Outcome of Government consultation
In light of the forthcoming abolition of defined benefit (“DB”) contracting-out in 2016, the UK Government is introducing legislation which will provide a unilateral power to sponsoring employers of private sector contracted-out DB schemes that are open to accrual, to amend their schemes to adjust for the loss of the employer’s National Insurance Contribution (“NIC”) rebate when DB contracting-out is abolished.
It will not however be possible for an employer to use the power to modify the benefits or contribution rate of members of certain pensions schemes who were granted legislative protection when their industries were privatised in the 1980s and 1990s (“Protected Persons”).
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. When the current state pension is abolished on 5 April 2016 to make way for the single-tier State Pension, schemes that have been contracted-out of the earnings-related element and whose 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), will lose that rebate. Going forward sponsoring employers and members will start paying standard rate NICs, thereby increasing costs to both parties.
Employer modification power
Clause 24 and Schedule 14 of the Pensions Act 2014 provide sponsoring employers of contracted-out schemes with the power to amend members’ future benefits or increase member contributions unilaterally to take account of the loss of the employers’ NIC rebate.
Employers will be able to use this modification power: (a) to increase the member contributions of the relevant members; (b) to alter the future accrual of benefits for or in respect of the relevant members; or (c) a combination of the two. The power can be exercised within five years of 6 April 2016. An employer intending to exercise the modification power will have to carry out 60-days pensions consultation with affected members.
In order for a rule change to be permitted under the modification power, the value of the reduction in accrual or the increase in member contributions may not exceed the additional NIC cost to the employer in respect of the relevant members. An actuarial certificate is required to confirm that this condition is met.
This modification power is standalone, and entirely separate from the powers of amendment under a scheme’s rules. Accordingly, provided the actuarial certificate described above can be given, an employer will be able to amend the rules, even if the amendment would ordinarily fall foul of any restriction under its scheme’s rules. If the amendment goes beyond what would be permitted by the statutory modification power, the scheme amendment power will have to be followed.
In bringing forward the statutory modification legislation, the Government consulted on whether to allow employers to use the power in respect of Protected Persons. At the time of nationalisation of the electricity, coal and rail industries in the 1980s and 1990s, legislation was put in place which broadly required the new private sector employers to provide pension benefits at least as good as those being earned at the time privatisation. It also prevented those employers (and their successors) from making changes to future benefits or increasing member contributions, except, in certain cases, where prescribed conditions are satisfied.
Following the above consultation, the Government decided not to allow the modification power to be used to affect the contributions or benefits of a Protected Person “The Government thinks it is import to stand by the promises made to former state workers at the time of privatisation. Therefore the Government proposes that employers should not be allowed to use the statutory override to alter the pension schemes in relation to members with protected person status.”. Therefore, an employer’s ability to pass on its increased costs as a result of the abolition of contracting-out will differ between those of its members who are Protected Persons and those who are not. This would not prevent employers of Electricity and Coal Protected Persons from seeking to pass on the NIC increase to Protected Persons using their scheme’s amendment power, however notoriously difficult member consent conditions would need to be satisfied for the amendment to be valid.
Given the conclusion of the consultation, employers should also anticipate significant interest from trade unions in the event of any proposals which could affect Protected Persons. In practice, any attempt to vary the benefits or contribution rate of Protected Persons would need to have some level of support from the recognised trade unions which represent the Protected Persons in order to have any chance of being implemented.
Amendments for non-Protected Persons
Employers with a mix of Protected and non-Protected members may therefore wish to consider whether to pass on their increased NIC costs to non-Protected Members and address any industrial relations implications of this.
Although not a requirement of the legislation, employers would be advised to consult with their scheme’s trustees as to the manner in which they intend to exercise the modification power; trustees are likely to favour the administration of a contribution increase over the introduction of a new benefit structure, which will increase the cost and complexity of scheme administration. Trustees may also wish to satisfy themselves – with the benefit of their own actuarial advice - that any proposals by the Company to adjust member contributions or benefits do no more than neutralise its increased NIC costs.
Sponsors of contracted-out DB schemes should have this issue on their agenda for Q2 of 2015, with a view to being in a position to consult affected members by Q4 and implementing any changes by the end of Q1 of 2016.
Companies will need appropriate actuarial and legal advice before finalising any modification proposals and should engage the trustees of their scheme at the earliest opportunity.
Trustees that have been engaged fully in the proposal by the company may be willing, where scheme rules permit, to agree to the amendments instead being made under the scheme’s normal amendment power, which may make the proposal more palatable to affected members.