’

in defined contribution arrangements.

Essentially, under current rules, one

quarter of the fund may be taken at

retirement, i.e. when other periodic

benefits are put into payment, as a tax

free lump sum.

On one level, it is an anomaly that the

tax rules, which otherwise focus so

much on ensuring that pension savings

are applied to secure an income for life

in old age, allow and indeed encourage

ch a arge part of the ‘pot’ to be

withdrawn at the start of retirement.

However, the tax free lump sum has

survived many revisions of the tax

regime probably because it fulfils

several valuable functions:

Without it the tax benefits of pension

saving are slim (for some it is only

tax deferral which may not seem

worth the long lock up);

It is used by many to clear mortgage

liabilities and other debts at the start

of retirement enabling them to live

more cost effectively on their

savings.

While the UK regulatory and tax rules

prohibit use of the pension savings as

collateral for other obligations and

restrict early access that might allow

pension savings to be used for housing,

the release of the tax free lump sum at

retirement effectively does allow the

pension scheme to provide collateral

for housing costs and other debts.

Non pension benefits traditionally

wrapped up in the pension plan

So, wrapped up in the pension plan and

linked to the basic benefit of an income

for life in old age for an employee, we

find:

Disability benefits;

Redundancy benefits or

compensation for termination of

employment;

Death in service benefits;

Provision for dependants in

retirement;

Wealth accumulation.

There is nevertheless a common

thread: protection of the employee and

his or her dependants against the

probability of not being able to work

past a certain age and the risk of loss

of earned income from a younger age

through death, disability or redundancy

or other termination of employment. It is

this coherence of protecting employees

and their families from loss of earning

capacity or earning potential that

underpins the tax policy of allowing

47

these other benefits to be paid from a

tax advantaged pension scheme.

Current rules

The current rules applicable in the UK

have three key sources:

UK tax policy;

UK regulatory policy;

The European Pensions Directive.6

UK tax rules

UK tax rules define what can be paid

from a tax-favoure ‘regi tere pen ion

cheme’. These rules allow:

Pensions or annuities payable for life

for employees from no earlier than

55 except in cases of ill-health;

Pensions or annuities payable for life

for adult dependants (subject to

marriage, civil partnership or

financial dependency or inter-

dependency);

Pensions or annuities for children up

to age 23 or for life if dependent

through disability;

‘Draw own’ of a variab e income

from the fund for the employee or his

dependants;

Tax free lump sums at retirement of

25% of fund;

Lump sum death benefits;

Full release of fund as a lump sum

for serious (terminal) ill-health or for

low value savings in special

circumstances such on winding up of

the pension scheme.

In addition there are limits on how

much can be accumulated in each year

6 Directive 2003/41/EC on the activities and

supervision of institutions for occupational retirement provision.

and over a lifetime without tax

penalties. Pensions can therefore only

be used for wealth management to a

limited extent.

Regulatory and EU

Registered pension schemes are tax

favoured arrangements. They can be

either occupational pension schemes

established by an employer typically

under a trust or personal pension plans

established under contract. Personal

pension plans include group personal

pension plans arranged by employers

with an insurance company as provider.

Occupational and personal pension

plans fall under different regulatory

regimes for many purposes. In

particular, only occupational pension

schemes are subject to the European

Pensions Directive. The European

Pensions Directive limits the activities

of occupational pension schemes to

“retirement-benefit related operations

and activities ari ing therefrom”. This is

generally understood as precluding

stand-alone provision of life assurance

benefits in the UK but as permitting

provision of life assurance and early

retirement and disability benefits that

are linked to retirement benefits.

Personal pensions

Personal pension plans (including

group personal pension plans) can be

linked to separately insured life cover

but can only themselves provide

pension savings. As the contract is

between the employee and the

provider, the benefits fully vest

immediately and the employee may

continue contributing after changing

jobs. The employee can access his

fund at any time from the age of 55 or

earlier on ill-health in accordance with

the tax rules. The whole fund is

48

available on his death for his

dependants.

Personal pension plans also include

what are known a ‘ e f-invested

pension plan ’ or SIPP ; under a SIPP,

the member controls the investment

strategy but tax rules prohibit use of the

pension fund to hold residential and

other tangible assets. The intention is

that the pension funding should not

have a collateral use prior to retirement.

General regulatory and tax

Similarly, there are regulatory or tax

restrictions for occupational and

personal pension plans on:

Employer-related loans and

investments; this is in part to avoid

the pension scheme assets being

used as a source of capital for the

employer; and

Members assigning their rights

under the pension scheme or using

them as collateral for other

obligations; and

e triction on ‘va e hifting’ and

prohibition on ‘pen ion iberation’.

Conclusion on tax and regulatory

restrictions

The clear policy intention remains that

pension assets should be for retirement

benefits and should not be used to

meet any other financial needs.

This is also reflected in the rules that

the UK tax authorities impose for

overseas pension schemes which

accept transfers from UK pension plans

(known a ‘q a if ing recogni e

over ea pen ion cheme ’ or

QROPS): such schemes must require

at least 70% of the fund to be applied to

the provision of an income for life in

retirement.

The effect of these various tax,

regulatory and European rules is that

the benefits that can be rolled into the

pension scheme is strictly limited. Early

access is strictly limited.

Current practice and trends

Pre-retirement packages

Emp o ee on’t a want the ame

thing. The age of long-lived companies

with long-term employees is gone. An

adaptable benefit package that suits a

wide range of employees is needed.

At the same time we have developed

discrimination law in Europe. Once

upon a time, employers made what

they saw as valid assumptions about

their employees and their proper

needs. It was common to exclude

women from the pension plan until they

were 30 or more on the assumption

that until then the probability was that

they would marry and be provided for

n er their h ban ’ pen ion cheme.

This is no longer acceptable. Anti-

discrimination legislation covers both

direct and indirect discrimination and

covers discrimination on grounds of

sex, sexual orientation, race, religion,

disability and age.

So, while an employer might suspect

that its younger employees are more

interested in gym membership and

cash earnings and that its older

employees value the pension and

medical insurance more, it would be at

risk of challenge if it excluded younger

workers from the pension plan etc.

The modern solution is flexible benefit

packages or ‘cafeteria benefits’. A

range of benefits is offered and the

employees pick and choose within a

budget. Cafeteria benefits in the UK

include train ticket loans, bicycle

schemes, nursery fee vouchers, life

49

assurance, gym membership,

permanent health insurance, medical

and dental insurance and pension

contributions. The emp o ee ma ‘b ’

these benefits by sacrificing salary.

This has a tax advantage for both the

employer and the employee as the

benefits in kind are not subject to

National Insurance contributions (UK

social charges or tax). As the employee

chooses, they get what they want and

there is no waste on provision of

unwanted benefits, while discrimination

risks are minimised.

Cafeteria benefits or flex benefits may

seem to be rolling the pension scheme

up with other benefits. From a legal and

regulatory perspective that is not quite

what is happening since the pension

plan assets are required to be held

separately. From the employment

contract perspective the pension

contributions are just one of a range of

‘pick an mix’ benefit .

There’ a imit to thi . In the UK, ‘auto-

enrolment’ is currently being rolled out.

Auto-enrolment requires all employers

to automatically enrol employees into a

pension scheme and pay employer

contributions and deduct and pay over

employee contributions. In default, all

sorts of sanctions apply. Consequently,

within the cafeteria benefits, a minimum

level of pension contributions must be

provi e for n e the emp o ee ‘opt

o t’ of a to-enrolment; the employee is

permitted to opt out after being auto-

enrolled but the employer cannot.

Post-retirement packages

There is little facility in the UK for post-

retirement packages. Largely private

medical insurance is seen as a luxury

in the UK given the availability of

largely uncapped medical care on the

National Health Service. Employers

may provide private medical insurance

for their employees but it is taxed as a

benefit in kind in the hands of the

employees (although not subject to

National Insurance contributions). The

cost of private medical insurance

increases with age and employers have

little incentive to provide this for their

retired former employees. It is therefore

a very rare benefit usually only

provided for migrant workers from other

jurisdictions and to employees on very

high value packages (probably

receiving pensions in excess of those

permitted under the tax favoured

registered pension schemes).

