What every scheme / section needs to know and decide on

Introduction
Validation process
Accounts to support s143
Information gathering
Accounting policy issues
Accounts during assessment
Examples
Closing accounts
Reconsideration accounts
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Introduction

Of course the insolvency of the sponsoring employer and the entry of a scheme into a PPF assessment period may have significant effects on the pension scheme, but it doesn’t mean that schemes in a PPF assessment period are exempt from any of the legislation and regulations governing pension schemes.  In the context of accounting and auditing, this means that trustees remain responsible for maintaining proper books and records, for obtaining audited accounts and for making available to scheme members an annual report.  Scheme advisers and others (including accountants, auditors and actuaries) are still required to report breaches of the law (such as the failure to obtain audited accounts) in compliance with the Pension Regulator’s codes of practice.  The code of practice on reporting breaches of the law requires the reporter to consider whether the breach is of material significance to the Regulator.

We would like to remind you however of the flexibility built into current regulations, for example to change a scheme’s accounting reference date, for legitimate purposes, provided the accounting period is not less than 6 and not more than 18 months long.  Any change in ARD should normally be agreed by the trustees before the ARD has lapsed; but, in the unpredictable circumstances of employer insolvency, retrospective changes of ARD would be very unlikely to be a breach of material significance to the Regulator.  Similarly, preparing statutory accounts for periods marginally in excess of 18 months are unlikely to be of material significance to the Regulator, particularly if the PPF has accepted that this course of action does not increase the risk to members’ benefits or to the PPF itself.  Reporters must of course consider each case on its own merits in the context of the Regulator’s Code on Reporting breaches of the law.

Validation process

The process of validating that an employer has experienced a qualifying insolvency event, and that the scheme is an eligible scheme for PPF compensation purposes, is not necessarily a quick and straightforward one.  However, once the validation process is complete and the PPF confirms the scheme has entered an assessment period, the date at which the assessment period begins is fixed as the date of the qualifying insolvency event.

Accounts to support s143

The single most important product of the assessment period is an actuarial valuation which assesses the ability of the scheme to pay benefits at a level at least as good as PPF compensation, measured as at the date of the insolvency of the employer.  If the scheme is able to pay benefits at this level, the scheme will exit the assessment period, for example, to proceed to buy out in the insurance market.  If the scheme is not able to pay benefits at this level, it will proceed to transfer its assets and liabilities to the PPF and wind up.  This process is set out in the Pensions Act 2004, beginning at section 143; the actuarial valuation prepared under this process is therefore known as an s143 valuation.  In common with formal actuarial valuations prepared for all kinds of statutory and other purposes, the assets taken into the s143 valuation must be taken from audited scheme accounts at the relevant date.  The Pensions Act defines this relevant date as the day before the occurrence of the insolvency event.  All schemes entering a PPF assessment period will therefore need to prepare a full set of audited financial statements as at close of business on the day before the insolvency event.

Information gathering

One practical difficulty arising from the validation process, and the confirmation of a scheme’s entry into a PPF assessment period, is that it may be some weeks or even months after the insolvency date that the need for accounts as at the day before that event is confirmed.  We therefore recommend that trustees and scheme accountants make every effort to obtain relevant information as soon as possible after the insolvency has occurred, particularly investment portfolio valuations, bank statements and similar documents.  Experience shows that delaying these actions until the validation process has been completed can lead to the information not being available at all, or only at significant additional effort and cost.   For example, it is usual for investment managers’ systems to be geared to produce valuations only at month or even quarter ends.  Statistically, few insolvencies will occur conveniently at month end, so the investment manager will inevitably have to produce a special valuation report for the scheme at the relevant mid-month date.  The sooner the scheme accountant requests this special valuation, the more likely it is that the investment manager will be able easily to comply.

Accounting policy issues

•  The insolvency of the sponsoring employer and the entry into a PPF assessment period will almost certainly have an impact on a scheme’s accounting policies, as the scheme is likely to be viewed as no longer a “going concern” and likely to be wound up within the foreseeable future.  This is likely to impact the scheme’s policies for:
• The valuation of investments and other assets in the context of their likely realisation in the foreseeable future. The Statement of Recommended Practice “Financial Reports of Pension Schemes”, paragraphs 2.86 to 2.94 covers these issues in some detail.
• Unpaid contributions and other amounts receivable from the employer – the recoverability of these amounts may need to be considered in the light of the insolvency of the employer which may constitute an adjusting post-balance sheet event.
• Scheme running expenses – the scheme’s employer may up to the point of insolvency have paid the scheme’s running expenses such as trustee and adviser fees, administration, accounting and audit fees, etc.  These expenses are likely to fall to the scheme to pay from its own resources, and this change of policy will need to be explained.
• Debt on the employer, contingent assets and related issues – the insolvency of the employer will trigger a number of specific insolvency related issues, which will need to be considered for accounts prepared during the assessment period.  These issues may not impact the accounts prepared for assessment purposes, as the relevant date for these accounts is the day before the insolvency event, and the considerations only arise on or after the insolvency date.  Post balance sheet event disclosures will of course need to be thought through, however.  For example, the PPF and the trustees may lodge a claim under section 75 of the Pensions Act 1995 for the full value of any debt on the employer under that legislation.  The trustees will need to consider the fair value of the amount recoverable under that claim.  As part of the negotiations around a s75 debt claim, the PPF and the trustees may agree to take an equity stake in a reconstructed or “phoenix” company arising out of the insolvent employer’s business.  The trustees will similarly need to consider the fair value of this equity stake (see SORP para 2.88).  The employer (when solvent) may have entered into contingent asset arrangements with the trustees, or other group or parent companies may have given guarantees to the scheme in the event of the insolvency of the participating employer.  These arrangements and agreements may have been disclosed as “contingent assets” in previous scheme accounts, but the occurrence of the trigger event (the insolvency of the employer) will require the trustees to consider whether conditional rights to contingent assets crystallise requiring valuation and inclusion in the financial statements.

