The coming months look set to be significant for the design, management and governance of pension funds. The following are some of the big themes that we anticipate will be at the forefront of developments.
We hope that you find our review useful in your strategic planning.
1. The end of contracting-out
The current two-tier state pension will be abolished from 6 April 2016, and replaced with a new, single-tier state pension. This means that from this date:
- members of defined benefit (DB) pension schemes will cease to accrue contracted-out rights (ie the element of their scheme pension linked to the second state pension); and
- all DB arrangements will cease to have contracted-out status.
Whilst most employers have already decided how they will address the additional national insurance contributions which will be payable from this date, there are still issues that may require further action – in some cases before April 2016. Employers and trustees may still need to consider how to:
- deal with state pension offsets under scheme rules;
- manage the risk of being required to provide an underpin to guaranteed minimum pensions (GMP) revaluation; and
- deal with the potential impact on DB schemes used to satisfy automatic enrolment requirements.
Click here to read our recent briefing for further details.
2. Benefit changes, scheme closures and the impact of recent cases
We expect that many sponsoring employers with open DB schemes will continue to assess their strategy and options in terms of benefit changes and closures. Such projects have the potential to be impacted by case-law developments from recent years as well as judgments expected later this year.
In 2014, the High Court in IBM1 held that when closing its scheme to future accrual IBM had breached its duty of good faith by acting contrary to members’ “reasonable expectations” without sufficient business justification for doing so.
In 2015 the High Court issued its judgment in the IBM remedies hearing2 making it clear that members can be entitled to both damages and equitable remedies in respect of an employer’s breach of duty in relation to benefit changes. This means that the decision of an employer can be set aside (so the members would be treated as if the closure had not taken place) and members can also claim damages if setting aside the decisions would not eradicate the loss that members have suffered.
Employers seeking to make benefit changes will need to conduct a thorough audit of any earlier communications issued to employees to ensure that they do not breach their employer duties, as a breach can undermine the effectiveness of any changes.
IBM has been granted permission to appeal both the original judgment and the remedies judgment, so we may see further development in this area later in 2016, although there is some speculation that the appeal will not be heard until 2017.
The Supreme Court’s decision in Eclairs3 highlighted (in that case, where directors exercise a statutory power) the importance of considering whether the exercise of power is done for a ‘proper purpose’. This essentially ensures that powers are exercised for the purposes for which they were conferred and not for an improper purpose.
This is similarly important to trustees exercising powers in pension schemes.
Careful thought should be given to the purpose of a power and ensuring that the exercise of discretion is properly documented so that proper purpose can be evidenced.
The appeal in Gleeds4 is expected to be heard later this year which will consider the consequences of not following execution formalities when amending a scheme. This case underlines the importance of documenting changes properly and ensuring that formalities are adhered to. At first instance, the court held that the defectively executed documents were ineffective.
3. Bulk transfers
The current regulations that will apply in relation to the end of contracting-out mean that, from April this year, member consent is needed to transfer contracted-out rights to any pension scheme which was not formerly contracted-out on a salary related basis. This means it will not be possible to establish new pension schemes to receive bulk transfers without member consent post-6 April 2016. This could be a significant impediment to a number of potential transactions, including demergers.
For more information, click here for our briefing.
4. Data protection – the impact on pensions
In October 2015 the Court of Justice of the European Union struck down the US Safe Harbor framework, which lets EU businesses send personal data to US business registered under the scheme. (To read our briefing on the issue, click here.)
Many UK pension schemes have entered into agreements which allow data transfer to the US. For example, this is reasonably common in agreements with actuarial and administration firms.
Following negotiations between the EU and the US, last week a new EU-US Privacy Shield has been agreed as a replacement for Safe Harbor. (Click here for our briefing.) Consequently, trustees and employers will need to consider the impact on their arrangements.
5. Incentive exercises
We continue to see significant numbers of employers and trustees implementing changes to their retirement processes, offering pension increase exchanges (PIEs) and options to transfer DB rights to DC arrangements. Such projects may be impacted by the updated code of best practice recently issued by the Incentive Exercises Monitoring Board (IEMB)5.
In addition, where a practice of offering incentive exercises to members (eg as part of your retirement processes) has already been established, it will be necessary to assess whether this offer is affected by the changes made to the Code. Please click here for our briefing on this topic.
6. Changes to the tax regime
a) The structure of pensions tax relief
HM Treasury is expected to announce the results of its consultation on pension tax relief6 in the Budget on 16 March 2016. The consultation proposed a number of options for reforming the pensions tax regime, including a possible wholesale shift from the current structure of “Exempt-Exempt-Taxed”7 to an ISA-type tax model, where pension contributions are taxed upfront.
