A round-up of pensions developments: November 2013
Top of the agenda
1. A ‘Bridge’ too far? – DWP consults on changes to the definition of “money purchase benefits”
The Department for Work and Pensions (DWP) has issued a consultation proposing to bring into force from 6 April 2014 provisions in section 29 of the Pensions Act 2011 that will change the statutory definition of “money purchase benefits” with retrospective effect from 1 January 1997 to the effect that a money purchase benefit will be a benefit in respect of which a deficit cannot arise – this despite considerable representation from various pensions groups during the informal consultation stage recommending that the change should be prospective.
Section 29 was introduced following the decision of the Supreme Court in Houldsworth and Another v Bridge Trustees Limited and Another and Secretary of State for Work and Pensions on 27 July 2011. The Supreme Court held in that case that the following benefits and practices fell within the statutory definition of ‘money purchase benefits:
A money purchase pot that is subject to a guaranteed rate of investment return.
Where a scheme converts a member’s money purchase pot into a pension which is then paid from the scheme (i.e. self annuitization), as opposed to the scheme buying an annuity from an insurance company.
The DWP issued a statement on the same day stating that it would amend the statutory definition of ‘money purchase benefits’ so that such benefits would fall outside the definition (and therefore be classified as defined benefits). A deficit could arise in relation to such benefits and if these benefits were not classified as defined benefits, there would be no statutory obligation on the employer to fund them, nor would members with such benefits be eligible for Pension Protection Fund compensation in respect of them.
Which schemes will be affected?
The proposals will affect:
Cash balance schemes (as they provide some form of guarantee during the accumulation phase and so are providing a ‘Bridge’ type benefit) which have treated themselves as money purchase;
Hybrid or money purchase schemes with ‘Bridge’ benefits that have treated them as money purchase.
The proposal will not affect schemes that have treated ‘Bridge’ benefits as defined benefits.
Draft regulations to temper impact of retrospective changes
To temper the impact on schemes of the retrospective nature of the amendment, the DWP has also issued for consultation draft regulations ("Regulations") to ensure that affected schemes will not have to revisit decisions made from 1 January 1997 to the DWP’s Statement of 27 July 2011.
Whilst this is to be welcomed, this does mean that affected schemes will have to revisit certain actions taken from 27 July 2011, principally in relation to the following:
Any employer debt event occurring on or after 28 July 2011 and any arrangement (other than a regulated apportionment arrangement or an approved withdrawal arrangement) will need to be revisited. Trustees will have to direct the actuary to issue a fresh employer debt certificate that includes the ‘Bridge’ benefits. This is likely to lead to a higher employer debt figure than under the previous method of arrangement. Arrangements will need to be made to deal with the debt - a default is prescribed under the draft regulations if arrangements dealing with the additional liability cannot be made.
Winding-ups triggered after 27 July 2011:
Any scheme with affected benefits that started winding-up on or after 28 July 2011 and completed before 6 April 2014 will need to be revisited if, broadly, members' entitlements under the scheme have not been met in full or if the former trustees take the view that further assets could be obtained from the employer by reopening the employer debt calculation.
Scheme funding, transfers-out and PPF eligibility
Thankfully, some of the provisions are only going to apply prospectively. Schemes will have to comply with the scheme funding regime in respect of ‘Bridge’ benefits from the date of the Regulations. In other words, there will be no need to produce funding valuations for the past, to revisit those already produced or revisit scheme funding obligations before the date the Regulations come into force. Similarly in relation to members who have transferred their benefits out of the scheme, there will be no obligation on the schemes to revisit such transfers made before the date of coming into force of the Regulations. Going forwards, ‘Bridge’ benefits will need to be treated as defined benefits in calculating members’ transfer values.
With respect to the PPF, schemes may be eligible for PPF compensation in respect of ‘Bridge’ benefits from 31 March 2015. This does, however, leave a gap between now and that date where it seems that schemes would not be eligible for PPF compensation in respect of "Bridge" benefits. The Government has asked if people are aware of any schemes that may be tipped into a PPF assessment period between now and the date of the Regulations, but it is not clear what it will do if the response to the Consultation shows that there are schemes at risk of going into a PPF assessment period between now and 31 March 2015.
As regards schemes in a PPF assessment period, broadly, they will not have to revisit the way in which any “Bridge” benefits have been treated. For instance, if they have been discharged as money purchase benefits outside the PPF, this will not need to be changed.
From 1 April 2015, schemes will also have to pay a Pension Protection levy and administration levy in respect of Bridge benefits. However, sensibly, there will not be any retrospective levy collected from schemes in respect of those benefits.
