In previous editions of our pensions publications we have referred to the change to the statutory definition of 'money purchase benefits' provided for in the Pensions Act 2011 which came into force with effect from 24 July 2014 ('the Effective Date'). We mentioned in our e-alert on this subject that this change is significant for those pension schemes which provide benefits which have become reclassified (with effect from 1 January 1997 and so retrospectively) as a result of the change. The associated regulations1 ('the Regulations') which are also now in force deal with two important issues:
- the historic treatment of benefits by affected pension schemes since 1 January 1997 given the retrospectivity of the change; and
- amending various aspects of pensions legislation to reflect how it applies going forwards in relation to certain reclassified benefits, given the nature of those benefits.
We look below in more detail at the areas covered by the Regulations and how they operate in relation to the above issues.
What kind of reclassified benefits?
As mentioned above, the change to the money purchase definition has meant that certain benefits previously treated as being money purchase have now been reclassified. This means that not only do they no longer fall within the money purchase definition, they effectively have not done so since 1 January 1997 as the change is retrospective, causing obvious issues in relation to actions schemes may have taken since that date on the basis that these benefits were money purchase. In relation to this, the Government's stated policy intention is that decisions taken by schemes between 1 January 1997 and the Effective Date, the date the new definition came into force, are validated except for some provisions in relation to winding up and employer debts. However, rather than provide for a blanket validation of actions taken in respect of all reclassified benefits, the legislation actually specifies the types of reclassified benefits which can take advantage of each easement. The only benefits and schemes to which most of the easements apply are those specifically referred to below. These include, where referred to in the Regulations, cash balance benefits, and arrangements involving a cash balance and money purchase underpin and defined benefit minimum top up benefit. The DWP was clear that it was not extending this to other reclassified benefits, should these arise.
'Cash Balance Benefits' for the purposes of the Regulations are where the sum of money for buying the pension is subject to some promise, such as to the amount or minimum return but there is no promise about the rate or amount of any pension that will be provided from that sum.
A scheme may offer a "defined benefit minimum" with a money purchase or cash balance benefit "underpin". In this case, the member will recover a guarantee of the defined benefit amount, or the money purchase/cash balance underpin amount, whichever is higher. The Regulations make it clear that if the money purchase underpin is higher then the defined benefit minimum at the relevant time then it is a money purchase benefit, and if the defined benefit minimum is higher then the whole of the benefit is not. This means, in particular, that a scheme that is offering a defined benefit with a money purchase underpin is not a money purchase pension scheme for the purposes of the statutory definition, but if a member retires and gets the money purchase underpin (because this is higher than the defined benefit), the member's benefit is money purchase.
Areas covered in the regulations
Part 4: Protected Rights
Under the Regulations, schemes which provided protected rights in the form of cash balance benefits, a defined benefit minimum (in relation to money purchase underpin benefits or cash balance underpin benefits) ("the Specified Reclassified Benefits") and treated them as protected rights for the purposes of contracting out legislation (but only in respect of periods up to 6 April 2012 when contracted out money purchase benefits ceased to accrue) do not generally have to revisit that treatment.
Part 5: Modification
Under section 67 of the Pensions Act 1995, since 6 April 2006 amendments to occupational pension schemes converting accrued non money purchase benefits to money purchase benefits, have been known as 'protected modifications' and must satisfy certain requirements under that section. In the period until the Effective Date converting the Specified Reclassified Benefits in this way would most probably not have satisfied these requirements. To deal with this, the Regulations effectively validate such amendments made between 6 April 2006 and the Effective Date provided that the requirements relating to 'detrimental modifications' under s.67 (2) (b) and (c) and s.67(C) have been satisfied.
Going forwards, the Regulations provide that the contingent right to a defined benefit minimum in relation to money purchase underpin benefits to which the member only becomes entitled if his money purchase benefits fall short of a defined benefit minimum fall within the definition of the subsisting rights for the purposes of s.67 and so subject to the full rigour of that section (including that any amendments which would or might adversely affect those rights would be detrimental modifications which need to satisfy the requirements of s.67). This should be borne in mind with regards to any proposed amendments to such benefits in the future.
Part 6: Winding Up
Generally, where winding up commenced before the Effective Date, cash balance benefits that were treated as being money purchase before that date can continue to be treated as if they were money purchase during the winding up process. This is to avoid schemes in the process of winding up having to go back and unwind actions already taken. However, this easement does not apply to schemes which have a defined benefit minimum and an underpin except in limited circumstances.
In relation to AVCs that derive from Specified Reclassified Benefits, even where winding up commences after the Effective Date, if the pension came into payment on or before 1 April 2015, the trustees may discharge the AVCs as money purchase benefits provided that they are satisfied that this approach is reasonable in the circumstances.