As mentioned above, the pension

scheme itself may only provide:

a lump sum at retirement;

a regular income as a scheme

pension or an annuity;

a variable income under the

‘ raw own’ r e ;

epen ant ’ pen ion an mp m

death benefits;

so it cannot provide medical insurance

or other benefits (although the

pensioner may then purchase medical

insurance if he wishes). If an employer

provides post-retirement medical or

dental insurance this will be under a

separate policy and not wrapped up

with the pension scheme.

Auto-enrolment and drawdown

Two of the most significant changes in

recent UK pensions legislation are:

Auto-enrolment; and

Drawdown.

Auto-enrolment makes employer and

employee contributions at minimum

rates for all workers earning above

50

£9,668pa compulsory subject only to

the emp o ee’ right to opt o t; the

employer cannot opt out or encourage

the employee to opt out. This is near

compulsion providing a low level of

pension saving to top up state pension

benefits.

Contributions are tax deductible for

employers as an expense, tax relief to

employees is provided up to the annual

and lifetime limits and the investments

accrue tax free. The benefits are taxed

a income bject to the pen ioner’

marginal rate at retirement and with the

exception of the 25% tax free lump

sum. The system is therefore exempt-

exempt-part taxed/part exempt

(EET/E). As the effective threshold for

income tax is about £10,000pa and the

state pension is being increased to

around £7,500pa, if a pensioner takes a

25% lump sum tax free from his fund

and applies the rest to secure an

income of £2,500 pa to top up his state

pension, pension provision will be EEE

as in Singapore. Anyone saving more

will pay some tax on benefits.

One of the most resented features of

the UK system was that savers had to

apply their fund by age 75 to purchase

an annuity. Annuity rates having fallen

well below 5% and even as low as 3%

for women retiring at 60, this became a

strong disincentive to saving in a

pension scheme. Drawdown has now

been introduced.

There are two drawdown options:

For those who have secured life-

time income of £20,000pa, the saver

is able to drawdown as much or as

little as he wishes in any year

(including withdrawing the totality of

the fund in the first year);

For all others, the amount that can

be withdrawn each year is no more

than 120% of the income that could

have been secured by an annuity as

determined by the Government

Act ar ’ Department; thi increa e

with age and is intended to ensure

that the saver will have sufficient

income for life but avoids the need to

disinvest and pay over the capital to

an annuity provider at retirement.

The ability to access savings at will

provided basic financial security

through old age can be demonstrated

and the ability to retain capital through

retirement (which can be passed on at

death) have been significant

concessions to encourage pension

savings. They are however more

significant for the better off.

Policy and possible future changes

How to encourage the young to save

for their own old age is as much a

challenge in the UK as anywhere else.

All of the access restrictions are seen

as a disincentive by the young – why

ock awa o r mone ti o ’re 55

when you need it now or may need it as

some point before you reach 55? ISAs

(which are tax sheltered savings

vehicles which work on a taxed-

exempt-exempt (TEE) basis) have

been far more successful presumably

because there are no restrictions on

access.

Auto-enrolment is intended to trigger a

savings culture but it is yet to be seen

whether it will succeed when employee

contributions rise to 5% of earnings.

Even that will not be sufficient to

provide good pensions.

Given this issue there is from time to

time consideration of the possibility of

allowing early access for particular

51

purposes such as housing – something

which is treated as a high priority in the

UK.

Pensions are used for housing to clear

mortgage debt at retirement using the

tax free lump sum and there have been

recent suggestions of allowing parents

to use their pension savings to provide

deposits for their children getting onto

the property ladder. There is great

interest in getting large pension funds

to invest in infrastructure projects and

housing development. Many who do

not save into pensions, treat their

houses as a source of retirement

income by down-sizing at retirement or

using equity release schemes. So the

separation of housing and pensions

which is so resented by savers and has

been so important in regulation and tax

policy is regularly under scrutiny.

For now, the two remain separate and

while pensioners may apply their tax

free lump sums to help their children

onto the property ladder or to house

themselves in retirement or clear their

mortgage liabilities, the young still need

to save separately for pensions and

housing and are likely to continue

prioritising housing.

52

Workshop 22

The ‘Waterford Crystal Judgment’ and Solvency Relief Measures in Ireland

Deborah McHugh

Mason Hayes & Curran Solicitors

Dublin, Ireland

[email protected]

Following on from the Court of Justice of the European Union (CJEU) judgment in Hogan and Others v Minister for Social and Family Affairs, Ireland and the Attorney General [Case C 398/11] (the ‘Waterford Crystal Case’), Ireland’s attempts at transposing Directive 2008/94/EC on the Protection of Employees of Insolvent Employers (the ‘Insolvency Directive’) into domestic law, raises wider issues on solvency relief measures in Ireland.


Background

In 2009, Receivers were appointed

over the assets and business of

Waterford Crystal Limited (the

‘Compan ’). At that time the Company

sponsored two defined benefit pension

cheme (the ‘Scheme ’) an the

appointed Receivers, by notice in

writing to the Trustees, terminated the

Compan ’ iabi it to make f rther

contributions thereto with immediate

effect.1 The schemes were

subsequently wound up with a reported

aggregate eficit of €110 mi ion.2

Under Irish law, pension scheme

trustees must distribute liabilities on

wind-up in a specific statutory order of

1 Under Irish pensions law, this is currently permissible when done in strict accordance with the provisions of the cheme ’ governing documentation.

2 This was calculated on the statutory, minimum funding standard basis as provided for in the Pensions Act 1990, as amended.

priorit (the ‘Priorit r er’).3 When that

Priority Order was applied in the instant

case, the members only received a

fraction of their pension expectation:

reportedly 18 - 29% calculated on a net

present value basis.4

In 2010, ten representative Scheme

members sued the State for its failure

3 Current priority order in which assets must be distributed under Irish pensions law: Expenses, Additional Voluntary Contribution (AVC) proceeds, Pensions without increases for members who are past normal retirement age or who were in receipt of pensions before the wind-up date, active and ex-emp o ee ’ preserved pension rights, non-preserved pensions and pension increases for all members rank equally at the bottom.

4 I.e. the present day commercial cost of securing the liabilities through the purchase of annuities and adjusting that cost to reflect the investment return that could be anticipated prior to the annuity being purchased. The only perfect theoretical match of meeting the pension liability would be to purchase deferred annuities payable at normal retirement age but these products are readily available in the Irish market.


53

to correctly transpose the Insolvency

Directive into Irish law; arguing that

their loss of pension benefits on the

insolvency of their employer and

Scheme was due to the State having

failed to honour its obligations under

Article 8 thereof to;

“ensure that the necessary measures

[were] taken to protect the interests of

employees and persons having already

left the employer’s undertaking or

business at the date of the onset of the

employer’s insolvency in respect of

rights conferring on them immediate or

prospective entitlement to old age

benefits, including survivor’s benefits,

under supplemental occupational or

inter-occupational pension schemes

outside the national statutory social

security schemes”.

The case was opened in the Irish High

Court in March 2011, and in July of that

year, under a preliminary reference

made to it,5 the CJEU interpreted and

answered seven questions of European

Law posed to it by the Irish Court and

found in favour of the plaintiffs on all

questions. Specifically, it held, inter

alia, that;

“[The Insolvency Directive] must be

interpreted as meaning that the fact

that the measures taken by Ireland

subsequent to ‘Robins and Others’6

have not brought about the result that

the plaintiffs would receive in excess of

49% of the value of their accrued old-

age pension benefits under their

occupational pension scheme, is in

itself a serious breach of [Ireland’s]

obligations”.