Perhaps the most difficult area under the draft proposals would be for trustees to have to revisit employer debts that have been triggered after 27 July 2011. The draft proposals mean that an employer who had ceased to be an employer (principally for funding and employer debt purposes) would become an employer again and be liable for the additional recertified employer debt, as well as any additional liabilities that may be attributed to the employer given the change in the scheme circumstances since then. The Regulations are also not clear as to what kind of ‘arrangement’ or ‘agreement’ employers may reach to deal with the additional employer debt liability.
Trustees of schemes that started winding up after 27 July 2011 and which have completed winding-up would now be faced with having to deal with the additional liability in respect of ‘Bridge’ benefits. They may find it difficult to buy new annuities in respect of this additional liability or to agree with the current annuity provider to take on this additional liability on competitive terms.
As far as scheme design is concerned, schemes that provide ‘Bridge’ benefits will have to be made aware that these will be defined benefits. Where self annuitization is to be offered (for example to deal with small money purchase pots), employers should be made aware that if those provisions are introduced and trustees implement them in respect of certain members, those benefits would be defined benefits and the scheme subject to the defined benefit regime.
- Desmond & Sons: Northern Ireland Court of Appeal holds that Upper Tribunal not bound by Regulator’s six month time-limit for issuing a Contribution Notice
The Northern Ireland Court of Appeal has allowed an appeal by the Pensions Regulator and the trustee of the Desmond & Sons Limited Life Assurance Scheme against a decision of the Upper Tribunal in April 2012 that it could not impose a contribution notice (CN) on another shareholder of Desmond & Sons Limited.
Desmond & Sons Limited, a clothing manufacturer, had been put into a member's voluntary liquidation (MVL) by the company's shareholders. The effect of the MVL was that an employer debt was triggered, which under legislation as it stood at the time in Northern Ireland, was calculated on a basis known as the Minimum Funding Requirement (MFR) rather than the buy-out basis. A debt on an MFR basis generally produced a much lower debt figure than that calculated on the buy-out basis (which looks at the notional cost to the scheme of buying annuities for the scheme members from an insurance company). The Pensions Regulator issued CNs to two director shareholders principally on the grounds that they had planned the MVL to enhance shareholder value to the detriment of the pension scheme, failed to inform the Trustee of events material to the scheme and acted in such a way as to avoid the Trustee being alerted to the decision to cease trading and enter into the MVL. The directors knew at the time that the legislation was about to change so that the employer debt would in the future be calculated on a buy-out basis. The Pensions Regulator did not issue a CN against Mrs Desmond, another shareholder of the company, however.
On reference to the Upper Tribunal by the parties (the director shareholders and the Trustee among them), the Tribunal held that it had jurisdiction to increase the amount required from the two director shareholders under the CNs already imposed. However, it did not have the power to require the Panel to issue a CN on Mrs Desmond because the Panel was now time barred – broadly, under the relevant legislation, a warning notice for a CN has to be issued within six years from the act or failure that is the subject of the CN - and the Tribunal could not make an order beyond the authority of the Panel. For our update on the Tribunal decision, click here
The Court acknowledged that both parties had accepted that the Trustee was a "directly affected person" for the purposes of being able to make a reference to the Tribunal. It cited the decision in Michel Van De Weile NV v The Pensions Regulator (Bonas Group Pension Scheme)  where it was held that the trustees were a "directly affected person" as the determination to issue a CN required a sum to be paid into the scheme.
It held that a negative decision (in this case the decision by the Panel not to issue a CN) may be referred to the Tribunal under the relevant Northern Ireland legislation. The legislation (Article 34 of the Pensions (Northern Ireland) Order 2005) provides a (six year) time limit in respect of the issue of CNs within which the Regulator must act and imposes a condition that the Regulator must be of the opinion that it was reasonable to impose liability on the person to pay the sums specified in the CN. If the Regulator fails to act within the timeframe or to form the required opinion, then it is deprived of its jurisdiction to impose a CN.
However, the Court held that the powers of the Tribunal are not purely "appellate". The Court of Appeal cited the following powers of the Tribunal:
- its powers to consider any evidence relating to the subject matter of the reference whether or not it was available to the Regulator at the material time (in other words the Tribunal can take into account not only the material that was before the Panel, but may also consider any fresh material).
- The Tribunal may remit the matter to the Regulator with, if appropriate, directions. Those directions include the power to substitute a different determination. The bare meaning of that power is that a new decision takes the place of the original decision from the date when the original decision was made by the Panel, since it is that decision which is being reviewed by the Tribunal.
