Insolvency of benefit scheme and creditors

[ST6_aspirant]

Hi, this is regarding Q7 (i), Paper 2, September 2014. The question in a nutshell for the purpose of my question is:

"A DB scheme is being wound up following insolvency of sponsor company. Scheme was in surplus at the time of the insolvency. What are the issues and choices to be considered by scheme's trustees?"

One of the points in the solution is - the surplus may need to be refunded to the insolvent sponsor or its creditors.

My question is - isn't the surplus of the scheme calculated after the creditors have been accounted for / paid off? In which case the point becomes redundant. Just trying to understand this so as not to lose the half a mark for a simple point like this.

 

[Lindsay Smitherman]

Hi - it sounds like you might be confusing the creditors of the pension scheme with the creditors of the company?

Bear in mind that the assets of the pension scheme are held separately from those of the company. This means that if a company becomes insolvent, then the assets of the pension scheme are protected from being taken by the creditors and shareholders of the company, hence protecting the accrued rights of the pension scheme members (to the extent to which these are adequately funded). Only if there is any surplus remaining in the pension scheme at the point at which it is wound up could there be a potential for it to be accessible by the company (or its creditors).

 

[ST6_aspirant]

Thank you! I see why i was confused now. The surplus is returned to the creditors of the company, which is different from the creditors of the scheme.

Your solution brings me to new questions - what is the difference between funding and solvency of a scheme? Suppose a scheme was unfunded, could it be declared insolvent? In that case, how will the company secure the rights of the members? My guess would be use its own assets, don't pay the company's creditors - (depending on some ranking specified in the company schedule?) pay the members the due benefits - rather fund the scheme which was unfunded and thus bordering or already insolvent, which brings me to the first question again. Thank you.

 

[Lindsay Smitherman]

Where a company becomes insolvent and the scheme is not fully funded at that point (i.e. there is a deficit of assets relative to the accrued pension liabilities - as would be the case for a totally unfunded scheme), whether the pension scheme receives any additional assets depends on the legislation within that country. As mentioned in Chapter 34, there may be a debt placed on the sponsor in relation to some (or all) of the shortfall - and this could rank above, alongside or below that of other parties, depending on various factors including the jurisdiction in which the scheme operated.

In practice, it can be difficult for a pension scheme with a deficit to obtain any further assets on insolvency of the sponsor, so benefits have to be reduced. This is why members would tend to prefer a funding method which accumulates assets in advance, e.g. advance lump sum, or regular contributions. The just-in-time method is also designed to avoid the issues mentioned here.

Unfunded pension schemes tend to have the government or State as the sponsor (not a corporation), so it is very unlikely that the sponsor would become insolvent. If the government gets into financial difficulties, they would likely start by reducing the amount of pensions payable - for example, as happened in Greece.

 

[Lindsay Smitherman]

what is the difference between funding and solvency of a scheme?

And just to pick up on this specific question: "funding" is more widely about how the funds are made available for the payment of scheme benefits. As mentioned in Chapter 48, the phrase "funding position" is equivalent to "solvency" in relation to a benefit scheme.

 

[ST6_aspirant]

Understood, thank you!