Top of the agenda
Pension Protection Fund
A round up of pensions developments: April 2015
Top of the agenda
1. The Pensions Regulator’s Guidance on DB to DC transfers and conversions
The Pensions Regulator has published its finalised Guidance on DB to DC transfers and conversions.
Under the Pension Schemes Act 2015 (the “Act”) trustees of schemes with defined benefits must ‘check’ that a member has received appropriate independent advice before processing a member’s request for a transfer to a DC scheme (including a personal pension plan) or a cash balance arrangement. These independent advice requirements also apply when a member or survivor’s safeguarded benefits (being any benefits that are not money purchase benefits or cash balance benefits, such as defined benefits) are ‘converted’ to a flexible benefit (i.e. DC or cash balance). This may happen by an internal transfer from a DB to a DC or a cash balance section in the same scheme.
Highlights from the finalised Guidance
The Guidance is wider in scope than the draft published for consultation in February. It now covers not only statutory transfers but also
- transfers made under scheme rules; and
- conversion of “safeguarded benefits”.
Transfers under scheme rules
The Guidance emphasises that the independent advice requirements apply whether a transfer is made under the statutory provisions or under the scheme rules.
The Guidance acknowledges that scheme rules might allow transfers in circumstances where a member does not have a right to a statutory transfer. For instance, the revised legislation on statutory transfers at benefit category level under the Pension Schemes Act 2015 does not expressly allow a member who has different types of benefit within each category to take one type while leaving the other type behind. Scheme rules may, however, allow partial transfers in this way, for instance the rules of an unsegregated scheme with two separate DB sections may allow a member to transfer the benefits from one DB section but not the other.
Where scheme rules include such options, the Regulator would expect “consistency of approach” with the statutory process as a means of enhancing member understanding.
Conversion of safeguarded to flexible benefits within the same scheme
The Guidance notes that a conversion of safeguarded benefits to flexible benefits is likely to constitute a ‘protected modification’ under Section 67 of the Pensions Act 1995 and so require members’ informed consent. It also notes that there is no statutory requirement for schemes to allow such transfers.
Regulator’s views on DB to DC transfers
The Guidance states that “it is likely to be in the best financial interests of the majority of members to remain in their DB scheme” and that “it is also unlikely that the application of best estimate assumptions used to calculate the transfer value would provide benefits of equal value to those given up”. That said, the Guidance does acknowledge that “some members may place a higher premium on accessing their benefits in a different way as compared to the regular income for life provided by their DB scheme.”
Transfers with a value of £30,000 or less
There is no statutory obligation on the trustees to check that the member has received appropriate independent advice if the value of the member’s safeguarded benefits in the scheme is £30,000 or less. The Guidance states that the member must, however, be reminded about the information on transfers available from the Pensions Regulator, the Pensions Advisory Service and the FCA. It also contains a reminder that under the Transfer Values Regulations 1996, trustees are required to inform the member that the member must take advice before deciding whether to transfer.
Trustee obligations regarding the advice
The Guidance states that the independent advice requirements do not require trustees to check what advice has been given or whether the member is following that advice.
Under regulations made under the Act, the adviser is required to provide confirmation in writing to the member of the following:
- That the advice has been provided which is specific to the type of transaction proposed by the member.
- That the adviser has the required authorisations to provide advice on the transfer of safeguarded benefits.
- The reference number of the company or business in which the adviser works.
- The name of the member and the scheme name.
Trustees should keep the adviser’s written confirmation. Before processing the transfer, they must verify the adviser’s details on the Financial Services Register maintained by the FCA. If advice is received from an adviser who is not on the FCA Register, trustees must not make a transfer. Trustees should keep a record of their checks before processing the transfer.
Impact on scheme funding and when transfers may be reduced
The Guidance makes the following points:
- Trustees should consider the impact on their DB scheme’s funding that the number and size of transfer requests could have.
- Trustees should identify any potential for different classes of transferring members to disproportionately affect scheme funding. Care with transfer bases will be especially important for smaller schemes where the departure of a few members with very large transfer values relative to the total scheme assets could have a disproportionate impact on the funding of the scheme.