- The mechanism of remission to the Regulator in compliance with a direction from the Upper Tribunal does not reengage Article 34 including the time limits in Article 34.
However, the Court did go on to make the point that when making a determination as to the appropriate action for the Regulator to take, the Tribunal will consider whether the statutory conditions in Article 34 are satisfied, taking into account the new material before it and basing its conclusion and time by reference to the date on which the Panel made its decision.
For the above reasons, the Tribunal allowed the Appeal. The Appeal will be heard in due course.
The Court of Appeal's decision echoes the reasoning of the English Court of Appeal in relation to the Lehman Brothers Pension Scheme in which it held that the Tribunal was not bound by the two year look-back period for the Pension's Regulator to issue a financial support direction. The Northern Ireland Court of Appeal recognised that while the legislative provisions are "somewhat different" in Northern Ireland, the outcomes are broadly consistent and that in making its decision, it had benefitted from the consideration of similar time issues in the Lehman Brothers decision.
The Pensions Regulator
- Code of practice on governance and administration of occupational DC schemes in force
The Pensions Regulator issued a statement on 21 November 2013 announcing the coming into force of its Code of Practice on the governance and administration of trust-based occupational defined contribution (DC) schemes from the same day. The Regulator had consulted on the Code earlier in the year, together with updated good practice guidance and its draft enforcement policy in relation to trust-based DC schemes – for our summary of the consultation, click here. The final versions of the guidance and the enforcement policy were also published on 21 November.
There is some overlap between the code and the guidance. The code focuses on:
- Trustee knowledge;
- Internal controls/risk;
- Conflicts of interest;
- Investment matters; and
whereas the guidance focuses on:
The Code and the guidance explain 31 DC quality features (some of which the Statement says are present in legislation, others in good industry practice). Twenty two of the quality features are in the Code (these features have a direct legislative underpin and therefore breaching them is likely to be a breach of the law) and the others (only some of which are supported by legislation) are in the guidance.
Trustees of DC schemes and DB schemes with AVCs should ensure that their schemes are compliant with the Code and guidance. The Regulator has said in its Statement that it will undertake thematic reviews of the extent to which trust-based schemes are compliant with pensions legislation and associated good practice. The Regulator will also publish a template "comply or explain " statement next year that DC trustees will be able to use to inform scheme members, employers and the Regulator, whether they meet the DC quality features (or, where the features are not fully present how their approach is in members' interests).
The Statement also highlights the sections in the good practice guidance in relation to transparency and disclosure of costs and charges deducted from a member's fund. The emphasis is timely, given the Government's recent consultation on imposing caps on charges on auto-enrolment DC scheme and their disclosure – for our update on the consultation, click here
- Pensions Regulator publishes new guidance on asset-backed funding
The Pensions Regulator has issued guidance on asset-backed funding (ABF) - in simple terms, using Company assets instead of cash to fund deficits in pension schemes with defined benefits. The guidance is aimed predominantly at trustees and managers of occupational pension schemes but it will also be of value to employers and professional advisers. As well as explaining what an ABF arrangement is, the guidance reviews the risks associated with such arrangements, what the Regulator expects of trustees when entering into them and the Pensions Regulator's approach to ABFs. We will be publishing a full briefing on the new guidance shortly.
- Government publishes ‘Defined Ambition’ proposals
Last year, the Department of Work and Pensions (DWP) published its report, "Reinvigorating workplace pensions", in which it outlined, among other things, its plans to revitalise workplace pensions by encouraging greater risk-sharing between members and employers. The report floated the idea of new "defined ambition" schemes that would create greater certainty in respect of members' benefits, whilst limiting the cost volatility to which employers are exposed.
The DWP has now published, for consultation, a strategy document, entitled 'Reshaping workplace pensions for future generations', outlining a new landscape for DB and DC workplace pensions, and proposing a framework for defined ambition schemes - these schemes would share longevity and investment risks between employers, individuals, and insurance and investment businesses. The government is working with a Defined Ambition Industry Working Group to assess the scope for innovation, explore methods by which defined ambition schemes may be accommodated within existing schemes, and develop new defined ambition models. In doing so, they are being guided by a number of principles that include intergenerational fairness, risk-sharing, proportionate regulation and transparency. The proposals include more flexible DB and DC schemes and new options for collective DC schemes.
Flexible forms of defined benefit pensions
The Consultation floats three models for defined ambition pension schemes based on the existing DB framework:
- Schemes with the ability to pay fluctuating benefits – this would allow employers to choose to provide additional benefits above the simple DB level when the scheme funding position allowed.
