Bermuda: Trusts in an Employment Context
When one thinks of trusts, one tends to think of the private family trusts which enable wealthy families to manage the transfer of their assets efficiently down the generations. Yet in fact some of the largest trusts in the world are found in the employment context and many ordinary workers will be beneficiaries of colossal trusts. For example, the Universities Superannuation Scheme in the UK had around £75 billion of assets under management as at 31st March 2023 – more than the GDP of some countries.
There are two main types of pension schemes – defined benefit schemes and defined contribution schemes. Defined benefit schemes promise to provide a certain level of benefits for each year of retirement (usually calculated by reference to final pensionable salary and taking into account inflation in some way). As the cost of providing these benefits cannot be known in advance − not least because individual life expectancy cannot be predicted all that can be done is to estimate the cost of providing these benefits using actuarial assumptions and the trustees of such plans need to maintain a pot of investments to meet the estimated liabilities when they fall due.
As a result of the inherent uncertainties involved in predicting the asset performance and liabilities of such trusts over time, they can fall into ‘deficit’. In the UK, some schemes have had deficits bigger than the companies sponsoring them in the past – catastrophic deficits which have brought down businesses. It has however been a good few years for pension schemes (due to various factors such as the increase in bond yields and high inflation) and the combined deficit of schemes in deficit positions has now reduced to around £28 billion, which is vastly lower than in the past, with many schemes now in surplus.
Buyers of companies with defined benefit pension schemes still need to be careful as the funding position of such schemes is hard to predict – the invention of statins was disastrous for the funding of many pension trusts because of the impact they had on life expectancy, new drugs such as Ozempic and the new immunological cancer treatments may also impact the funding of pension trusts as their potential impact on mortality feeds into actuarial tables.
The funding position of such trusts is also heavily affected by changes in stock market performance, inflation, interest rates and bond yields. Hence, one could buy a company with a scheme in surplus but find oneself with billions of pounds of liabilities to fund in the event of an unforeseen medical advance or stock market crash. Robust due diligence (and appropriate warranties and indemnities in the sale agreement) is essential when acquiring any company with legacy defined benefit liabilities.
The other side of the coin is that sometimes employers have a right to large surpluses in pension schemes, so buying companies with a view to ‘buying out’ their pension liabilities with an insurer – and then pocketing surplus in the pension scheme (which may also run into billions) – is sometimes an investment opportunity.
In the UK there is a large insurance buy-out industry which specialises in assuming pensions liabilities for a one-off price.
This business is subject to tough solvency rules set by the Prudential Regulation Authority (PRA). In a recent speech Charlotte Gerken, executive director of insurance supervision at the PRA, noted that buying out ‘jumbo schemes’ presented exciting opportunities for insurers, noting that the UK life insurance industry could onboard more than £500 billion of pension liabilities over the next 10 years. She did however caution against insurers “expanding their risk appetite, sometimes outside their current core expertise.” Insurers buying out pension schemes are required to manage interest rate and inflation risks which could cause issues for financial markets. “Insurers… need to understand, as they take on these vast sums of assets and liabilities, how they may become greater sources or amplifiers of liquidity risk.” Nonetheless, there are significant opportunities in this market.
In Bermuda − as in the UK − defined benefit plans tend to be closed to new members and future accrual. Pensions are now usually provided for by means of defined contribution plans. Such schemes do not promise a set level of benefits on retirement – merely whatever can be purchased from the pot of funds built up at the time – so defined contribution schemes cannot fall into deficit, with risks such as mortality and investment performance falling solely on the employees. Whether some kind of defined benefit schemes will ever come back into favour to attract top talent remains to be seen.
Another trust which is often encountered in the workplace context is the employee benefit or share scheme trust. Such arrangements are commonly structured such that shares in the employer (or a related company) are held for the benefit of certain employees for a defined period of time (e.g. five or 10 years. If the employee remains employed at the end of that time, the shares vest in them. If they die, their families commonly receive the shares. On the other hand, if they leave the company, their entitlements to the shares will lapse. Such
schemes therefore encourage employee retention. Because the assets held are commonly company shares, they also provide a strong incentive for employees to work hard to further the success of the company.
Employee benefit schemes are fairly simple to establish, will generally be safeguarded by trustees who will hold legal title to the shares (or other assets) until they vest and can provide an important element of remuneration packages.
Care needs to be taken in the design of any work-based trust. In the UK, many employers ran into problems because they linked the age at which benefits could be drawn from occupational pension trusts to state pension age – which itself discriminated on the grounds of sex (women being, for many years, permitted to draw state pensions before men) – this was subsequently challenged in the courts. This stresses that one needs to bear in mind employment law in the design of any workplace arrangements.
Contract law also comes into play and employers should be careful when drafting employment contracts and employee handbooks which summarise the provisions of pension schemes or share schemes, as it should be clear that the governing terms of the pension or share scheme prevail and that such schemes can be amended or withdrawn. In that vein, to oversimplify, the general position is that amendments to such arrangements are possible as long as they do not affect benefits which have accrued up to the date of the amendment – but the power of amendment for the arrangement in question should always be checked, as well as any overriding legislation and contractual restrictions.
With the proper advice and careful drafting, workplace trusts can play an important role, encouraging employees to be loyal to their employer, giving them a financial interest in its performance and taking care of them in their retirement. There are lots of opportunities − and risks − in this market, including in the M&A context, for insurers and for those seeking to attract and retain talent.
First Published In the Bermuda Business Review 2024-2025 – July 2024