- In some situations, reducing transfer values for underfunding may be appropriate. The Regulator’s guidance on transfer values sets out the matters that trustees should consider.
- A decision to reduce transfer values should be kept under review to ensure the level of reduction remains appropriate.
Circumstances where employers must pay for the advice
Under regulations, employers are required to pay for appropriate independent advice where they, or the trustees, or another third party on their behalf, encourages, persuades or induces the member or the survivor to take a transfer or a conversion of benefits.
The Guidance explains that routine communication from trustees (including pre-retirement communications that include a transfer value) or where the trustees routinely include transfer values as part of an annual benefit statement, would not trigger these requirements.
However, care must be exercised that trustees do not place a particular emphasis on particular option(s) and that communications should be ‘unbiased’. Trustees should consider the employer’s reasons for any request to include transfer values and/or information about transferring when communicating with members. In such a situation, they should take advice.
The Regulator will review the Guidance in 2016.
The extended scope of the final version of the Guidance, particularly in relation to transfers made under a scheme’s rules is to be welcomed. Scheme transfer rules would have been drafted with the previous statutory transfer regime in mind. Schemes, especially those with complex structures, such as sectionalised schemes offering a mix of DB and DC benefits, should review and consolidate their transfer rules to ensure they reflect what is intended, particularly in light of the revised legislation that allows transfers at benefit category level.
The pensions press has reported an increased demand for DB to DC transfers from 6 April 2015. The Guidance points out that this may cause a strain on the scheme’s funding and that scheme trustees may have to consider reducing transfer values. As well as the statutory provisions relating to when transfer values may be reduced, there may be provisions under scheme rules relating to a reduction of (non-statutory) transfer values. Trustees considering a reduction in transfer values should obtain legal and actuarial advice.
2. Last man standing schemes should confirm to the PPF by 29 May that they have received legal advice, to qualify for a Levy reduction
A ‘last man standing’ scheme is a scheme in which the last remaining employer is responsible for securing the liabilities; in such schemes, the termination provisions will not require that a proportion of assets be segregated and the liabilities of a withdrawing employer be secured when that employer withdraws from the scheme i.e. there will no partial wind-up rule. The PPF used to apply a flat rate discount (of 10%) to the PPF Levy for last man standing schemes on account of the fact that no claim on the PPF will arise until all employers have entered insolvency, leading to a potentially lower risk of claims on the PPF compared to single employer schemes or those with an optional discretion to segregate assets and secure liabilities.
In its consultation on the Pension Protection Levy framework in May 2014, the PPF reviewed its approach, expressing concerns that in some last man standing schemes there is no genuine spreading of risk, especially where the smallest employer is the last man standing. For our update on the consultation, click here. In its response to the consultation, the PPF stated that full discount would be available where the scheme membership was widely dispersed, but where the membership was highly concentrated with perhaps a handful of members in employers other than the largest, very little discount would be applied.
Schemes currently have to indicate whether they are a last man standing scheme on their annual scheme return. According to The 2015/16 Levy Policy Statement (dated December 2014), schemes that are classified as last man standing on their scheme return should receive an email from the Regulator, requiring them to confirm via an online form to the PPF that they have received appropriate legal advice from an appropriate solicitor, confirming that the current scheme rules do not contain any requirement or discretion for the trustees to segregate assets on cessation of participation of an employer. This will make clear that where trustees can be required to segregate assets at the option of another party, i.e. the employer, that this test is not met. Schemes must confirm to the PPF by 29 May 2015 that they have received the required legal advice.
Last man standing schemes that wish to qualify for a discount to the PPF Levy should obtain the legal advice required and confirm to the PPF via the online form that they have obtained the advice by the 29 May deadline. Schemes are not required to supply a copy of the advice to the PPF although the PPF may require it in the future. Failure to do so will mean that no discount factor will be applied by the PPF to the scheme’s PPF Levy.
Where schemes have confirmed to the PPF that the appropriate advice has been obtained, the actual discount given will depend on the precise dispersion of the members across the employers of that particular scheme. The Levy Determination contains a mathematical formula to calculate this based on the number of members, allocation of members, and number of employers for each particular scheme. The discount factor for any particular scheme will be between zero and the current flat rate discount.