5 Under Article 177 of the Treaty of Rome.

6 Earlier UK judgment of Robins and Others v Secretary of State for Work and Pensions C-278/05 (‘ obin ’).

The matter will now be re-listed before

the Irish Commercial Court in the

coming months for its determination on

the extent of the protection to which the

plaintiffs are entitled.

Ireland’s Solvency Relief Measures

The 2008 Directive codified an earlier

1980 Directive, also on the Protection

of Employees of Insolvent Employers

[1980/987/EEC]. Taken collectively, the

legislative measures Ireland introduced

following that earlier Directive included;

The Protection of Employees

(Employers' Insolvency) Act, 1984 –

2006 introduced an Insolvency

Payments Scheme whereby claims

can be made from the Social

Insurance Fund where an insolvent

employer has failed to pay

contributions in accordance with an

occupational pension scheme for a

capped period of time. This extends

to contributions which the employer

an /or the emp o ee were ‘ iab e to

pa ’ into an occ pationa pen ion

scheme or Personal Retirement

Savings Account in the twelve

month prece ing the emp o er’

in o venc . ‘Liab e to pa ’ ho

not, however, necessarily be

construed as meaning the obligation

to fund the deficit.

The Pensions Insolvency Payment

Scheme 2010 (‘PIPS’) i a co t-

neutral Exchequer scheme offering

special payments where a defined

benefit scheme is winding up in

deficit and the sponsoring employer

is insolvent. This applies only to

pensions in payment and up to the

value of the assets that can be

transferred to the PIPS.

The Social Welfare and Pensions

Act 2009 amended Section 48 of the

54

Pensions Act affecting the Priority

Order on the wind-up of a defined

benefit scheme.7 Guaranteed post-

retirement increases now rank after

the entitlements of active and

deferred members in the order of

priority of payments.

Despite these measures and a 1995

European Commission Report8

observing that; “an overall examination

of the legislation [in Ireland] gives no

cause for objection”, the CJEU found

that the result of the all these measures

(e pecia po t ‘ obin ’) i not ati f

Ire an ’ ob igation n er the

Insolvency Directive.

When the case reappears in the High

Court, the Irish State might take

cogni ance of the ECJ’ comment in

the ‘ obin ’ j gment where the facts

were predominantly on all fours with the

‘Waterfor Cr ta ’ ca e (inc ing the

Commi ion’ en or ement of the UK’

solvency relief measures pre-Robins)

ruling that “The national court could

take into consideration the findings of

the [1995 report] as having reinforced

its view with regard to the transposition

of the Directive into domestic law”.

Employee Claims Must Exist Against

the Employer

At the outset, the High Court sought

clarification from the CJEU as to

whether the Directive was applicable in

this case, having regard to Article 1(1)

of the Directive and to the fact that

under existing Irish pensions law, the

loss of pension benefits claimed by the

plaintiffs are not a debt on the employer

which would be recognised in any

winding-up procedure and do not

7 By the insertion of sections 48(1A) and 48(1B).

8 COM (95) 164 Final.

otherwise provide a legal basis for a

claim against their employer.9

Article 1 of the Directive provides that;

“The Directive shall apply to

employees’ claims arising from

contracts of employment or

employment relationships and existing

against employers who are in a state of

insolvency…” (emphasis added).

Serious doubt may be cast over the

CJEU holding that the Insolvency

Directive applies to the plaintiffs simply

as they were required to join one of the

Schemes under their contract of

employment. This fails to acknowledge

the second of the dual pronged tests of

applicability set out in Article 1(1), i.e.

whi e the p aintiff ’ c aim certain aro e

out of an ‘employment relationship’,10

no contractual claim for accrued

pension entitlements ever existed

against Waterford Crystal. It is the

writer’ view therefore that thi ca e

should have fallen on the first question.

Signalled pension reforms

Following the CJEU judgment, the

Government’ re pon e i awaite . It

might be noted that a recent

comprehensive review of the Irish

pensions system was published on 23

April 2013 by the OECD; three days

before the Waterford Crystal judgment

was delivered. Amongst its chief

recommendations was that Ireland

introduce legislation to prevent healthy

emp o er from ‘wa king awa ’ from

defined benefit schemes unless assets

of that scheme cover 90% of the

9 Absent any contractual promise the sponsoring employer may otherwise have ma e to f n a cheme’ iabi itie o t i e the terms of its trust

10 Article 1(1) of EU Directive 2008/94/EC.

55

iabi itie on a ‘pr ent’ act aria ba i .

Thi “debt on the employer” approach

has been on a legislative footing in the

UK since 200411 and it may garner

Government support in the Irish context

in the coming months. Given the

current challenges facing sponsoring

employers of defined benefit schemes

in Ireland, it may be unrealistic to

expect employers to assume further

financial responsibility.

The OECD report also suggested

reform to the Priority Order,

recommending greater risk sharing

between all categories of scheme

members and sponsors and noted that

same would constitute a “fundamental

change to the architecture of pensions

in Ireland”. On 22 May 2013, The

Minister for Social Protection, Joan

Burton TD published the Social Welfare

and Pensions (Miscellaneous

Provisions) Bill 2013 that the

government had previously indicated

would include a change to the Priority

Order aimed at equalising the burden of

a scheme deficit amongst category of

members, however such reform was

deferred due to the CJEU decision in

the Waterford Crystal case in response

to which the Minister said that a

“comprehensive policy and legislative

response that addresses the range of

issues involved” was required.

Challenges Ahead

An immediate question for the State is

whether there are now inconsistencies

between the protections available on

‘ o b e in o venc ’ compare to tho e

for single insolvency where only the

scheme and not the employer is

insolvent. What appears unsustainable

in the Irish context is that it appears

11

Section 75 Pensions Act 2004 (UK).

better for an employee, if both their

employer and pension scheme is

insolvent rather than to have an

insolvent scheme with a viable

employer.

The Waterford Crystal judgment has

given rise to heated speculation as to

whether it will result in employer and

trustee conspired orchestrations

whereby the trustees present a

‘contrib tion eman ’ from the

sponsoring employer designed to result

in the insolvency of the employer,

enabling it to re-open under a new

structure, thereby abandoning its

defined benefit pension liabilities. The

i ea being that it wo create a ‘ o b e

insolvency situation, giving the

members recourse to whatever

measures the State will later introduce

to meet its EU Insolvency Directive

obligations. This somewhat simplified

thinking is unhelpful in circumstances

where a ‘contrib tion eman ’

presented to an employer by a scheme

trustee will not, of itself, give rise to a

Co rt’ abi it to give mmar

judgment against the employer. That

ability and the strength of any such

demand is absolutely scheme specific

and dependent on the wording of the

governing documentation. It is

anticipated that anti-avoidance

measures will be incorporated in any

legislation, as was the case in the PIPS

2010 Scheme where individuals were

excluded from the Scheme where they

had “contrived the qualifying conditions

for PIPS or have wilfully contributed to

the pension scheme deficit or employer

insolvency”.

In the meantime, for some pension

scheme trustees and company

directors grappling with the implications

of the decision in so far as their own

tie an ‘bottom ine’ are concerne

56

there is arguably a positive obligation

on them not only to consider the

implications of the judgment but to do

so in the wider context of the suite of

pension reforms signalled in the short

term. To fail to do so could present a

lost opportunity to take action for which

the consequences could be,

economically, far reaching.

57

Workshop 24

Auto Arrangements in Pension Plans

Andrew Harrison

Jane Dale

Andrew Harrison

Borden Ladner Gervais LLP, Toronto, Canada

[email protected]

Jane Dale

Slaughter and May, London, United Kingdom

[email protected]

The article summarizes the workshop on auto arrangements in pension plans, including the speakers’ presentations and the workshop participants’ comments. The jurisdictions of Canada and the UK each have different types of auto arrangements for pension plans, and each jurisdiction’s schemes are briefly explained. Topics covered in these summaries include mandatory and voluntary auto arrangement obligations and options, available to employees and employers. A summary of the perspectives of the workshop participants on auto arrangements for pension plans in Germany, South Africa, Sweden and the Netherlands completes the article.