When planning ahead, trustees and employers should be aware that it is possible that the measures announced in the Budget may be significant, and some may require immediate action.
The Government may opt for a flat-rate system whereby all individuals are given tax relief at the same fixed rate, rather than at their personal marginal rate of taxation. In addition, some commentators are predicting changes to tax-free lump sums and salary-sacrifice arrangements.
For further information, please refer to our Pensions Bulletin June / July 2015.
b) Changes to the lifetime allowance
From the tax year 2016/17 the lifetime allowance will reduce from £1.25 million to £1 million. Alongside this, two new forms of protection are due to come into effect: fixed protection 2016 and individual protection 2016. The draft legislation was published in December 2015 with the changes due to be implemented by the Finance Act 2016.
Employers and trustees may wish to communicate these changes to members, particularly those that are likely to want to benefit from the new forms of protection.
c) Changes to the annual allowance
For the tax year 2016/17 the annual allowance will be reduced for those that have annual incomes in excess of £150,000. For every £2 of income they have over £150,000, their annual allowance will be reduced by £1, down to a minimum of £10,000. Pension contributions are counted as income for this purpose unless the individual's income net of pension contributions is £110,000 or less.
Employers and trustees should consider communicating these changes to members if they’ve not already done so and existing member literature may need to be updated to reflect the changes.
Employers may also wish to alter the benefit design of their scheme if the trust deed does not offer sufficient flexibility to pay DC contributions or provide DB benefit accrual in any given year which is below the new annual allowance threshold.
In October 2015 HMRC set out its latest position on the recovery of input VAT on management services provided to DB pension funds. This included a 12-month extension until 31 December 2016 to the transitional period during which employer groups can continue to recover VAT on administration services (including legal and actuarial services), and to use the 70:30 concessionary method for single invoices covering both administration and investment management services.
An expanded statement is expected in the coming months, although it is unclear at this stage whether it will resolve the obstacles that exist to the any of the potential options currently on the table. Please click here for our briefing on this subject.
2016 may see changes which impact on private companies that enter into outsourcing arrangements with local authorities.
In 2013 significant changes were made to the non-statutory ‘Fair Deal’ rules which are relevant to public sector outsourcing, meaning that private companies now effectively become participating employers in public sector schemes where previously they had set up their own. Whilst these changes applied to the majority of public sector pension schemes, they did not apply to the Local Government Pension Scheme which is covered by alternative statutory arrangements contained in the Best Value Authorities Staff Transfers (Pensions) Direction 2007. We are still waiting on a revised version of the Best Value Direction, and it has been suggested that this will be published during 2016.
Employers planning any impacted outsourcings should seek legal advice at the earliest opportunity.
8. DC Governance
a) Statement and disclosures
2015 was a transformative year for the trustees of defined contribution (DC) pension schemes, including new requirements for a chair and annual governance statement. Trustees will need to make further disclosures in 2016 concerning their investment decisions in relation to default arrangements (ie the default funds used to meet automatic enrolment obligations), core financial transactions and costs and charges.
To access our briefing, “Key facts: New requirement for DC schemes to have a chair and for a chair’s annual governance statement”, please click here.
b) New code on the governance and administration of occupational DC schemes
The Pensions Regulator (TPR) is considering the outcome of its consultation on a new draft code on the governance and administration of occupational DC schemes, to replace the current version.
We are expecting TPR to issue new “how to” guides for consultation in spring 2016.
The code and guidance are due to come into force in July 2016 and may require action from both employers and trustees.
c) Active member discounts and member-borne commission
From 6 April 2016 active member discounts will be banned in DC schemes which are used by an employer to satisfy its auto-enrolment obligations. These schemes will no longer be allowed to impose higher charges on members whose contributions cease after 6 April 2016 when compared to an equivalent active member. Employers and trustees should consider whether they need to take action in light of these changes.
The government has signalled its intention to ban new member-borne commission arrangements in relation to DC schemes which are used by employers to satisfy their auto-enrolment obligations. This is expected to impact new arrangements from 6 April 2016, with a ban on existing arrangements introduced later in the year. Much of the detail is still awaited, so trustees and employers should revisit this as it develops.
9. Regulation of OTC derivatives
The exemption from the clearing obligation for pension scheme arrangements under European Market Infrastructure Regulation (EMIR) has been extended until 16 August 2017. Pension schemes will, nevertheless, still need to make preparations in 2016, including:
- keeping their investment strategy under review and responding to the increased cost of clearing and collateral when structuring the fund’s portfolio or investments in pooled funds;
- checking whether their investment management arrangements reflect these obligations (eg by requiring their investment managers to comply with the regime and meet the risk mitigation and reporting standards when entering into OTC derivatives on behalf of pension schemes);
- ensuring they have systems in place to meet any direct reporting and trade confirmation requirements if they are investing directly in OTC derivatives;
- assessing whether they will rely on the exemption from central clearing for pension schemes; and
- considering whether they want to establish infrastructure for voluntary clearing before the exemption ceases to have effect.
