The Pensions Act 2014 provides sponsoring employers of contracted-out schemes with a special power to make changes to their schemes, in order to offset the loss of the employer’s National Insurance contributions (‘NICs’) rebate when contracting-out of the State Second Pension is finally abolished from 6 April 2016.
In May 2014, the Department for Work and Pensions (‘DWP’) issued a consultation paper on the detailed workings of the override power. The Government’s formal response to that consultation was published on 4 March 2015. Final regulations which prescribe how the statutory amendment power may be used were laid before Parliament on the same day, and will come into force on 6 April this year
Assuming that most employers will want to make changes which are effective immediately on 6 April 2016, this gives employers a little over twelve months in which to assess their options, undertake 60-day member consultation on their proposals (where required), and finalise and communicate changes to members and trustees.
The current state pension consists of two elements: a basic state pension, and an earnings-related element based on the NICs paid by an individual. Where schemes are contracted-out of the earnings-related element, their sponsoring employers and members receive a NIC rebate for so doing (3.4% and 1.4% of earnings between the Lower Earnings Limit (£153 p.w.) and Upper Accrual Point (£770 p.w.), respectively).
When the current state pension is abolished from 6 April 2016 to make way for the single-tier state pension, the rebate will no longer be payable; instead, sponsoring employers and members will start paying standard rate NICs, resulting in increased costs for both parties.
Employer amendment power
The statutory amendment power allows the sponsoring employer of a contracted-out scheme to amend certain aspects of the scheme unilaterally, without the need for the consent of either the members or the scheme trustees, and regardless of any restrictions in the scheme’s rules.
The power can be used to increase member contributions payable by the relevant members, to alter the future accrual of benefits relating to those members, or to make both types of change. However, whatever approach is selected, the savings from the changes made using the power must not exceed the employer’s increase in NIC liabilities. If the employer wants to make more extensive changes, another legal mechanism (such as the scheme’s own amendment power) will need to be used instead.
The power can be exercised at any time up to 5 April 2021, though changes cannot take effect before 6 April 2016. It can be used more than once, provided that the aggregate effect of the changes is still limited to what is needed to offset the increased NIC costs. There is also nothing to prevent an employer making amendments using the scheme power first and then using the statutory power (though the DWP’s view is that trustees asked to consent to changes under the scheme’s power should make their consent conditional upon the employer’s undertaking not to use the statutory power at a later date).
An actuary appointed by the employer must calculate the value of the reduction in accrual and/or the aggregate increase in member contributions, and must issue a certificate confirming that the changes do not go beyond what is needed to offset the employer’s NIC increase. Both the actuarial calculations and the certificate must meet specific requirements, which are set out in the regulations.
To simplify the process as far as possible, the employer can instruct the actuary to carry out the calculations as at a past date on or after 1 January 2012. The idea here is that the employer can select the date of the most recent valuation, which will potentially mean that the actuary can re-use the existing valuation data, rather than having to collate fresh data.
Any assumptions used in the calculations must be those which were used to calculate the scheme’s technical provisions at the last valuation on or before the calculation date, updated to reflect market conditions at the calculation date.
Since the intention is that the figures should reflect a best estimate basis wherever possible, the employer is permitted to instruct the actuary (in writing) to strip out any margin for prudence which is included in any of those assumptions, as long as the actuary is comfortable that the adjustments are consistent with the scheme’s transfer value basis.
Multi-employer schemes / sections
Where a scheme (or a segregated section of a scheme) has more than one statutory employer, the regulations provide that the “principal employer” alone can exercise the power. In this context, this means the person who is nominated to act on behalf of the employers for the purposes of the scheme funding regime under the Pensions Act 2004, which will commonly be the same as the “principal employer” under the scheme’s rules. In a case where there is no such nominee, the regulations provide for the employers to be able to nominate someone specifically for the purposes of the statutory amendment power.
Provision of information
The trustees must provide any information reasonably requested by the employer in connection with the calculation, and must do so within a reasonable period of time agreed with the employer. This is a welcome relaxation of the DWP’s initial proposal, which would have required the trustees to respond within 4 weeks or face the risk of civil penalties.
However, it is not clear what will happen if the trustees and the employer fail to agree on a “reasonable period” for the trustees to respond. There is also no obligation for other employers in a multi-employer scheme to provide requested information (which may cause difficulties in an industry-wide scheme where the employers are not associated with each other and, indeed, may be competitors). The DWP’s view is that it will be up to such schemes to “devise pragmatic local solutions” to any problems encountered.
The DWP response confirms that the usual 60 days’ consultation applies to any exercise of the statutory power, meaning that most employers will have to consult with affected members. Consultation is likely to focus on questions such as whether any changes should be made at all (ie. should the employer simply absorb the NI increase?), and if so, what type of change(s) should be made, and for which members.
On the latter point, the DWP initially proposed that where a scheme had different benefit or contribution structures for different categories of member, each category would be treated as a separate section (requiring separate exercises of the amendment power in each case). Fortunately, this provision – which many commentators were afraid would make the power unworkably complex – has been dropped from the final regulations. Instead, the DWP considers that as part of the consultation process, employers will need to explain clearly to members how different groups will be affected by the changes, and to show that the changes are equitable across the scheme membership.
There is also a limited requirement to consult the trustees over the effective date for the amendments. In practice, most employers are likely to seek the trustees’ views on the substance of their proposals as well.
Certain members will have special statutory protection, where they were previously employed within publicly owned industries (operating in sectors such as coal, electricity and rail) which were privatised from the early 1990s onwards. Because of the nature of these protections, the employer cannot use the statutory amendment power to alter future accruals or contributions in respect of these persons.
Separately, the regulations also confirm that amendments made using the power cannot alter the balance of power as between employer and trustees by taking power to determine any matter away from the trustees.
One particular area of concern raised during consultation was the fact that the power does not allow the employer to reduce its own contributions to offset its NIC increases. The DWP has confirmed that this is intentional, and that it will be up to trustees to review the schedule of contributions (using their existing powers to revise recovery plans and schedules of contributions mid-way through a valuation cycle). So employers will need to be prepared to fund the NIC increase at least initially, until the scheme funding documentation has caught up with the effects of changes made under the power.
Although the final regulations do not address all the technical concerns raised during consultation, a number of the real problem areas have been cleared up. The DWP’s explanation of the way the power is intended to operate will also provide some practical guidance for employers considering using the power.
Now that the statutory framework has been finalised, the next step for employers will be to consider the options open to them and to start working out concrete proposals which can be used as the basis for consultation. Although many schemes are currently preoccupied with all the other changes taking effect from 6 April this year, the lead time required to make effective use of the statutory override power means that this item ideally needs to be placed fairly high on the employer’s agenda.