Introduction

This workshop looked at the different

automatic pension arrangements which

have been, or are being, adopted in

Canada and the UK. Participants also

provided their insights on the automatic

pension arrangements in their

respective jurisdictions, including the

jurisdictions of Germany, South Africa,

Sweden, and the Netherlands.

Comparisons were drawn between the

different systems and different

voluntary and mandatory systems were

discussed, including opting out, and

automatic escalation of contribution

rates.

Canada

In Canada, pension and employment

matters are regulated by each province,

except in areas of federal competence

(e.g. banking, shipping, and airlines)

where such matters are regulated by

federal pension and employment laws.

This overview focuses on the

applicable federal and Ontario

legislation in the context of automatic

enrolment and automatic escalation,

with a brief discussion on the new

pension legislation passed in Alberta

and British Columbia.

Traditional Federal and Ontario

Pension Standards Legislative

Framework

The federal and Ontario pension

standards legislation are similar with

respect to automatic pension

arrangements. The relevant legislation,

the federal Pension Benefits Standards

Act, 1985 and the Ontario Pension

Benefits Act, does not contain specific

provisions related to automatic pension

arrangements. Employers are,



58

however, permitted to enrol employees

automatically in pension plan

arrangements, as long as it is a

condition of their employment.

However, once enrolled, the matter of

employee contributions often arises.

The federal and Ontario employment

standards legislation contain provisions

that regulate the deductions that can be

taken from an emp o ee’ pa o it i

important for employers to determine

whether it is permissible to make

e ction from an emp o ee’ pa .

New Pooled Registered Pension Plans

(PRPP)

A new pension arrangement in Canada

is the pooled registered pension plan,

under the Pooled Registered Pension

Plans Act (PRPPA). A PRPP is a type

of defined contribution pension plan

that is intended to provide retirement

income for employees and self-

employed individuals who do not have

access to a workplace pension. Unlike

a traditional pension plan, a PRPP is

administered by a financial institution,

and the obligation of the employer is

largely limited to making contributions.

The PRPPA applies only in areas of

federal jurisdiction and each province

will have to pass their own legislation in

order to implement a PRPP-type

arrangement.

Employers are not obliged to participate

in a PRPP arrangement for their

employees. For employers that choose

to participate in a PRPP, subject to

certain exceptions, their employees are

automatically enrolled. An employee

can “opt o t” of the P PP arrangement

by notifying his/her employer within 60

days after receiving a prescribed

notice. The PRPPA specifically

authorizes employers to deduct a

member’ contrib tion to the P PP

from his/her remuneration. The PRPPA

also indicates that the contribution rates

and any increases to those rates are

set by the administrator (not the

employee or the employer), although a

member may set his/her contribution

rate to 0% in certain circumstances, for

a maximum of 5 years at a time. This

suggests that deductions from the pay

of employees for PRPP contributions

under the PRPPA, including automatic

escalations, will be permissible

deductions.

Some Canadian provinces have

introduced PRPP legislation and some

have passed such legislation, although

none is yet in force. All PRPP

legislation to date, except in Quebec,

has provided for optional participation

by employers. In contra t Q ebec’

proposed version of the PRPP is

mandatory for employers in Quebec

who employ 5 or more employees.

New Alberta and British Columbia

Pension Standards Legislation

New pension standards legislation has

been passed in both Alberta and British

Columbia. Both expressly state that a

pension plan may provide that, as part

of the terms and conditions of

employment, the employee (a) must be

a member of the plan or (b) the

employee becomes a member of the

plan if the employee receives a

prescribed notice and does not, within

the prescribed period after receiving

that notice, elect in the prescribed

manner not to be a member. This

explicit recognition pport emp o er ’

ability to enrol their employees

automatically in a pension plan and (a)

mandatorily require their participation

witho t an “opt-o t” option or

(b) provi e them with an “opt-o t”

option.

59

The new legislation does not, however,

to the degree addressed in the PRPPA,

directly address deductions from pay

for contributions to pension plans,

including automatic escalation of

contribution rates. Nevertheless, the

explicit recognition of mandatory

automatic enrolment and automatic

enrolment with an “opt-o t” option

signals a move towards recognizing

automatic enrolment in Canada.

United Kingdom

In the UK, voluntary (or contractual)

auto-enrolment into pension plans has

been operated by a number of

employers for some time. This is

achieved b wa of the worker’

contract of employment, but it sits

alongside a statutory right on the part of

the worker to opt out of membership at

any time.

A more recent development is

statutorily-required auto-enrolment,

which is in the early stages of being

rolled out to all UK employers. As with

voluntary auto-enrolment, workers will

be able to opt out at any time.

Statutory Auto-Enrolment

A system of statutorily-required auto-

enrolment is in the process of being

rolled out in the UK. It started in

October 2012 with the very largest

employers, and will apply to all

employers by February 2018 (in

accor ance with a “ taging ate”

timetable set out in the legislation).

Smaller employers are not exempt. The

auto-enrolment legislation imposes a

number of duties on employers, the key

ones being:

the duty to auto-enrol all eligible

jobholders into a pension plan

which meets minimum standards set

out in the legislation (and to go

through a re-enrolment exercise

broadly every 3 years),

the duty to enrol non-eligible

jobholders on their request into a

pension plan which meets minimum

standards set out in the legislation,

the duty to enrol entitled workers

on their request into a registered

pension plan (but there is no

requirement for the employer to

contribute in this case), and

the duty to maintain a jobholder’s

active membership of a pension plan

which meets minimum standards set

out in the legislation (except where

the jobholder leaves employment, or

otherwise opts of his own volition to

leave the plan).

The different definitions of workers (as

identified above) are set out in the

egi ation. However an “e igib e

jobho er” (i.e. a per on who m t be

auto-enrolled) is a worker who works or

ordinarily works in the UK, is aged at

least 22 and up to state pension age,

and earns more than £9,440 per annum

(based on figures for the 2013/14 tax

year). £9,440 equates to the income tax

threshold for UK (about USD14,440 or

Eu11,200).

Employers must enrol eligible workers

into a pension scheme which meets

certain standards specified in the

legislation. Essentially, this means that

the scheme must be tax-registered and

must also provide a minimum level of

benefits or (in the case of a DC

scheme) contributions.

The auto-enrolment date is the date

that the “e igib e jobho er” fir t meet

the definition. For existing employees,

the date is set out in the legislation, and

depends on the size of the employer.

60

Otherwise, it would be, for example,

when the person starts work, or

reaches age 22. The employer can also

opt to defer auto-enrolment for up to a

maximum of 3 months (and this can be

used, for example, to get around having

to auto-enrol seasonal workers). This

deferment is achieved by giving a

notice containing statutorily-required

information to the relevant jobholder.

Workers who are already active

members of a good quality scheme

when they would otherwise be auto-

enrolled can be left as they are.

However, the same minimum level of

benefits and/or contributions apply as

when the worker is auto-enrolled. It is

the employer (not the worker) who

decides what scheme to nominate as

its auto-enrolment vehicle, subject to

the minimum standards set out in the

legislation.

The scheme can be an occupational

(i.e. trust-based) or a personal (i.e.

contract-based) pension scheme.

Some new master trusts have also

been set up for auto-enrolment

purposes. There is also a Government

run scheme (the National Employment

Saving Tr t or “NEST”) which

employers may use.

It is expected that the majority of

employers will use a DC scheme for

auto-enrolment purposes. For DC

schemes, there is a mandatory

minimum level of contributions. In terms

of charge NEST’ charge are 1.8%

on all contributions paid in and an

annual management charge of 0.3% on

the total value of the retirement pot. It is

expected that a limit on charges will be

introduced for other pension schemes

(the Government is to consult on this).

All employees who are auto-enrolled

will have a statutory right to opt out so

that their membership is cancelled

retroactively from day 1, i.e. as if they

had never become a member on that

occasion. However, the opt-out window

is short (1 month). Members will still be

able to opt out after this, but in such a

case their membership will not be

cancelled retroactively. Employers

cannot opt out.