For further assistance, please speak to your usual contact in the pensions team.
3. Pensions Regulator's revised guidance reflecting recent changes to the auto-enrolment regime
The Pensions Regulator has updated its auto-enrolment guidance in light of recent technical legislative changes made to the auto enrolment regime. These changes took effect from 1 April 2015.
Alternative tests for DB schemes
Following the technical changes, new tests are now in place which defined benefit (DB) schemes can use to demonstrate that they meet the requirements of an auto enrolment scheme (“the quality requirements”).
The first test is intended for schemes that, following the changes to the definition of “money purchase benefits” under the Pensions Act 2011, are now classified as DB schemes but otherwise have features of a money purchase scheme. An example is a scheme that provides DC benefits with a guarantee as to the minimum level of investment return. Such schemes may find it easier to demonstrate that they meet the quality requirements for a DC scheme (due to the contribution rate). The new rules allow such schemes to meet the DC quality requirements.
The other tests are based on the cost of funding future accrual of benefits. These new tests will be useful for schemes that currently rely on the contracted-out scheme test for DB schemes but which they will no longer be able to satisfy when contracting out on a defined benefit ends in April 2016.
Paring back of the information requirements – Regulations have been introduced with the aim of reducing communications an employer must send to members in relation to auto enrolment.
‘Exceptions’ from the duty to auto-enrol – an employer “may” now choose to enrol or re-enrol certain employees (but does not have to). Principally, these are:
- Employees that have tax protection (such as primary protection, enhanced protection, fixed protection and individual protection) – this is to ensure that the employee does not lose the benefit of the tax protection by virtue of being auto-enrolled and accruing further benefits.
- Where an employee is in a notice period six weeks after the employee’s auto enrolment (or auto re-enrolment date).
Employers should consider how these changes apply to them. DB Schemes that want to take advantage of the new quality requirements should consider which of the new tests are suitable for them. Employers will also need to decide whether or not they will auto-enrol employees who they now have a discretion to auto-enrol. Auto-enrolment schemes will also need to consider the revised information requirements. For more about the implications of these changes, speak to your usual contact in the Pensions team.
4. DWP revises its guidance for trustees on the charges cap
The DWP has revised its guidance on caps on charges to reflect the recent amending regulations which clarify that the cap on charges provisions do not apply to AVC only arrangements. The DWP had consulted on the changes in March.
The deadline for complying with the cap on charges provisions was 6 April 2015. For our detailed update on these requirements, click here. Trustees of DC auto-enrolment schemes should take steps to ensure that the charges on default arrangements are below the cap, if they have not already done so. For further information, speak to a member of the Pensions team.
5. High Court rules that “pensions contributions” includes a section 75 debt
The High Court has held that a term in a service agreement to pay “pensions contributions” included payment of debt under section 75 of the Pensions Act 1995.
A group-wide service agreement existed between a holding company, MF Global Holdings Europe Limited (“Holdings”) and a service company, MF Global UK Services Limited (“Services”). Services employed staff and seconded them to other group companies, including a company called MF Global UK Limited (“MFG UK”), a subsidiary of Holdings.
There was no express agreement between Services and MFG UK governing the secondment arrangements. Under the group-wide service agreement, MFG UK had to pay “payroll costs”, including “pensions contributions”, to Services for seconded staff.
Services went into administration and a section 75 debt of around £35k was triggered. The question arose as to whether MFG UK was obliged to indemnify Services for the liability to pay the employer debt.
The Court held that although there was no express contract governing the secondment arrangements between MFG UK and Services, there was an implied contract between them. This was because:
- MFG UK was reimbursing Services for the employment costs of seconded staff. This included sums equal to the employer’s pension contributions paid by Services to the pension scheme.
- MFG UK was paying deficit reduction contributions directly to the Trustees of the scheme, pursuant to a recovery plan agreed by Services with the Trustees.
The Court considered that these payments were in the nature of contractual obligations, and that they evidenced an intention by MFG UK and Services to enter into legal relations.
