Summary

The DWP has published its response to the consultation on the Deregulatory Review, outlining the responses it received and setting out the Government’s decisions taken in relation to the issues consulted on, in particular the reduction in the revaluation cap on deferred pensions and exercise of a statutory override to enable schemes to be amended to reflect proposed changes. Other matters addressed include employer debt and scheme surpluses.

Introduction

In August 2007, Chris Lewin and Ed Sweeney submitted to the Department for Work and Pensions (DWP) their report entitled “The Deregulatory Review of Private Pensions” and the DWP published its response to the Review’s recommendations in October 2007. On the back of that response, the DWP then consulted the pensions industry on the issues highlighted below. On 5 December 2007, the DWP published the results of the consultation, and this briefing outlines the responses received by the DWP and the Governmental decisions that have subsequently been taken.

The principal issues upon which the DWP consulted the pensions industry were:

  • a reduction in the revaluation cap on deferred pensions from 5 per cent to 2.5 per cent for future accruals;
  • the introduction of a statutory override to enable schemes to be amended to reflect the reduction of the Limited Price Indexation (LPI) cap from 5 per cent to 2.5 per cent for pensions in payment and/or the proposed reduction in the revaluation cap; and
  • the introduction of legislation governing certain types of risk-sharing pension schemes.

Revaluation of deferred benefits

The Government’s concern about the continuing decline in final salary occupational pension provision was behind its support for the proposal to reduce the revaluation cap for deferred benefits from 5 per cent to 2.5 per cent for future accruals. This proposal was generally welcomed by employers and the pensions industry. However, most responses also cautioned that the proposed change in revaluation alone would be unlikely to have a significant impact on employers' decisions on whether or not to continue to provide final salary pensions.

Most organisations representing members (e.g. the TUC and various trade unions) were strongly opposed to any change to the cap. This view was supported by Standard Life and First Actuarial, with concerns focusing on the potential impact of future high inflation, the possible negative impact on labour market mobility and the risk of a disproportionate impact on women and carers.

Decision - having considered all the representations, the Government has decided to proceed with this proposal and to reduce the level of the cap to 2.5 per cent going forward. Relevant provisions will be included in the forthcoming Pensions Bill.

Statutory override

Three main questions were posed by the Government in relation to the statutory override:

  • Should any statutory override to restrictions on amendments in scheme rules be exercisable only if trustees and employers agree to the change, or should it be available to employers without trustee consent?
  • If trustee and employer consent is appropriate, should special provision be made for paid-up schemes administered by insurance companies where there is no employer and they are unable to implement the changes required under the Finance Act 2004? Is the inability to make changes creating significant problems for such schemes?
  • Is there any case for any particular classes of schemes to be exempted from any statutory override? If so, which schemes should be exempted?

As with revaluation, the responses were distinctly spilt. Organisations representing employers were in favour of an override and wanted it to be available for use by employers without trustee consent. Unions who responded to the consultation were mostly against an override in principle, and in the event one was provided, considered it should be exercisable only with trustee consent. Some responses raised concerns that allowing the employer alone to make use of the statutory override could risk undermining the balance of power in the scheme.

Decision - the Government has decided that overrides to enable scheme rules to be amended to reflect the 2004 change to the indexation cap for service going forward and for future change to the revaluation cap should be exercisable with the agreement of both trustees and employers. Appropriate regulations will be issued in due course.

Risk-sharing schemes

Risk-sharing schemes represent a half-way house between final salary arrangements in which all the investment risk falls on the employer, and money purchase arrangements that leave all risks with the employee. The suggestion was that the current restrictive regulatory framework should be adjusted to facilitate the creation of risk-sharing schemes to halt the shift from final salary schemes into pure money purchase arrangements that leave all risks with the employee.

Three key areas which might facilitate the development of risk-sharing schemes by giving employers greater flexibility over managing their future liabilities were identified as:

  • removing the statutory requirement to provide future indexation for pensions in payment;
  • reducing the cap on the required future revaluation of deferred pensions; and
  • making it easier for employers to change normal pension age for all service (not just for future accruals) to take account of increasing longevity.

The DWP asked two main questions:

  • Would it be appropriate to introduce a third layer of legislation which would make provision for a specific type of risk-sharing scheme and to introduce flexibility for such schemes, for example, on revaluation and indexation, which currently does not exist? Is the model outlined in the Review the right model?
  • Alternatively, is there already sufficient flexibility for innovative approaches to risk-sharing?

Many responses were sceptical about the idea of a third layer of legislation for risk-sharing schemes. Most rejected a wholly new regime and hoped the existing regime could be amended or relaxed to allow more risk-sharing approaches. Other comments related to conditional indexation, where indexation would be targeted and employers would be required to fund prudently with the intention of providing indexation. In the event of a deficit in any given year, employers would be allowed to forego indexation for that year, with the lost indexation being restored in the event of a future surplus.