Employment law protections apply (with

sanctions for breach) in relation to the

new duties. Also, it is a criminal offence

if an employer willfully fails to comply

with the auto-enrolment requirements.

The Pensions Regulator may also

impose penalties, and has enforcement

powers (e.g. the right to enter an

emp o er’ premi e ) if it pect that

there is a breach of the duties.

In the case of personal (i.e. contract-

based) pension plans, EU financial

services legislation (in particular in

relation to the distance marketing of

financial products) requires that the

worker must agree to join the plan –

which obviously cuts across the auto-

enrolment concept. A solution has been

provided in the UK auto-enrolment

legislation, which means that, provided

specified information is given to the

worker, the worker is deemed to have

agreed to be auto-enrolled.

Voluntary Auto-Enrolment

Voluntary auto-enrolment (or enrolment

by contract) has also been around for a

while. This is achieved through the

contract of employment, but the worker

also has a statutory right to opt out of

membership.

Voluntary (or contractual) auto-

enrolment still has its place,

notwithstanding that statutory auto-

enrolment is being introduced. For

example, it may be used as an

61

alternative to statutory auto-enrolment

(if a worker is contractually enrolled into

a scheme of suitable quality before his

auto-enrolment date, then he does not

need to be auto-enrolled). It may also

be used to auto-enrol non-eligible

jobholders and entitled workers, who

would not otherwise be auto-enrolled

under the legislation (i.e. so that the

different categories of worker can be

treated the same, whether or not there

would be a statutory requirement to

auto-enrol them).

The Government is to look into making

changes to the legislation to align

contractual enrolment closer to

statutory enrolment, where employers

have decided to use this in giving effect

to their auto-enrolment duties.

Workshop Participant Comments

In Germany, auto arrangements are

being widely discussed, although very

few plans have been adopted.

Employers can automatically enroll

employees but this is not mandatory.

Automatic enrolment for new hires is

easy, but it is difficult with existing

employees. The only effective way to

automatically enrol is by agreeing with

the Works Council, but the Works

Council cannot agree to reduction in

salary. Employee consent is generally

needed.

Pension funds are mandatory in the

Netherlands, and there is an obligation

in law to participate. Opting out is

possible, but a waiver needs to be

signed and there is a need to ensure

that the employee understands.

Usually, only people with religious

objections object.

South Africa is similar to Canada with

respect to automatic enrolment. In

South Africa, there has been a change

in focus to the preservation of pension

funds.

In Sweden, all employees are covered

by a pension plan, by collective

agreement. Only the employer makes

contributions.

62

Workshop 27

Severance Packages and Golden Parachutes: An Overview of Severance Programs and Internal Revenue Code Section 280g in

the United States

Susan A. Wetzel

Partner

Haynes and Boone, LLP

Dallas, Texas, United States

[email protected]

The following paper is a brief overview of severance programs in the United

States, and Code section 280G of the Internal Revenue Code of 1986, as

amended (the “Code”).


Overview

Employers in the United States are not

required to provide severance to

employees by law. Accordingly,

whether severance is payable to an

employee at the time of his or her

termination of employment often is

subject to negotiation between the

employer and the employee. If

severance is provided, the payment of

the severance is generally contingent

upon the employee agreeing to release

all claims against the employer.

Severance pay programs in the United

States generally can be divided into

three basic categories:

Severance provided by employment

agreements;

Severance provided by a formal

severance pay plan; and

Severance provided through

informal severance pay policies or

arrangements.

Severance in the United States can be

paid in a lump sum payment, or in

installments. Installment payments are

often made as a means of enforcing

pre-existing restrictive covenants (such

as non-competition, non-solicitation and

confidentiality agreements). In these

cases, if the employee violates the

restrictive covenants, the employer

generally includes a provision that

would allow the employer to stop all

severance payments and the employee

would forfeit his or her right to future

severance payments.

Severance pay programs for executives

also often include benefits in addition to

cash severance payments, such as a

continued automobile allowance,


63

continued payment by the employer for

health or other welfare benefits,

acceleration of equity grants (such as

options or restricted stock awards),

continued payment of country club

memberships, and continued coverage

n er emp o er’ in emnit in rance.

Employers sometimes offer some of

these benefits, such as continued

payment for health insurance, to non-

executive employees in connection with

large reductions in workforce (i.e.

layoffs), if the employer otherwise

sponsors a formal severance pay plan,

or in connection with individually

negotiated severance packages.

Severance payments, regardless of

whether they are paid pursuant to a

contract, plan or informal arrangement,

generally are not treated as

“compen ation” for p rpo e of an

emp o er’ q a ifie retirement p an

( ch a the emp o er’ efine

contribution or defined benefit

programs) since these payments are

being pai to a “former emp o ee” an

do not constitute payments relating to

current services being performed. It is

important to note that some qualified

retirement plans do treat accrued salary

or bon e a “compen ation” for

purposes of elective deferrals and

employer contributions, even if these

payments are paid after the date the

employee terminates employment, so

practitioner ho review the p an’

definition of compensation in order to

properly advise employers on whether

these amounts should be included.

When reviewing severance programs in

the United States, practitioners also

must be concerned with, inter alia, (i)

Code section 409A and the final

Treasury Regulations issued

thereunder (the “Final Regulations”);

(ii) the requirements of the Employee

Retirement Income Security Act of

1974 a amen e (“ERISA”); an (iii) if

the severance is being paid in

connection with (or within the one year

period following) a change in control,

with Code sections 280G and 4999.

The following paper provides a brief

overview of each of these three issues.

Code section 409A

In general, any plan or agreement that

provides for payment upon a

“ eparation from ervice” i potentia

subject to compliance with the

requirements of Code section 409A.

However, the Final Regulations provide

that certain types of payments made

pon a “ eparation from ervice” wi

not constitute deferred compensation

and, as such, will not be subject to the

rules of Code section 409A or the

requirements of the Final Regulations.

The following outlines the basic rules

set forth in the Final Regulations

regarding what constitutes a

“ eparation from ervice” a we a

the types of payments that are not

subject to the requirements of Code

section 409A or the Final Regulations.

1. Definition of “Separation from

Service”. A “ eparation from ervice”

is defined in the Final Regulations

specifically by reference to the type

of service provider: employees and

independent contractors (which

would include non-employee

directors). Treas. Reg. §1.409A-1(h).

As a general rule, an employee is

considered to have separated from

service when the employee dies,

retires, or otherwise has a

“termination of emp o ment” with the

employer. Treas. Reg. §1.409A-

1(h)(1)(i). An employee is not

considered to have separated from

service while the employee is on

64

military leave, sick leave or other

bona fide leave of absence if the

period of such leave of absence

does not exceed six months, or, if

longer, so long as the individual

retains the right to reemployment

with the service recipient under an

applicable statute or by contract. For

purposes of the Final Regulations, a

leave of absence constitutes a bona

fide leave of absence only if there is

a reasonable expectation that the

employee will return to perform

services for the employer. If the

period of leave exceeds six months

and the individual does not retain a

right to reemployment under an

applicable statute or by contract, the

employment relationship is deemed

to terminate on the first date

immediately following such six-

month period. Notwithstanding the

foregoing, where a leave of absence

is due to any medically determinable

physical or mental impairment that

can be expected to result in death or

can be expected to last for a

continuous period of not less than

six months, where such impairment

causes the employee to be unable to

perform the duties of his or her

position of employment or any

substantially similar position of

employment, the Final Regulations

permit the parties to substitute a 29-

month period of absence for the six-

month period.