The Court held that the terms of the implied contract were the same as the terms of the group-wide service agreement. In reaching this conclusion, the Court placed significant weight on the corporate structure of the MF Global Group. The Court noted that Services was reimbursed without any mark-up for its liabilities as an employer by the companies to which staff were seconded; Services did not carry on any trading activity and had no ability to meet any liabilities except through the amounts recharged; and Services had no net assets and a small deficit each year. As such, Services would be unable to repay any section 75 debt that might arise from time to time and would thus automatically become insolvent absent an obligation on MFG UK to recharge any section 75 debt. The Court considered it unlikely that such an outcome was intended. The Court regarded the argument that the Pensions Regulator could impose a Financial Support Direction to satisfy any employer debt liability as being no answer to the issue, as it would not prevent Services from becoming insolvent. Comment
Although the Court’s decision provides authority for interpreting a term in an agreement covering payment of “pensions contributions” to include payment of a section 75 debt, the case is highly fact specific. In this case, the Court’s decision was highly influenced by the fact that MFG UK was reimbursing Services for employment costs and making deficit reduction contributions directly to the Trustees, as well as the corporate structure of the MG Global Group. As such, if parties to a service agreement or any other agreement wish to include payment of a section 75 debt, then they should refer expressly to the section 75 debt.
6. Supreme Court turns down trustees' appeal in Olympic Airlines case
Olympic Airlines, which was incorporated in Greece, had three UK offices and several employees in the UK. It entered into insolvency proceedings in Greece in 2009, at which point the Olympic Airlines SA Pension & Life Assurance Scheme (the "Scheme") had a deficit of about £16 million. Olympic Airlines was unable to pay the debt.
In September 2009, Olympic Airlines closed two of its UK offices. On 20 July 2010, the trustees of the Scheme applied to the High Court of England and Wales to wind up Olympic Airlines in a secondary insolvency under the Insolvency Act 1986 so that there was a "qualifying insolvency event" for the purpose of the PPF eligibility requirements and the Scheme could enter the Pension Protection Fund. The "qualifying insolvency event" in this case was to be the making of a winding up order in the UK.
The High Court's power to wind up a foreign company in these circumstances turned on whether Olympic Airlines had an "establishment" in the UK (under Regulation 1346/2000 on Insolvency Proceedings 2000). An "establishment" is defined in the Regulation as a "place of operations" where the debtor carried out "non-transitory economic activity with human means and goods." The High Court had made a winding-up order, finding that the Olympic Airlines UK activities had amounted to an "economic activity". The Court of Appeal, however, overturned that decision. It held that economic activity had to be more than activity relating to the winding up of Olympic Airlines' affairs.
The Supreme Court upheld the Court of Appeal's decision, and held that acts of internal administration were not sufficient. The Court found that Olypmic Airlines was not carrying on any business activities on 20 July 2010 and that business activities had stopped some time beforehand. Olympic Airlines' three remaining employees were handling matters of internal administration associated with the disposal of the means of carrying on business. Furthermore, the Court held that there had to be at least some subsisting business with third parties, even if the exact nature of the business and the degree to which it had to be visible to outsiders might be open to argument. Olympic Airlines, however, was not conducting any external business in the UK.
After the Court of Appeal's decision, the PPF entry rules were amended to include a new "insolvency event" so as to effectively allow the Scheme to qualify for the PPF on the basis of the Greek proceedings. However, the new insolvency event is only deemed to occur on the fifth anniversary of the date of the Greek proceedings (i.e. 2 October 2014). The appeal was therefore still important to the trustees in that the Board of the PPF may now require the trustees to claw back any overpaid benefits between the commencement of the Greek liquidation proceedings in 2010 and the new insolvency event, a period of over 4 years. The court however did not make a ruling as to the extent to which the PPF may or may not require the trustees to claw back benefits already paid out to members in the interim.
7. Further determinations from the Ombudsman on transfers to suspected pensions liberation schemes
The Pensions Ombudsman has issued three fresh determinations relating to complaints by individuals concerning transfers of their pension pots to suspected pensions liberation schemes.