Where a scheme entered a PPF assessment period before the Effective Date and the scheme subsequently winds up, Specified Reclassified Benefits that were treated as being money purchase during the assessment period may continue to be treated as being money purchase in a subsequent winding up unless the PPF has determined otherwise.
Part 7: Employer debt - Section 75
Again, trustees will not generally have to revisit the past as significant easements have been introduced. For s.75 trigger events in the period before the Effective Date:
- where a scheme was treated as money purchase (so no debt was treated as arising) and the only Specified Reclassified Benefits the scheme provided were cash balance benefits no debt will now arise as a result of the reclassification; and
- where a scheme that provided Specified Reclassified Benefits was not treated as being money purchase, if a s.75 debt arose before the Effective Date and the Specified Reclassified Benefits were treated as money purchase benefits for the purposes of calculating the debt, the debt does not need to be revisited.
However, trustees may need to take action now in respect of periods before the Effective Date in the following circumstances:
- where no debt was treated as having arisen because a scheme was treated as being money purchase, and there was a defined benefit minimum with an underpin or any benefit that has been reclassified but is not a Specified Reclassified Benefit; or
- where (broadly) benefits that even before the reclassification were defined benefit were erroneously treated as being money purchase and so were excluded from the calculation of a debt.
Even then, the employer (or the exiting employer in a multi-employer scheme) will not necessarily need to pay a s.75 debt. A debt will generally only arise where the scheme is winding up, the employer (or, in a multi-employer scheme, at least one employer) is solvent and a valuation obtained as soon as reasonably possible after 24 July 2014 shows that there is a deficit on the buyout basis. No debt will arise if the scheme is not winding up and either:
- there has been an actuarial valuation within the three years preceding 24 July 2014, and either the scheme was fully funded or a recovery plan is in force; or
- the trustees obtain an actuarial valuation with an effective date within 12 months of 24 July 2014, and the valuation is received within 15 months of that effective date, and either the scheme is fully funded or a recovery plan is put in force within 6 months of the effective date.
Where the employer or employers are insolvent, the Specified Reclassified Benefits can continue to be treated as if they were money purchase and there is no need to revisit the debt. This recognises the likely cost and futility of pursuing a debt against insolvent employers and will avoid complicating existing insolvency proceedings.
Part 8: Revaluation, indexation and preservation
The Regulations provide that Specified Reclassified Benefits (but where the available sum in relation to cash balance benefits are not calculated by reference to final salary) accrued prior to the Effective Date may, if those benefits have been treated as being money purchase, and if the trustees think it is appropriate (noting that they have no obligation to obtain employer consent), be revalued using a money purchase method. There are also provisions which effectively say that the statutory requirements to increase pensions in payment in s.51 of the Pensions Act 1995 do not apply to pensions derived from the Specified Reclassified Benefits in respect of pensionable service on or after 6 April 2007 and which came into payment on or after 6 April 2006 but before the Effective Date and where the trustees before the Effective Date treated those benefits as being money purchase benefits.
The Regulations also make certain technical changes to the preservation legislation to clarify that uniform accrual does not apply to money purchase benefits and how money purchase benefits should be determined for the purposes of the preservation requirements.
Parts 9 and 10: Transfers
The Government response to the consultation says that those responding to it on this issue 'unanimously agreed' that schemes should not have to revisit transfers which have already taken place because the cost of doing so would be 'disproportionate and substantial'. The Regulations support this position so that trustees do not have to unravel transfers paid (or indeed applied for) in relation to the Specified Reclassified Benefits before the Effective Date provided that certain conditions are satisfied. The Regulations also effectively exempt schemes, for the period up until the Effective Date from having to provide statements of entitlement in relation to Specified Reclassified Benefits which were treated as money purchase benefits. There are also provisions which deal with the frequency with which a member can apply for a guaranteed statement of entitlement where Specified Reclassified Benefits are involved.
Going forwards, the Regulations also provide for the transfer value in respect of cash balance benefits in respect of which the available sum is not calculated by reference to final salary to be determined in accordance with the realisable value of the member's benefits (as is the case with money purchase benefits) but with adjustments to that value to reflect any awards of interest or guarantees available under the scheme rules, and any options available which would increase scheme benefits and any discretionary benefits which the trustees determine should be taken into account. There is also provision for such transfer values (being in relation to non money purchase benefits) to be reduced in the event of the scheme being underfunded. Affected schemes with these sorts of benefits should ensure that their administration systems are geared up to perform these calculations.
The Regulations operate in a similar manner for transfers in relation to certain 'early leavers' (i.e. members who left pensionable service before the Effective Date with between three months and 2 years' pensionable service) and with Specified Reclassified Benefits so that where such a member was or has been given a transfer value calculated as if those benefits were money purchase and the trustees have been notified that he wishes to take that transfer then the trustees may honour that and be discharged under the legislation from having to provide benefits to which the transfer value relates.