To access our briefing, “Update on EU regulation of OTC derivatives: impact on pension schemes”, please click here.
10. The outlook for international pensions in 2016
a) The UK’s place in the EU
2016 could be the year that the United Kingdom decides to leave the European Union (EU).
Much of the UK’s pensions law has its source in EU law, including funding and investment requirements and prohibitions on age and sex discrimination. Leaving the EU could therefore have major ramifications for the industry.
EU law also provides a framework allowing pension schemes that are approved to operate in one Member State to admit members in other Member States. Leaving the EU would mean that UK businesses using cross-border pension schemes would become subject to different regulatory requirements in different European countries.
Pension scheme trustees and administrators should anticipate the risk of greater uncertainty and volatility in the UK markets in the run-up to the referendum. Investment committees should engage with investment managers to consider how to minimise the potential impact on scheme assets.
b) IORP II Directive
It is expected that the much delayed, revised Directive on the activities and supervision of institutions for occupational retirement provision (IORP II) will be adopted in the summer of 2016. This follows a review by European Parliament's Committee on Economic and Monetary Affairs in 2015, which made numerous amendments to the text proposed by the European Commission. The recast Directive will introduce extensive new governance and risk assessment requirements and minimum standards for disclosure.
c) EIOPA advice on solvency rules
The European Insurance and Occupational Pensions Authority (EIOPA) is expected to deliver further advice to the European Commission on whether a new solvency regime should be introduced for pension funds; in particular, how regulators should use a ‘holistic balance sheet’ when setting solvency and minimum funding requirements. The European Commission decided not to proceed with a solvency regime in the revised IORP II Directive, but tasked EIOPA with continuing to explore the feasibility of such a regime and ways in which it could be implemented.
11. Personal Pensions
a) European market for personal pensions
EIOPA is due to deliver advice to the European Commission on the creation of a standardised Pan-European Personal Pension Product (PEPP) early in 2016. EIOPA’s consultation on proposals for PEPPs closed on 5 October.
To access our briefing, “Pan-European personal pensions: a new opportunity for international workforces”, please click here.
b) FCA regulation of Personal Pensions
The Financial Conduct Authority (FCA)’s consultation “Pension reforms – proposed changes to our rules and guidance” closed on 4 January 2016. The consultation paper notes that the FCA intends that final rules and guidance on the following areas will come into effect within six months:
- communications concerning accessing pension savings;
- pension freedoms communications;
- self-invested personal plan (SIPP) retained interest;
- high net worth investors;
- determining maximum projection rates;
- projections including guarantees; and
- glossary amendments.
A look back at the highlights of 2015
2015 was another busy year for the pensions industry:
- schemes and employers implemented the DC benefit flexibilities which came into effect in April 2015;
- the Pension Schemes Act 2015 introduced the framework for defined ambition benefit structures, but those provisions were somewhat overshadowed by the new DC benefit flexibilities and we’ve yet to see any noticeable renewed interest in the area;
- TPR issued guidance on assessing and monitoring the employer covenant of a DB scheme in August 2015 to replace the original 2010 guide to monitoring employer support;
- the judgment in MNRPF8 provided a useful indication of how trustees can approach balancing the interest of members and employers. It also gave some much needed clarity to the question as to the status of schemes that have closed to future accrual yet continue to offer employees that are deferred members enhanced terms in the scheme;
- the Court of Appeal dismissed the appeal in Walker v Innospec9, finding that it is not possible to claim rights retrospectively when there is subsequent change in legislation which supports the position of schemes that take advantage of the ability to restrict survivors’ benefits for same sex couples (to see our briefing “Pension right of same sex partners: time for legislation” please click here);
- the High Court issued its judgment in Buckinghamshire v Barnardo’s10, with Warren J holding that in that case the trustees did not have power to select a different index or the purposes of indexation and revaluation so long as RPI remains an officially published index. This case confirms that the question of whether a scheme may switch the index it uses is very much one of construction of the particular scheme rules and therefore requires specialist legal advice; and
- the High Court found in Bradbury v BBC11 that the BBC did not breach its implied duties in imposing a cap on increases to pensionable salary. The case is good news for employers in the same position . For further details, please refer to our Pensions Bulletin June / July 2015.