The determination of whether a

“termination of emp o ment” ha

occurred is based upon whether all

of the facts and circumstances

indicate that the employer and the

employee reasonably anticipated

that the employee would not provide

any additional service after a certain

date or that the level of the bona fide

services the employee would

perform after such date (whether as

an employee or as an independent

contractor) would permanently

decrease to no more than 20

percent of the average level of bona

fide services performed (whether as

an employee or an independent

contractor) over the immediately

preceding 36-month period (or the

full period in the event the employee

has been employed for less than 36

months). Treas. Reg. §1.409A-

1(h)(1)(ii). If an employee continues

to be treated as an employee for

other purposes (such as

continuation of salary and

participation in employee benefit

programs), then this fact would lean

in favor of treating the employee as

if no termination of employment

occurred. The Final Regulations set

forth the following presumptions

regarding whether an employee has

incurred a separation from service:

If the level of bona fide services

an employee performs decreases

to a level equal to 20 percent or

less of the services average

performed by the employee

during the immediately preceding

36-month period, then the

employee is presumed to have

separated from service;



to a level equal to 50 percent or

more of the average services



36-month period, then the

employee is presumed not to

have separated from service; and



65

to a level over 20 percent but less

than 50 percent of the services



36-month period, then there is no

presumption and whether the

employee has incurred a

separation from service is based

upon all of the facts and

circumstances.

In the case where the level of

services will be 50 percent or more,

the presumption that the employee

has not separated from service is

rebuttable if the parties can

demonstrate that the employer and

the employee reasonably anticipated

that as of a certain date the level of

bona fide services would be reduced

permanently to a level less than or

equal to 20 percent of the average

level of bona fide services provided


36-month period or full period of

services provided to the employer if

the employee has been employed

for a period of less than 36 months

(or that the level of bona fide

services would not be so reduced).

The Final Regulations also permit

employers to treat another level of

reasonably anticipated permanent

reduction in the level of bona fide

services as a separation from

service, provided that the level of

reduction required is designated in

writing as a specific percentage, and

the reasonably anticipated reduced

level of bona fide services must be

greater than 20 percent but less than

50 percent of the average level of

bona fide services provided in the

immediately preceding 12 months.

The Final Regulations further require

that the plan specify the definition of

separation from service on or before

the date on which a separation from

service is designated as a time of

payment of the applicable amount

deferred, and once designated, any

change to the definition of

separation from service with respect

to such amount deferred will be

subject to the rules regarding

subsequent deferrals and the

acceleration of payments.

2. Exceptions for Certain Payments

Upon Separation from Service. The

Final Regulations provide several

certain exceptions from the

requirements of Code section 409A

for payments made in connection

with a separation from service. The

following highlights some of these

exceptions:

Plans that are collectively

bargained separation pay plans

and only provide for separation

pay upon an involuntary

separation from service or

p r ant to a “win ow program”

(within the meaning of Code

section 409A) are not generally

subject to compliance with Code

section 409A. Treas. Reg.

§1.409A01(b)(9)(ii). It is important

to note that only the portion of the

plan that covers collectively

bargained employees is exempt.

If a plan or agreement provides

for payments solely upon an

involuntary separation from

service (as defined in the Final

Regulations), the plan or

agreement generally will not be

subject to the compliance with the

requirements of Code section

409A and the Final Regulations.

Treas. Reg. §1.409A-1(b)(9)(iii).

In order to qualify for this

exception: (i) the payments made

66

upon a separation from service

(other than amounts paid

pursuant to a foreign separation

plan or certain reimbursements)

must not exceed two times the

lesser of: (1) the sum of the

ervice provi er’ ann a ize

compensation for the taxable year

preceding the year in which the

service provider separates from

service or (2) the dollar amount

under Code section 401(a)(17) for

the taxable year in which the

service provider separates from

service (for 2013, this limit is

$255,000); and (ii) all payments

under the plan or agreement must

be paid no later than the last day

of the second taxable year

following the taxable year in

which the separation from service

occurs (for example, if a

separation from service occurred

in 2013, all payments must be

paid no later than December 31,

2015). Treas. Reg. §1.409A-

1(b)(9)(iii)(A) and (B).


for payments of amounts upon a

separation from service and such

payments are required under the

applicable law of a foreign

jurisdiction, the plan or agreement

generally will not be subject to

compliance with the requirements

of Code section 409A or the Final

Regulations. Treas. Reg.

§1.409A-1(b)(9)(iv). The Final

Regulations provide that a

provision of foreign law shall be

considered only applicable to

foreign earned income (as

defined under Code section

911(b)(1)) without regard to Code

section 911(b)(1)(B)(iv) and

without regard to the requirement

that the income be attributable to

services performed during the

period described in Code section

911(d)(1)(A) or (B) from sources

within the foreign country that

promulgated such law.

If a plan or agreement entitles the

service provider to payment from

the service recipient of amounts

that are not otherwise excludible

from gross income but the service

provider would be otherwise

entitled to deduct the amounts

under either Code section 162 or

Code section 167 as business

expenses incurred in connection

with the performance of services

(without regard to any limitations

on deductions based upon

adjusted gross income), or of

reasonable outplacement

expenses and reasonable moving

expenses actually incurred by the

service provider and directly

re ate to the ervice provi er’

separation from service

(including, without limitation,

reimbursement of all or part of

any loss the service provider

actually incurs due to the sale of

a primary resident in connection

with a separation from service),

then such plan or agreement

generally will not be subject to

compliance with the requirements

of Code section 409A and the

Final Regulations. Treas. Reg.

§1.409A-1(b)(9)(v). Unlike some

of the other exceptions provided

in the Final Regulations, this

exception applies regardless of

whether the separation from

service is voluntary or involuntary.

However, in order to qualify for

this exception, the plan or

agreement must provide that all

67

expenses eligible for

reimbursement must be incurred

no later than the last day of the

second taxable year following the

taxable year in which the

separation from service occurred

and reimbursement of those

expenses must occur no later

than the end of the third taxable

year following the taxable year in


occurred.


for reimbursement of the service

provider of payments of medical

expenses incurred and paid by

the service provider but not

reimbursed by a person other

than the service recipient and

allowable as a deduction under

Code section 213 (with regard to

the requirement in Code section

213(a) that the deduction is

available only to the extent such

expenses exceed 7.5 percent of

adjusted gross income), the plan

or agreement generally will not be

subject to compliance with Code

section 409A or the Final

Regulations, but only to the

extent that such reimbursements

occur within the time period that

the service provider would be

entitled (or would, but for such

plan, be entitled) to continuation

of health coverage under the

Consolidated Omnibus Budget

Reconciliation Act of 1986

(“COBRA”) (i.e. 18 month ) if the

service provider elected such

coverage and paid the applicable

premiums. Treas. Reg. §1.409A-

1(b)(9)(v)(B).

If a plan or agreement entitles the

service provider to certain in-kind

benefits from the service recipient

upon his or her separation from

service, or a payment by the

service recipient directly to the

person providing the goods or

services to the service provider,

then the plan or agreement

generally will not be required to

comply with Code section 409A

or the Final Regulations, so long

as the right would not be treated

as a deferral of compensation

under the exception for

reimbursements or the exception

for medical benefits, as discussed

above. Treas. Reg. §1.409A-

1(b)(9)(v)(C). Further, in order to

qualify for this exception, the

payment of the in-kind benefits

must occur no later than the last

day of the second taxable year

following the taxable year in


occurred.

Even if a payment is not

otherwise excluded under one of

the exceptions set forth in the

Final Regulations, if the plan or

agreement provides for payments

that, in the aggregate, do not

exceed the applicable dollar

amount under Code section

402(g)(1)(B) (for 2007, this dollar

amount is $15,500) for the year of

the separation from service, then

the plan or agreement generally

will not be subject to compliance

with Code section 409A or the

Final Regulations. Treas. Reg.

§1.409A-1(b)(9)(v)(D).


the service provider with the right

to the indemnification (or,

requires the service recipient to

purchase an insurance policy

providing for payments) of all or

part of the expenses incurred or

68

damages paid or payable by a

service provider with respect to a

bona fide claim against the

service provider or service

recipient, including amounts paid

or payable by the service provider

upon the settlement of a bona

fide claim against the service

provider or service recipient,

where such claim is based on

actions or failure to act by the

service provider in his or her

capacity as a service provider of

the service recipient. Treas. Reg.