Part 11: Surplus to employer
Broadly, surplus payments made before the Effective Date do not need to be revisited. Payments made after that date for schemes with reclassified benefits will need to be made on the basis of a new valuation which recognises the changed status of those benefits.
Part 12: Scheme Administration
Appointment of an Actuary under s.47
S.47(1)(b) of the Pensions Act 1995 requires occupational pension schemes to appoint an actuary unless the scheme is an exempted scheme under the Scheme Administration Regulations 19962.
One of the exemptions is where the scheme is a money purchase scheme. With effect from s.29 coming into force, those schemes previously treated as being money purchase schemes even though they included benefits which are no longer money purchase ('Reclassified Schemes') would technically be in breach of that requirement.
Regulation 40 of the Regulations addresses this by stipulating that an actuary should now have been appointed by 6 October 2014. Furthermore, where there is no actuary appointed because the scheme was previously classified as money purchase, the exemption in the Scheme Administration Regulations still applied until 6 October. If no actuary is in place after 6 October then the Reclassified Scheme will be in breach of the Scheme Administration Regulations from that point onwards. This provision also applies to schemes that have become defined benefit without having Specified Reclassified Benefits.
Scheme accounts will obviously historically have been prepared as if benefits which are now defined benefit were money purchase benefits so would technically now not be accurate. To address this Regulation 41 of the Regulations states that there is no impact on the validity of any scheme accounts prepared in the past. Going forwards, they should be compiled to accurately reflect the new definition.
Part 13: Pension Protection Fund ('PPF')
Eligibility and Levy
Very importantly, Reclassified Schemes will only become eligible for the Pension Protection Fund from 1 April 2015, not immediately.
Whilst on the face of it the delay of PPF protection might seem unfair, it should be borne in mind that PPF protection flows from paying the PPF levy, which Reclassified Schemes will not have done. It is considered that the appropriate valuation and levy raising will take time and thus the levy will fall due for the first time for the schemes from April 2015 onwards. However the PPF is permitted to revisit the levy for Reclassified Schemes which do not have Specified Reclassified Benefits, which is less equitable.
Considering eligibility in more detail, a Reclassified Scheme will become eligible for the PPF from 1 April 2015 unless:
- it is otherwise excluded by the PPF Entry Rules Regulations; or
- the insolvency event occurred before 1 April 2015; or
- in period from when s.29 comes into force until 1 April 2015 the trustees entered into agreement to reduce the amount of s.75 debt due to the scheme.
In relation to multi-employer schemes identifying the nature of the scheme will be key to potential eligibility from 2015. If the scheme is a "last man standing" scheme, the insolvency test (that might stop a scheme from becoming eligible on 1 April 2015) only relates to the last employer, so as long as the last employer is solvent on 1 April 2015 the scheme will still become eligible for the PPF even if lots other employers in respect of the scheme have fallen victim to insolvency before that date.
If the trustees of a scheme have entered into a s.75 debt compromise and would therefore be excluded from PPF eligibility, it will be possible to still secure eligibility if the level of compromise is above the level of PPF compensation that would be available. This is the position for "standard" schemes at present and the Regulations extend this grace to Reclassified Schemes.
There will be no impact on the validity of any valuation or determination obtained before s.29 came into force where an assessment period has already started for a scheme even if it has Reclassified Benefits that were being treated as money purchase when the valuation/determination was carried out.
Schemes that will come under the PPF for the first time will have to secure a s.179 valuation before 31 March 2015 with an effective date between the Effective Date and 31 March 2015. The usual repeat valuation timetables will apply from then on. Seeing as the valuation will have to be done before the scheme is technically an "eligible scheme" the procedure is to treat it as if it were in fact already eligible for the purposes of the calculation of assets and liabilities under the PPF Valuation Regulations.
Schemes that are already eligible but who haven’t included Reclassified Benefits in previous valuations must let the Pensions Regulator ('the Regulator') know before 31 March 2015 and then the Pensions Regulator or the PPF may ask for more documents such as accounts and actuarial reports. There is then power for the PPF or the Regulator to call for an out of cycle valuation from 2015 onwards and recalculate the levy if needs be. But there will be no re-visiting of valuations for levy purposes for years prior to 2015.
Reclassified Schemes becoming newly eligible will have to pay the administration levy and the PPF levy within 28 days of notification of the amount payable.
Discharge of benefits
Those Specified Reclassified Benefits secured before the Effective Date are treated as discharged. For schemes already in an assessment period, the PPF has discretion to determine that Specified Reclassified Benefits can continue to be treated as money purchase benefits and discharged as such, where it is reasonable in the circumstances (and of course, the Trustees had previously treated the Specified Reclassified Benefits as money purchase benefits).
