While a defined benefit occupational pension scheme is ongoing, it must meet a statutory funding test called the minimum funding requirement (MFR). This is broadly calculated on the basis of the cash value of members' benefits in the scheme. However, if a scheme goes into winding-up (from 11 June 2003), and the employer remains solvent, the employer has to meet the full buy-out cost of members' benefits, that is, the cost of securing them through annuities with an insurance company (section 75, Pensions Act 1995).

If an employer leaves a pension scheme while it is ongoing (for example, because of a share sale), and the scheme is in deficit on the MFR basis, this triggers a debt due from the departing employer. The employer is liable to pay its share of the MFR debt, calculated by reference to the benefits accrued by its employees in the scheme (unless the scheme rules provide otherwise).

If there is no MFR debt, then there will be no debt for the departing employer to pay.

The government is changing the basis for calculating the debt due from a departing employer from MFR to buy-out (as if the scheme was being wound-up). This will need to be calculated by the scheme actuary, who is appointed by the trustees rather than the employer. Schemes that currently meet the MFR test can still be significantly in deficit on the buy-out basis, frequently by millions.

At the moment it seems likely that this change will only affect employers leaving schemes after the date of change (expected to be spring 2005). There is a risk, however, that the government might make this retrospective.

The 2004 Act contains new provisions designed to ensure that if there is a debt in a scheme, other group companies may be held responsible for it. The rationale for this is to protect the PPF against employers that deliberately try to avoid or reduce any debt that could eventually fall on the PPF.

The PPF is intended to provide some degree of protection to members of underfunded company schemes whose employers become insolvent. To start with it will be financed by a scheme levy based on the number of members in defined benefit schemes. Once it is up and running (after the first year), there will also be an additional risk-based levy, calculated by reference to how well funded the employer's scheme is. The PPF will also take over the assets of underfunded pension schemes it takes on liability for.

The moral hazard provisions empower the new Pensions Regulator (the Regulator) to issue the following:

Contribution notices. The Regulator will be able to issue contribution notices if it believes there has been a deliberate attempt (since 27 April 2004, the date the moral hazard provisions were announced) to prevent the recovery of a debt, prevent a debt becoming due or reduce a debt (section 39, 2004 Act).

A contribution notice could be issued at any time after the Regulator becomes aware of the situation. In practice it is likely that the Regulator might be notified by concerned trustees or members. The Regulator is being given wide-ranging powers to investigate matters relating to pension schemes.

Contribution notices could be issued against an employer, anyone connected with or an associate of the employer. This could include directors and their advisers but expressly excludes insolvency practitioners. A contribution notice will specify the amount (all or part of the debt) the individual or company is liable to pay to the pension scheme.

Contribution notices are not, however, intended to stop bona fide business activities carried out without any intention to avoid a debt. The key point is whether a purpose of the transaction (or an action taken in the course of a transaction) is to avoid or reduce a debt.

The government has, therefore, proposed that in future, companies will be able to get advance clearance from the Regulator that undertaking a particular transaction (including restructurings) will not result in the Regulator imposing a contribution notice. Also, there will be a six-year time limit for issuing a contribution notice.

Contribution notices are not limited geographically, but in practice debt enforcement may be easier in some countries than in others.

Financial support directions. The Regulator will be able to issue financial support directions if it believes an employer has insufficient resources to meet its liabilities under the pension scheme (section 44, 2004 Act).

This will be determined by reference to a prescribed percentage of the estimated funding deficiency in the scheme (possibly calculated on the buy-out basis). Directions can be issued against other companies in the group, and will effectively require them to take on liabilities for the pension scheme, even if they do not participate in the scheme.

Financial support directions will apply to liabilities for all service under the scheme, and not just service built up from the date of change. If a financial support direction is not complied with, a contribution notice can be issued. There is no cap on the amount the Regulator can order to be paid under a financial support direction.

Buying a company with liability to a pension scheme will in future mean the entire group takes on this liability.

Restoration orders. Restoration orders may be made under section 53 of the 2004 Act where on or after 27 April 2004, and within two years of an employer's insolvency, there has been a transaction at an undervalue involving scheme assets (that is, a transaction with no consideration or otherwise at a significant undervalue) (section 53(b), 2004 Act).

A transaction at an undervalue could conceivably include the payment of an enhanced transfer value (for example, following a sale) just before an insolvency event. The likely effect of a restoration order in these circumstances would be that the recipient of the transfer has to pay this back to the transferring scheme. Again, a contribution notice can be issued if a restoration order is not complied with.