§1.409A-1(b)(10). In order to


provision must be limited to the

coverage permissible under

applicable law.


for the payment of an amount to a

service provider as a settlement

or award to resolve a bona legal

claim based upon certain

permissible causes of action or

for reimbursements or payments

of reasonable attorneys fees or

other reasonable expenses

incurred by the service provider

related to such bona fide legal

claims, the plan or agreement

generally will not be required to

comply with the requirements of

Code section 409A or the Final


§1.409A-1(b)(11). In order to


claim must be based on wrongful

termination, employment

discrimination, the Fair Labor

Standards Act or worker’

compensation statutes, including

claims under applicable Federal,

state, local, or foreign laws. The

payments will not fail to qualify for

this exception solely because the

settlements, awards, or

reimbursement or payment of

expenses pursuant to such claims

are treated as compensation or

wages for Federal tax purposes.

Moreover, simply because the

service provider must execute a

waiver of any or all of such types

of claims does not necessarily

indicate that the amounts are paid

as an award or settlement of an

actual bona fide claim for

damages under applicable law.

This exception does not apply to

any deferred amounts that did not

arise as a result of an actual bona

fide claim for damages under

applicable law, such as amounts

that would have been deferred or

paid regardless of the existence

of such claim, even if such

amounts are paid or modified as

part of a settlement or award

resolving an actual bona fide

claim.

If a plan or agreement entitles a

service provider to educational

benefits that are taxable, the plan

or agreement is not subject to

Code section 409A or Final


§1.409A-1(b)(12). However, the

benefits must consist solely of

educational assistance benefits

for the education of the service

provider and cannot provide

benefits for the education of any

other person, including, without

limitation, any spouse, child or

other family member of the

service provider.

A plan or agreement will not be

subject to the requirements of

Code section 409A or the Final

Regulations if the payments

made pursuant to the plan or

69

agreement will be actually or

constructively received by the

service provider on or before the

date that is 2½ months following

the later of (A) the service

provi er’ fir t taxab e ear in

which the right to the payment is

no longer subject to a substantial

risk of forfeiture or (B) the end of

the ervice recipient’ fir t taxab e

year in which the right to the

payment is no longer subject to a

substantial risk of forfeiture.

Treas. Reg. §1.409A-1(b)(4)(i).

3. Six-Month De a for “Specifie

Emp o ee ”. If a plan or agreement

is subject to compliance with Code

section 409A and the Final

Regulations, then the plan or

agreement must provide that

i trib tion to a “ pecifie

emp o ee” (a efine b Co e

section 409A and the Final

Regulations) may not be made

before the date that is six months

after the date of the service

provi er’ eparation from ervice

or, if earlier, the date specified

emp o ee’ eath (common

referred to a the “ ix-month delay

r e”). Treas. Reg. §1.409A-

1(c)(3)(v). The six-month delay rule

must be expressly set forth in the

plan or agreement that provides for

the payments.

Severance Pay Programs and ERISA

Many employers have only informal

severance pay policies or

arrangements, and commonly assume

that these policies and arrangements

are not subject to ERISA. Although

informal arrangements typically feature

one-time payments in response to ad

hoc situations, it is not always clear

when the become “emp o ee benefit

p an ” that are bject to E ISA an

employers should not assume that they

are a tomatica exempt from E ISA’

requirements.

Whether a severance arrangement is

informal and not subject to ERISA will

depend on the individual circumstances

surrounding the arrangement and its

communication to affected employees.

In determining whether a severance

arrangement is or is not subject to

ERISA, courts determine whether there

i ome t pe of “ongoing a mini trative

cheme.” A growing n mber of ca e

have grappled with the extent of

ongoing administration and the amount

of employer involvement needed to

create a plan.

It i genera not to the emp o er’

advantage to have its severance

strategy characterized as an informal

arrangement not subject to ERISA. For

example, the beneficiary of such an

arrangement is able to sue in state

court for benefits. This could expose

the employer to larger damage awards

than are available under ERISA.

If a severance plan is subject to ERISA,

it i t pica c a ifie a an “employee

we fare benefit p an.” However, if

severance benefits are contingent

(directly or indirectly) on retirement,

excee o b e the emp o ee’ fina

annual compensation, or are not

completed within 24 months of

termination from service (or, if later,

within 24 months after normal

retirement age if the termination wa “in

connection with a limited program of

termination ”) the arrangement wi be

viewed as a pension plan. Severance

pay eligibility standards that require

attainment of a specific age and/or

substantial service and in practice limit

benefits to senior employees indicate

70

the plan is a retirement rather than a

severance pay plan.

Overview of Code Sections 280G

and 4999

Severance pay programs can be

particularly problematic when paid in

connection with a change of control or

ownership of the employer, if the

employer is a corporation, and the

severance (along with other payments

being made to the employee in

connection with a change of control)

exceeds certain amounts set forth in

Code section 280G so that it is

considered an “exce parach te

pa ment.” Code section 4999 imposes

a 20% excise tax on the recipient of an

“exce parach te pa ment.” Code

section 280G disallows a deduction for

the pa or of ch “exce parach te

pa ment.” The 20% excise tax under

Code section 4999 and the

disallowance of deductions under Code

section 280G only apply if there is an

“exce parach te pa ment ” an there

can only be an excess if there is first a

“parach te pa ment.” Determining

whether a parachute payment exists

depends upon calculation of the

recipient’ “ba e amo nt.” In general

terms, payments and other benefits

provided as a result of a change of

control will not be subject to these

provisions if they do not equal or

excee three time the recipient’ five-

year average compensation.

The phra e “change of contro ” i not

specifically defined in the statute. The

regulations create a presumption that

acquisition of 20% or more of the total

voting power of the corporation by any

person or group will be a change of

effective control of a corporation, and

that replacement of a majority of the

member of a corporation’ boar of

directors (other than directors whose

appointment or election is endorsed by

a majority of the current board) will also

be a change of effective control.

However, this presumption can be

rebutted. Further, these changes must

occur within a 12-month period; if an

individual purchases 10% of the stock

each year for three years, the

presumption would not apply. If a

corporation is owned by its founders,

and as a result of a public offering the

founders retained 60% ownership,

unless any one person or a group of

persons (acting as a group) acquired

20% or more in the offering, no change

of effective control would have

occurred. See Treas. Reg. §1.280G-1,

Q&A-27, -28, and 29.

There are five types of payments that

are exempt from the definition of

“parach te pa ment.” These payments

are not included in the calculation of the

base amount and are not taken into

account in determining the amount of

any excess parachute payments, even

if they would be deemed contingent

upon a change in ownership. These

payments are (i) payments with respect

to a Subchapter S Corporation (see

Section 280G(b)(5) and Treas. Reg. §

1.280G-1, Q&A-6); (ii) payments with

respect to a privately-held company if

certain shareholder vote requirements

are met (see Code section 280G(b)(5)

and Treas. Reg. § 1.280G-1, Q&A-6

and Q&A-7); (iii) payments to or from

certain qualified plans (such as the

Compan ’ 401(k) p an) ( ee Co e

section 280G(b)(5) and Treas. Reg. §

1.280G-1, Q&A-6 and Q&A-8); (iv)

payments with respect to certain tax-

exempt organizations (see Code

section 280G(b)(5) and Treas. Reg. §

1.280G-1, Q&A-6); and (v) payments

that can be e tab i he b “c ear an

71

convincing evi ence” to be rea onab e

compensation for services rendered

(see Code section 280G(b)(5) and

Treas. Reg. § 1.280G-1, Q&A-6 and

Q&A-9). The exemptions set forth in

clauses (ii), (iii) and (v) are discussed in

more detail below.

