Background
Accounting issues
Periods between insolvency events
Audit issues
Allocation of scheme liabilities and scheme assets
Timing of the allocation process and accounts preparation
Audit of the allocation process
Statement of trustees’ responsibilities
Audit opinion
“Closing” accounts for sectionalised schemes
Closing accounts flowchart

Background

The majority of pension schemes in the UK are sponsored by more than one employer, typically by a number of related companies in a group, with the group holding company acting as Principal Employer.  These group structures do not remain static; group restructurings, mergers, acquisitions and disposals of employers may result in the scheme having members (usually deferred or pensioner members) who have had no employment relationship with any entity currently participating in the scheme.  In some arrangements, the companies act in a sense as guarantors for each other so that the insolvency of one single employer leads to the other employers picking up that employer’s liabilities, commonly known as “last man standing” arrangements.  In other cases, the withdrawal of an employer leads (either mandatorily or at the discretion of the trustees) to a partial winding up of the scheme.

When one or more employers participating in such a group scheme experiences an insolvency event, the Multi-Employer Regulations apply to govern the situation.  Put at its simplest, these regulations take effect to create a separate section of the scheme for the insolvent employer into which the members associated with that employer can be allocated.  The liabilities for these members can then be valued, and a proportion of the scheme’s assets also allocated to the section, so that the funding level of that section can be assessed.  If that section cannot afford to pay benefits at least equal to PPF benefits, then that section and that section alone will transfer into the PPF.  What happens to the rest of the scheme depends on the situation of the remaining employers; if they remain solvent, the rest of the scheme will continue outside of the PPF as a normal ongoing scheme.  If any of the remaining employers go on to experience an insolvency event (whether at the same or a later date), another section of the scheme will be created for members associated with that employer, whose funding level will be separately assessed, while the rest of the scheme continues as a normal ongoing scheme.

Even if all the employers participating in a scheme experience an insolvency event at the same date or within a very short period of time, the regulations still apply to break the scheme up into separate sections which will be individually assessed.  Certain tasks may be dealt with on a scheme wide basis for the sake of economy and efficiency (such as eventual transition of scheme assets to the PPF) but each section remains a separate entity assessed for PPF entry in its own right.

Accounting issues

The interaction of the Multi-employer regulations with the requirement to produce an actuarial valuation at the relevant date (the day before the insolvency event), supported by audited accounts, can lead to significant complications.  It is crucial that trustees, their administrators, accountants and auditors, liaise closely with other scheme advisers and their PPF Caseworker to understand the impact on their scheme.  Early engagement on planning and preparation of required actuarial valuations and accounts is vital, but plans must remain flexible to incorporate new events in fast-moving situations (e.g. further insolvencies of group employers).  Information gathering (see paragraph n above) will be especially important.

This area of regulation may be especially difficult, but the PPF’s objective remains the same; to assist trustees to comply with relevant laws and regulations but to minimise the costs of compliance.  For example: where a number of employers participating in a scheme experience insolvency events at the same date or within a short period, we encourage trustees and their advisers to consider delivering the required accounting or actuarial information in one consolidated document for all sections.  Provided the crucial information (such as the audited net asset value for each section) is readily identifiable, producing one document should save on preparation, review and production costs.

Periods between insolvency events

The periods between the multiple insolvency events of group scheme employers are in effect separate accounting periods for the scheme and the allocation of financial transactions and balances during and at the end of these periods needs careful thought.  As an illustration;

Scheme S has a normal ARD of 31 March; Employer A becomes insolvent on 1 July, Employer B on 1 August, employers C, D and E remain solvent.  Regardless of whether this is presented in one or more documents, the financial statements will be required to show:

1. A fund account for Scheme S (as a single entity) for the period 1 April to 30 June;
2. A net asset statement for Scheme S (as a single entity) as at 30 June;
3. An allocation of the net assets of the scheme over Section A (associated with Employer A) and the rest of Scheme S as at 30 June;
4. Fund accounts for Section A and for the rest of Scheme S, with totals to show the total of the trustees’ transactions, for the period 1 July to 31 July;
5. a net asset statement showing the net assets of Section A as at 31 July and the allocation of the net assets of the rest of Scheme S over Section B (associated with Employer B) and the rest of the rest of Scheme S, with totals to show the total net assets for which the trustees are responsible.