Accounts during assessment

As we have already pointed out, the obligation on the trustees to obtain audited accounts and make available an annual report persists throughout the assessment period, and the PPF and the scheme trustees have a common interest in maintaining audit scrutiny over the transactions of the scheme during the assessment period and in gaining independent assurance over the existence and value of the scheme’s scarce resources which may end up being transferred to the PPF.

But we do encourage trustees to take full advantage of the flexibility in existing regulations to design an accounts and audit plan that minimises the number of sets of accounts to be prepared whilst ensuring continuity of audit scrutiny (“no gaps”) and eliminating avoidable duplication (“no overlaps”).

EXAMPLES

Scenario 1

Scheme ARD 31 March , last accounts to 31 March 2xx1 have been fully signed off; employer insolvency event 15 May 2xx2.  Some planning and preparatory work on accounts to 31 March 2xx2 done, but no substantive work yet undertaken.

Solution:  extend statutory accounting period to 14 May 2xx2 (13½ months) and prepare annual report and full set of financial statements to that date.  Advise all scheme advisers and TPR of this retrospective change of ARD.  Amend the next accounting period to the next 31 March 2xx3 (10½ months) as ARD for the next annual report; or, amend to the future date of the PPF transfer (if transfer plans are definite) and within an eighteen month period (plus consider requesting a TPR easement where the transfer period slightly exceeds eighteen months).

Scenario 2

Scheme ARD 31 March, employer insolvency event 15 September 2xx1.  31 March 2xx1 annual report has been prepared, accounts audited, awaiting final sign off by trustees and auditors.

Solution: sign off the 31 March 2xx1 accounts that have been audited – there’s no point throwing them away and starting again.  Prepare accounts to 14 September 2xx1.  The period 1 April to 14 September is less than 6 months so these accounts cannot be used as statutory accounts to meet the Audited Accounts Regulation 1996 S.I.1975.  They will be special purpose accounts solely to meet the requirements of s143 of PA04, so do not require a trustees’ report and other accompanying narrative disclosures.  Decide on future ARDs in the context of PPF transfer plans including the preparation of closing accounts.

Scenario 3

Scheme ARD 31 March, 31 March 2xx1 annual report has been fully signed off and summary sent to scheme membership; employer insolvency event 15 January 2xx2.

Solution:  shorten statutory accounting period to 14 January 2xx2 (9½ months) and prepare annual report and full set of financial statements to that date.  Advise all scheme advisers and TPR of this retrospective change of ARD.  Extend the next accounting period to 14½ months to 31 March 2xx3: or, extend to the future date of the PPF transfer (if transfer plans are definite) and within an eighteen month period (plus consider requesting a TPR easement where the transfer period slightly exceeds eighteen months).

Closing accounts

We recognise that it is considered best practice, according to paragraph 2.94 of the 2007 SORP, when a scheme completes wind-up, for trustees to prepare a set of closing accounts, in order to gain audit assurance that all of the scheme’s liabilities have been discharged and all of the scheme’s assets disposed of (for example, transferred to an insurer).  The transfer of scheme assets and liabilities to PPF is similar to this wind-up process; however there are a number of important differences which mean that the costs of this additional set of accounts will rarely be justified.  A flowchart can be found on the following page, which sets out the questions the PPF will ask when deciding whether to insist on closing accounts being prepared. A more cost effective alternative to providing assurance to the Trustee and the PPF has been introduced in the form of the Completion Statement.  A Trustee can access the information needed to complete a Completion Statement from the scheme records and cash book.  A worked example can be found here.

Reconsideration accounts

Even if a s143 valuation establishes that a scheme is able to pay benefits at least equal to PPF compensation levels, it is conceivable that the scheme may not succeed in buying out at above PPF levels in the insurance market.  In these circumstances, because PPF compensation represents the best outcome for scheme members, the trustees can apply to the PPF for the scheme to be re-considered for entry to the PPF under s151 of the Pensions Act 2004.  This application must be made within 6 months of the original s143 valuation becoming binding. An essential document supporting this application for re-consideration is a set of audited accounts for a period ending with a date which falls within the prescribed 6 month period.  These accounts will usually be a special purpose set of accounts so do not require a trustees’ report and other accompanying narrative disclosures.  However, they are required to be a full set of financial statements, including a fund account from the end of the previous accounting period, a net asset statement and accompanying notes.

Next page: Sectionalised Schemes and Associated Issues