1. Private Companies with Shareholder

Vote. Payments with respect to a

change in ownership of a private

company if the payment is approved

by 75 percent of the shareholders

entitled to vote immediately before

the change in ownership, after

adequate disclosure to all

shareholders entitled to vote (see

Code section 280G(b)(5) and

Regulations §1.280G-1, Q&A 6 and

Q&A 7). For these purposes,

shareholder approval can be

retroactively obtained. The

shareholder population is the

shareholders of record, as

determined no more than six months

before the date of the change in

ownership or control. However,

shares owned (directly or

constructively) by a person who is to

receive a payment that would be a

parachute payment if shareholder

approval is not obtained are not

eligible to vote (and are not counted

as outstanding for purposes of the

vote).

Regulation §1.280G-1, Q&A 7(c)

provides that in order for the

disclosure to the shareholders to be

a eq ate the “ i c o re m t be

full and truthful disclosure of the

material facts and such additional

information as is necessary to make

the disclosure not materially

misleading at the time the disclosure

i ma e.” The e cription nee to

include a description of the event

triggering the payment(s), the total

amount of the payment(s) that would

be parachute payment(s) if the

shareholder approval requirements

are not satisfied and a brief

description of the payment(s) (e.g.,

accelerated vesting of options,

bonus, or salary). The disclosure

should give information on the effect

of approval or disapproval.

2. Qualified Plans. Payments to or from

(i) a plan qualified under Code

section 401(a) which includes a trust

exempt from tax under Code section

501(a); (ii) an annuity plan described

in Code section 403(a); (iii) a

simplified employee pension plan

(as defined in Code section 408(k));

or (iv) a simple retirement account

(as defined in Code section 408(p))

(see Code section 280G(b)(5) and

Treas. Reg. § 1.280G-1, Q&A-6 and

Q&A-8).

3. Reasonable Compensation. Certain

payments that can be established by

“c ear an convincing evi ence” to

be reasonable compensation for

services rendered on or after the

change in ownership or control (see

Code section 280G(b)(5) and Treas.

Reg. § 1.280G-1, Q&A-6 and Q&A-

9). The regulations issued under

Code section 280G provide that the

relevant factors to the determination

of whether a payment is reasonable

compensation include, but are not

limited to, the following:

The nature of the services

rendered or to be rendered;

The in ivi a ’ hi toric

compensation for performing

such services; and

The compensation of individuals

performing comparable services

in situations where the

72

compensation is not contingent

on a change of control (see

Treas. Reg. § 1.280G-1, Q&A-

40(a)).

Q&A-40(b) of the regulations

provides specifically that payments

in exchange for covenants not to

compete are reasonable

compensation for services to be

rendered on or after the change of

control (accord, IRS Letter Ruling

9314034).

There are two important notes in this

discussion of reasonable

compensation. First, all payments in

connection with a change of control

are presumed unreasonable. The

burden is on the taxpayer to

establish by clear and convincing

evidence that the payments are

reasonable compensation for

services rendered or to be rendered.

A showing that payments are made

under a nondiscriminatory employee

plan or program generally is

considered to be clear and

convincing evidence that the

payments are reasonable

compensation. Treas. Reg. §

1.280G-1, Q&A-41.

Second, there is a distinction

between the treatment of


before the change of control and


on or after the change of control.

The latter category—payments for

services rendered on or after the

change of control (e.g., continued

salary, post-transaction consulting

arrangements, payments for

covenant not to compete)—are not

con i ere “parach te pa ment ”

and thus are excluded from the

determination of whether all

payments in connection with a

change of control exceed the three

times base amount threshold. Code

section 280G(b)(4)(A). However,

payments for services rendered prior

to the change of control (e.g.,

payment of any accrued but unused

vacation or sick days) are

con i ere “parach te pa ment ”

b t are not con i ere “exce

parach te pa ment .” Code section

280G(b)(4)(B). Thus, payments for

services rendered before a change

of control (i) are included for

purposes of determining whether all

payments received in connection

with a change of control exceed the

three times base amount threshold,

but (ii) are exempt from the 20%

excise tax and (iii) may be deducted

by the payor.

Under Code section 280G(b)(2), a

parachute payment is any payment

in the nature of compensation to (or

for the benefit of) a “ i q a ifie

in ivi a ” if (i) the pa ment i

contingent on a change of the

ownership or effective control of the

corporation or in the ownership of a

substantial portion of the assets of

the corporation, and (ii) the

aggregate present value of the

payments in the nature of

compensation which are contingent

on such change equals or exceeds

three time the in ivi a ’ ba e

amount.

A disqualified individual includes any

individual (employee or independent

contractor) who is an officer,

shareholder, or highly-compensated

individual with respect to the

corporation. Code section 280G(c);

Treas. Reg. § 1.280G-1, Q&A-15(a).

Additionally, directors are

considered disqualified individuals if

73

the director is also a shareholder,

officer, or highly-compensated

individual with respect to the

corporation. Treas. Reg. § 1.280G-1,

Q&A-15(b). Please note that an

individual may fall into more than

one category of “ i q a ifie

in ivi a .” If an individual falls into

any one of these categories, he or

she will be a disqualified individual

for purposes of Code section 280G.

Whether a payment is contingent on

a change of control is generally

determine n er a “b t for” te t. To

exclude the payment, it must be

substantially certain, at the time of

the change, that the payment would

have been made whether or not the

change occurred. In Q&A-22 of the

regulations, the Service again

emphasizes that acceleration of

vesting or acceleration of the time

for payment will cause the payment

to be treated as contingent upon the

change, at least to some extent.

Under Q&A-24, the Service explains

that the portion of the payment

treated as contingent is the amount

by which the payment exceeds the

present value of the payment absent

the acceleration. However, if the

payment of deferred compensation

was not vested (for example, it

would have been forfeited had the

executive terminated employment

prior to age 65), the entire amount of

the payment will be included in the

computation if the change results in

substantial vesting.

If a payment is merely accelerated

by a change of control, it will not be

treated as contingent upon the

change of control if the acceleration

does not increase the present value

of the payment. These calculations

are complicated if the payment

which is accelerated would have

been paid without regard to the

change so long as the individual

continued to perform services for a

specified period of time. In that

event, the value of the acceleration

will take into account not only the

value provided to the executive by

earlier payment, but also the value

added by elimination of the risk of

forfeiture for failure to continue to

perform services. If the executive

and the employer are unable to

establish a reasonably ascertainable

value for both of these elements,

then the entire amount of the

accelerated payment will be included

in the computation.

An executive will not be treated as

having received a parachute

payment unless the aggregate

amount of payments received in the

nature of compensation which were

contingent upon the change of

control exceeds three times his base

amount. Base amount is defined as

the executive’ average ann a

compensation payable by his

employer and includible in gross

income ring the “ba e perio ”

which is the five most recent taxable

years ending before the change of

control. Ordinary income with

respect to stock options would be

included, but gains on a sale of

stock acquired with incentive stock

options would ordinarily not be

included; further, benefits provided

under non-taxable welfare benefits

and fringe benefits such as health

plans would not be included. If the

executive has not performed

services for the entire 5 year period,

his total employment period will be

included with compensation for any

partial year being annualized. Also,

74

benefits provided to an executive

which have not yet become taxable,

such as unexercised stock options

or deferred compensation, will have

a direct impact on this calculation. If

an executive earns $500,000 a year,

and he exercised stock options in

the year prior to the change of

control resulting in additional

compensation income of

$1,000,000, that exec tive’ ba e

amount will be increased by

$200,000 (assuming he has worked

for the corporation for at least five

years).

Loss of deductibility and application

of the excise tax only apply to the

excess parachute payment. Once it

has been determined that there is a

parachute payment (that the

payment is contingent on change of

control exceed three times the base

amount), the excess of such

contingent payments over one times

the base amount will be considered

the “exce parach te pa ment” to

which the excise tax and loss of

deduction apply. In other words,

going one dollar over the three times

base amount threshold results in the

entire amount of the contingent

payments, reduced only by one

times the base amount, being

subject to these tax provisions.

Volume 80 – May 2014

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