Financial transactions should be allocated to scheme sections as far as is practicable on an actual basis.  For example:

• Benefit payments should be allocated to the fund account of the section into which the member is allocated.
• Contributions (or, more likely in an insolvency, recoveries from the Redundancy Fund) should be allocated to the section into which the member in respect of whom the claim has been made has been allocated.
• Scheme wide income or expenditure (such as advisory fees) may have to be allocated over sections on an agreed basis (such as proportion of member liabilities)
• Debt on the employer and related issues: We would like to point out that, until a scheme section has transferred into the PPF, it still exists as part of the scheme as a whole for the purposes of section 75 debt regulations.  Any dividends payable out of the insolvency of any employer in any form (cash, equity etc.) will therefore benefit all sections of the scheme.  These assets would usually be allocated to each section in proportion to their actuarial liabilities as at the date the debt arose, subject of course to any particular requirements of the scheme rules.

Trustees are encouraged to consider whether running the scheme’s investment portfolio as if it were a Common Investment Fund might be the simplest solution to the allocation of investment activities and balances.  In such an arrangement, the portfolio would be notionally unitised and each section allocated a number of units in the CIF at a standard notional price.  This would apply particularly to schemes which are directly invested in a variety of stocks and shares, with complex record keeping requirements for purchases, sales, dividend receipts, tax reclaims, trading costs etc.  Under a CIF arrangement, these transactions would not have to be allocated to the scheme’s sections; the CIF would account for them in detail, but their impact would be to vary the current unit price used to value each section’s share of the total portfolio.  Cash flows in or out of the portfolio (investing contributions, disinvesting to fund benefit payments and expenses, and so on) would be treated as the purchase or sale of units on behalf of the relevant sections at the prevailing unit price.

Trustees are similarly encouraged to consider whether opening separate bank accounts may be advisable – additional bank charges may be incurred, but the separation may make the preparation and audit of sectionalised accounts more straightforward and more cost-effective.

Audit issues

Many issues surrounding the audit of sectionalised accounts will be familiar to accountants and auditors who deal with accounts for schemes with multiple benefit structures (see SORP and PN15).  These schemes (usually with DB and DC benefit structures in the same trust) present similar challenges about ensuring the segregation (or proper allocation) of transactions and balances over sections for which separate accounting is required.

Also relevant will be accounting and audit experience of, for example, industry wide schemes which operate on a sectionalised basis as part of their normal method of operation, participating in Common Investment Fund arrangements, maintaining segregated accounting records (for non-investment activities), segregated actuarial valuations etc as a matter of course.

Some issues are peculiar to sectionalised schemes in a PPF assessment period, however, and these are discussed below.

Allocation of scheme liabilities and scheme assets

The trustees of the scheme are responsible for the allocation of scheme liabilities and scheme assets over the scheme sections created by the insolvency of one or more employers, and they will have to take into account

• the requirements if any of their own trust deed and rules;
• the requirements of the relevant PPF regulations;
• the recommendations of the scheme actuary;
• any specific directions issued by the PPF

when carrying out this piece of work.  In addition to the Data Audit work that all schemes in assessment will need to carry out, the allocation work will involve the actuary (working with scheme administrators) in:

• establishing the employer (or, the last group employer) who employed the member;
• establishing how to deal with “orphan” members whose only employment relationship was with employers who no longer participate in the scheme;
• valuing the liabilities of all members and allocating the total scheme liabilities into the sections created by the insolvency of one or more employers;
• recommending to the trustees the allocation of scheme net assets, usually in the same ratio as the allocation of scheme liabilities.

Timing of the allocation process and accounts preparation

The work involved in allocating scheme liabilities across sections, and the subsequent allocation of scheme assets, may be significant and time-consuming.  Trustees may therefore find themselves caught in the dilemma of wishing to use accounts at the assessment date as their statutory accounts, but not having allocation information available to produce sectionalised accounts in time to meet statutory deadlines.

In these circumstances, trustees may wish to consider completing statutory accounts for the scheme as a single entity, at the assessment date and within statutory deadlines.  Once allocation information is available, trustees may then prepare a sectionalised net asset statement, allocating the scheme’s net assets over the sections.  The trustees need to make it absolutely clear that this special-purpose net asset statement is derived from a full set of audited accounts, for example by quoting the date the accounts were signed by the trustees and auditors.  The PPF would in principle be content to accept these two documents in combination (un-sectionalised full accounts, sectionalised net asset statement as at the same date but signed off at a later date) as “relevant accounts” to support the s143 valuation.

Audit of the allocation process

We would like to emphasise that the results of the allocation process (in terms of the sectionalisation of scheme assets), and therefore the allocation process itself, are clearly within the scope of the audit of sectionalised accounts.  Trustees and auditors need to be absolutely clear about the requirements for audited accounts of scheme sections and the implications when agreeing the scope and other terms of engagement for such audit assignments.