Decision - the Government will continue to work with the Pension Protection Fund on their treatment of risk-sharing schemes and will liaise with the Pensions Regulator to consider the scope for sharing information about existing risk-sharing schemes. The Government also proposes to explore the practical implications of issues such as conditional indexation but remains to be convinced that such measures would provide sufficient incentive for employers to continue with final salary pension provision. No immediate legislation is contemplated.

Limited price indexation of pensions in payment

Subject to what was said above on the exploration of conditional indexing, the DWP does not believe that the removal of such an important protection for members would strike the right balance between employer concerns and member protection. While trade unions welcomed this decision, employers were disappointed, as some felt that a change would have been a significant encouragement to maintain or even re-open final salary pension schemes.

Decision - no changes will be made to the current requirements.

Accrued rights

Where the issue of accrued rights was raised, the Government’s proposal not to make any changes met with the approval of respondents to the consultation. Decision - no regulatory changes should be made which would adversely affect the position of pensioners, deferred members or the past service rights of active members.

Scheme surpluses

The Government did not agree with the Review’s recommendation that a return of scheme funds to the employer should, with trustees' agreement, be available once the scheme specific funding target had been met. Most actuaries and employers who responded to the consultation felt that the requirements concerning surplus are too onerous and could discourage employers from agreeing to sufficiently prudent funding objectives for their scheme. The TUC felt that the ownership of surplus was not straightforward and that, in some cases, the first call on any excess scheme funds should be to restore any member benefits under the scheme that have previously been reduced.

Decision - the Government has decided not to pursue the removal of the legal requirement for trustees to be satisfied that a payment of surplus to the employer must be in the scheme members' interests. Other means to address concerns about funds building up in schemes will be explored over the coming months.

Pension sharing on divorce

There are concerns about the complexity of the requirements and the different treatment of pension credit rights. The DWP agreed that some of the requirements are unnecessary and that it will repeal the legislative requirements relating to safeguarded rights (that part of a pension credit following a pension sharing order which is attributable to the member’s contracted-out benefits).

Decision - the repeal of the legislative requirements relating to safeguarded rights will be taken forward in the Pensions Bill. There will be further consultation on other aspects of pension sharing in the first half of 2008.

Trustee knowledge and understanding

The Government rejected the Review’s recommendation to amend legislation on trustee knowledge and understanding, although it did accept that there may be widespread misconceptions about the burdens imposed by the existing requirements. The recommendations on overriding legislation on trustee legal expenses and personal liability issues were also rejected.

There was a high level of agreement in the responses to the consultation. Although it was felt that the Government should put in place sufficiently clear guidance for trustees, the current legislation was considered by some respondents to be less restrictive than many employers believe.

Decision - the Government will discuss with the Pensions Regulator what clarification can be offered to trustees.

Trivial commutation

In the 2006 Pre-Budget Report, in response to pensions industry concerns over the administration of trivial commutation, the Government announced that HM Revenue and Customs would discuss with interested parties the administration of the trivial commutation rules. These discussions are ongoing. Responses have highlighted the risks of satisfying the contributor’s short term interests at the expense of the longer term, and that the main difficulty from 6 April 2006 has been aggregating benefits to decide whether a member’s rights are less than 1 per cent of the lifetime allowance.

Decision - no decision as yet. The consultation responses have been shared with HMRC and will be considered as part of the ongoing discussions.

Employer debt

The Government has accepted the recommendations in the Review to allow a 12 month period of grace after an employer ceases to employ any active members in a scheme before the triggering of an employment cessation event and the resultant statutory debt on the employer. Responses to the relevant consultation are now being considered.

In some responses to the consultation, it was noted that the triggers leading to a statutory debt on an employer do not always reflect the policy intent. While the TUC believed the employer debt should be triggered unless an alternative withdrawal agreement is approved by the trustees and the Pensions Regulator, others thought this was excessively burdensome. The CBI proposed that corporate restructurings should be excluded from section 75 (of the Pensions Act 1995) altogether, particularly where the employer's covenant is not weakened following the change.

Decision - amendments to the current employer debt regulations are planned shortly. In addition, the Government intends to work with industry over coming months to seek a practical solution to the difficulties presented by the current provisions which does not undermine the principle that employers should meet their pensions obligations in full.

Principles-based legislation

The Government agreed in principle to the Review’s recommendations for a more framework-based approach to legislation and is encouraged that responses show agreement that legislation governing disclosure of pension scheme information is the right place to start.

Decision - a working group of key stakeholders has been set up and has met to agree the broad parameters for the work. The next meeting of the group is in January 2008 with the aim being to produce a report by summer 2008, and to have new legislation in force by April 2010.