The first two relate to the same individual, Mr Winning, who made a complaint against both Legal & General and Scottish Widows, with whom he had personal pension plans, that they had transferred his pension pot to a pension scheme called the Capita Oak Pension Scheme, without making the necessary checks about the receiving scheme. Following the transfer, Winnings had difficulty contacting the Capita Oak Pension Scheme and became worried about his money.
The Ombudsman dismissed Mr Winning's complaint against Legal & General and Scottish Widows, holding that Scottish Widows and Legal & General had complied with good industry practice at the time. In both cases, the providers had received paperwork supplied by the Capita Oak Pension Scheme, stating that it was a defined contribution occupational pension scheme and that it was registered with HMRC (a registration number was provided). A declaration was also supplied by the Capita Oak Pension Scheme that it was willing to accept the transfer payment which would be applied to provide benefits consistent with the HMRC scheme registration. Mr Winnings had also completed the paper work requesting the transfer.
The transfers were completed in November 2012 before the Pensions Regulator had issued its guidance about pensions liberation in February 2013. The Pensions Regulator's guidance sets out an extensive list of checks that transferring scheme trustees and providers of transferring schemes should make before transferring to a suspected pensions liberation scheme. However, the Ombudsman held that he could not apply the current levels of knowledge and understanding of pensions liberation/scams or present standards of practice to a past situation. Both Legal & General and Scottish Widows were faced with a member who apparently wished to exercise his legal right to transfer and a receiving scheme that was properly registered with HMRC and had provided the appropriate declarations and information. The providers were under a statutory duty to make the transfer and did so. The Ombudsman added that Mr Winnings may have been lured into making the transfer in search of "high investment returns" and an "inducement of a cash sum" and that even if Mr Winning had been warned that the transfer was an unusual or risky step, he may still have persisted with the transfer.
In the other complaint, Harrison, the Pensions Ombudsman ordered Prudential to transfer the complainant's, Mr Harrison's, individual personal pension pot, after Prudential refused to transfer it on suspicion that the receiving arrangement, the Cheshire Food Services Pension Scheme, was a pensions liberation scheme. Among Prudential's concerns was that, for various reasons, the scheme could not be regarded as properly registered with HMRC. The Ombudsman held that on the facts, Mr Harrison did have a right to a transfer under the rules of the Prudential scheme. It was up to Prudential, not the member, to satisfy itself that there was a right to a transfer under the rules and process the transfer accordingly. If Prudential had concerns about the registration status of the receiving scheme, this was not enough to regard the scheme's registration as invalid - it merely made it suspect. Prudential was directed to make the transfer, with a transfer value that is the higher of:
- the transfer value as at 31 July 2013 (the date, the Ombudsman held, by which Prudential should have reached the decision that Mr Harrison was entitled to exercise his contractual right to transfer to the Cheshire FSP) plus simple interest; and
- the transfer value at the date of payment.
The determinations relating to Legal & General and Scottish Widows confirm the Ombudsman's position that so long as the individual has a statutory right to transfer or a right to transfer under the rules and the providers (or trustees of occupational pension schemes) have complied with good industry practice, that they are unlikely to be at fault for making a transfer to a pensions liberation scheme. The onus however is on the provider or the trustees to check whether the individual has a right to a transfer under the statutory provisions and under the scheme rules.
The Harrison determination is a warning that where there is a right to transfer, providers or trustees may be liable if they refuse a transfer on suspicion that the receiving scheme may be a pensions liberation scheme.
Pension Protection Fund
8. PPF explains that many of the Budget 2014 changes do not apply to it
The Pension Protection Fund has issued its Technical News (Issue 7) explaining the implications of the Budget 2014 measures for schemes that enter a PPF assessment period and transfer to the PPF. It reminds readers that the benefits that the PPF can pay as compensation do not always follow the pattern of benefits more generally applicable to occupational pension schemes.
Notably, the PPF will not be able to pay an Uncrystallised Funds Pensions Lump Sum to discharge money purchase benefits.
Given that the PPF cannot pay a UFPLS when a scheme has been transferred to the PPF, trustees should make sure any UFPLS's are paid prior to a scheme’s transfer to the PPF so that the opportunity for benefits to be fully commuted is not lost.