As with any assignment, the auditor would carry out a risk assessment to establish areas of audit emphasis and to allocate audit resource.  In the case of sectionalised accounts, the PPF expects this assessment to be carried out in the context of the decisions which will be made based on the entry valuation and the supporting audited accounts.  From a PPF perspective the decision is of course whether to allow entry to individual sections into the PPF, and therefore the risk is that individual sections may be wrongly allowed or refused entry to the PPF.  This risk is highest where there are solvent employers supporting sections of the scheme which will continue on outside of the PPF, or where funding levels are very close to meeting PPF liabilities, and errors in the allocation of liabilities may push sections above or below the PPF entry level.  Where all sections are in PPF assessment, and funding levels are so far below PPF funding levels that the risk of the PPF making a wrong entry decision is very low indeed, the auditor would plan the audit work accordingly.

The PPF expects auditors to have regard to ISA620 “Using the Work of an Expert” in determining the approach to be taken when reporting on sectionalised accounts.  Therefore, the auditor has to obtain sufficient appropriate evidence that the actuary’s work is adequate for the purposes of the audit report (620.2).  To this end, the auditor should assess the professional qualifications, experience and resources of the actuary (620.8-1), and check that the scope of the actuary’s work is adequate for the audit (620.11).  (TECH 02/08 contains some practical guidance on auditors’ and actuaries’ inter-professional communication, which covers these points).

Also relevant is ISA315 “Obtaining an understanding of the entity and its environment and assessing the risks of material misstatement”, particularly paragraphs 100 to 119.  We suggest that this auditing standard might lead auditors to consider whether:

• to review the quality control processes the actuary has used to check the accuracy of the data, and validate that it is consistent with the membership data that the auditors have seen in other contexts;
• to review the reasonableness of any assumptions the actuary has had to make in order to fill gaps in the data;
• to test whether the actuaries have disclosed in their report or elsewhere any reservations or qualifications on the completeness and accuracy the data which may have a material impact on the outcome of the sectionalisation.

It goes without saying that the PPF does not expect auditors to replicate or carry out detailed checks on the actuarial calculations themselves; but we do suggest that auditors review the valuation results in the light of their knowledge of the scheme, its history and development, and the development of the group of employers participating in the scheme.  We suggest that auditors satisfy themselves with the reasonableness of any assumptions used by the actuary, particularly the justification for using different assumptions for different sections (for example, regional or industry-sector specific assumptions on longevity).

Statement of trustees’ responsibilities

We consider it likely that the Statement of Trustees’ Responsibilities will have to be expanded to recognise explicitly the additional responsibilities of the trustees for the creation of scheme sections and obtaining financial statements accounting for the sectionalisation of the scheme.  We recognise that the exact wording of the Statement is a matter for the trustees and their auditors, but we can provide samples of previously used wording that all parties have found acceptable.

Audit opinion

In addition to the expected “true and fair” opinion on the transactions and balances of the scheme as a whole, we expect that auditors will express an opinion about the sectionalisation of the net assets of the scheme in the first accounts where sectionalisation is applied.  The opinion would be in terms of:

• It being performed in accordance with the Trust Deed and Rules (or that the Trust Deed and Rules are silent on the matter);
• It being consistent with the Scheme Actuary’s calculation of the allocation of scheme liabilities between the sections;
• It being performed in accordance with any directions issued by the PPF.

We recognise that the exact wording of the opinion is a matter for the auditors and their clients, reflecting the individual circumstances of the scheme, in particular whether there are ongoing sections of the scheme which are not in a PPF assessment period.  However, we can provide samples of previously used wording that all parties have found acceptable.

For subsequent sets of accounts, for example statutory accounts prepared during the assessment period, where the sectionalised presentation is maintained, we expect the audit opinion to refer not to the creation of scheme sections but to their maintenance and the allocation of transactions across the different sections

“Closing” accounts for sectionalised schemes

You will see from the “Closing accounts flowchart” (below) that the PPF is likely to insist on scheme accounts being prepared in every case where a section of the scheme in question is continuing outside of the PPF after the section in assessment has completed the process of transferring into the PPF.  The Accounting Reference Date for this set of accounts will normally be the effective date of the s160 Transfer Notice, and will show the value of net assets transferred or transferable to the PPF.  We view this as easily the most effective way of gaining assurance that the trustees of the ongoing section have retained their due share of the net assets of the scheme to fund its continuing existence outside of the PPF.  The PPF and its auditors also gain the required assurance that the scheme has transferred over our proper share of the scheme’s net assets.

Closing accounts flowchart