Part 14: Scheme funding, valuations and PPF
Schemes that were not treated as money purchase, but have carried out valuations which treated benefits as money purchase which are not now money purchase, will need to prepare the next valuation on the new basis. Old valuations generally remain valid until then.
Schemes that were treated as being wholly money purchase but contain Reclassified Benefits will have to arrange a funding valuation with an effective date no later than 24 July 2015, with the valuation to be completed within 15 months of that effective date.
The PPF s.179 valuation deadline is particularly tight. If trustees have not appointed an actuary until early October 2014, this would give only 6 months in which to obtain the s.179 PPF valuation.
Part 15: Financial Assistance Scheme
Unlike the PPF, the change in definition has no impact for the purposes of the Financial Assistance Scheme as where a scheme was treated as a money purchase scheme immediately before it entered winding up it shall remain a non-qualifying scheme and the same applies to benefits.
Parts 16 and 17 : Equality and pension sharing
There are also amendments which:
- Confirm that, up until the Effective Date the trustees of an occupational pension scheme treated the benefits in question as if they were money purchase benefits and used different actuarial factors for men and women when determining the rate of pension to be derived from money purchase benefits, the trustees will not, because of applicable exemptions, be in breach of certain equal treatment legislation because of this treatment;
- In relation to pension sharing, in broad terms the Regulations do not require the trustees to re-visit any valuations provided before the Effective Date. Indeed, under certain conditions, the trustees can continue to apply a money purchase basis for valuing certain Specified Reclassified Benefits and pensions derived from them in this context in the same or connected divorce proceedings.
Part 18: Cross border schemes
For a UK occupational pension scheme to receive contributions from a European employer (e.g. where its members are to be employed by an employer in another European member state) the trustees or managers of the scheme must make a successful application to do so to the Regulator. Schemes which provide benefits which were historically money purchase, would, before the Effective Date, most likely have made this application on the basis of the scheme being money purchase.
The Regulations effectively provide, as long as certain conditions are satisfied and the scheme provides only death benefits, cash balance benefits and/or money purchase benefits (and pensions derived from those), that the trustees do not now have to correct this for the period before the Effective Date and that the authorisation to receive contributions on this basis will continue until the Regulator makes its decision about any further application. On that, if schemes wish to continue to receive European employer contributions after the Effective Date they have to apply for fresh authorisation to do so on a non money purchase basis by 24 July 2015, even if those contributions are to stop before then.
One of the conditions that a non money purchase scheme must satisfy to be given such authorisation is that it must be fully funded on the statutory scheme specific funding basis, which is likely to be a tall order, given the timeframes involved, so schemes affected by this issue should be considering how to deal with it without delay. The exemption for the past application on a money purchase basis does not apply to a scheme with a defined benefit minimum and underpin.
Part 19: Disclosure obligations
It has been confirmed in the Regulations that there is no obligation to supply the documents that a non-money purchase scheme would normally be required to supply to beneficiaries under the disclosure regulations3;in respect of periods before the Effective Date and as such no civil penalties will apply in respect of such information not being provided before that date. But from now on the position will be different for Reclassified Schemes and they will need to adhere to the requirements of the disclosure regulations with more disclosures being required to members. Schemes will have to consider their existing benefit statement communicating methods and consider what amendments and additions will be necessary.
Is there anything else to think about and notifying the Pensions Regulator
Whilst the Regulations provide welcome reassurance about not having to re-visit the past treatment of Specified Reclassified Benefits in most instances, they do not address any possible issues under specific pension scheme rules which should also be checked to ensure that there are no knock on side effects with the change in the definition of money purchase benefits – for example where certain scheme rules make reference to the statutory definitions which have now been changed. In addition if a scheme is no longer money purchase with benefits which fall outside the statutory definitions for Specified Reclassified Benefits, there may be significant issues.
As mentioned above, if they have not already done so, schemes that provide benefits that would have been regarded as money purchase under the old statutory definition should consider urgently the impact of the new definition coming into force retrospectively on their schemes and what legal requirements now apply to them to ensure compliance and that the scheme's administrative systems are also adjusted accordingly. This is reinforced by a statement issued by the Pensions Regulator in July 2014 which said, amongst other things, that it:
….urge (s) trustees to review their scheme’s trust deed and rules and seek independent legal advice in order to determine the character of benefits provided by their scheme in light of the clarified definition of money purchase benefits….. Conducting such a review and obtaining the necessary legal advice should assist trustees of affected schemes in complying with the appropriate legislative and regulatory regimes.'
Further, the Regulator said that if, following such a review, and despite its current and historic treatment of benefits, the scheme offers benefits that have the potential to result in a funding deficit, then the Regulator must be notified immediately so that it can amend its records.