- Automatic conversion to DC when members leave pensionable service before retirement date – with this type of arrangement, employers would provide employees with pension benefits that accrued at a given level during the period of employment. If employees left pensionable service before retirement, the level of pension benefit accrued in the scheme would crystallise, and the cash value would be transferred to a nominated DC pension fund. If they died in service or retired at normal retirement age, normal scheme rules would apply.
- Ability to change scheme pension age – employers providing DB-type provisions would be able to adjust their scheme retirement age so that it was based on the projected number of years in retirement, rather than being tied to a fixed age that does not account for changes to longevity. The age at which members were entitled to a full scheme pension could be adjusted to account for changes to longevity assumptions, so that members would be expected to spend broadly the same length of time in retirement.
New Models of Defined Contribution Pension Schemes with Guarantees
Various models are proposed that would provide greater certainty, by way of a guarantee, for members of DC schemes without any funding liability on the employer's balance sheet. These are
- Money-back guarantee funded by the member's funds – this model is intended to ensure that the amount of accumulated savings at retirement or at the point of transferring out of the scheme does not fall below the nominal value of contributions made to the scheme.
- Capital and investment return guarantee – this model would offer guarantees at the mid-point of the pension life cycle, i.e. when members have built up a sum. A fiduciary would purchase the guarantee from an insurance company using the members' funds to secure a guarantee against part of the capital and possibly an investment return for a fixed period.
- Retirement Income Insurance – This model is intended to provide certainty about income in retirement before the member retires, to address the single event conversion risk associated with buying an annuity, and seeks to maximise the investment returns on the member’s fund. Each year from, for example, age 50, a fiduciary would use a portion of the member’s fund to buy, on the member’s behalf, an income insurance product that insures a minimum level of income, which grows each year as further insurance is purchased. At retirement, the saver draws their pension directly from their fund and only if their fund is reduced to zero would the income guarantee insurance kick-in.
- Pension Income Builder – in this model, a proportion of contributions would be used to purchase a deferred nominal annuity, payable from the current pension age. For every year of contributions, individuals would have a pension made up of a series of these deferred annuities, which would vary according to market interest rates and expectations of future longevity. Any remaining contributions would be invested into a collective pool of risk-seeking assets. This pool would be used to provide future indexation on a conditional basis.
Collective Defined Contribution Schemes
The paper also considers whether Dutch-style Collective Defined Contribution (CDC) schemes could be incorporated into the UK pensions framework. Broadly, these schemes offer alternative approaches to risk sharing and pooling assets. The employer pays a fixed rate of contributions, and risk is shared between members. An expected benefit is calculated, but not promised, so the pension on retirement is not certain. The consultation proposes to further explore the changes in the legal framework that would be required to enable CDCs to operate in the UK.
A New Legal Framework
The paper considers whether the existing legislation should be recast to distinguish between DA schemes and money purchase schemes and define DB schemes in their own right. This would allow clear and proportionate regulation according to scheme type to be more easily provided, and would give explicit recognition in the legislative framework to the different types of schemes.
The government previously consulted on the introduction of risk-sharing models into the existing DB and DC framework in 2008. The proposals proved to be unpopular due to the complexity of reform and the need for new or extended regulation to accommodate any changes to the existing legislative framework. The new models too involve a degree of complexity. Pensions Minister Steve Webb has, however, defended the current proposals, on the grounds that without DA schemes, it will be difficult for DB schemes to survive. However, the government does recognise that the feasibility of the proposed new models will require further assessment and development, covering legal, government policy, and financial implications.
- Changes to HMRC's registration process for pension schemes
Changes to registration process for pension schemes
HM Revenue and Customs ("HMRC") has made amendments to the Registered Pension Schemes Manual ("RPSM") to reflect changes to the process for registering pension schemes. The most important change is the replacement of th e "instant" registration system that granted registration instantly on a "process now and check later" basis with a system that will involve HMRC considering applications for registration, and asking for further information if necessary before deciding whether or not to grant the application.
Changes to declarations accompanying an application
As part of the new system, the declarations which scheme administrators must make when making an application for registration have been changed.
Firstly, scheme administrators must now declare that they are responsible for discharging their statutory functions and intend to do so at all times. They must also acknowledge that if they fail to discharge those functions, HMRC might impose penalties on them or deregister the pension scheme, or both.
Secondly, three of the declarations which scheme administrators must make on applying for registration have been altered as follows:
- Scheme administrators must still declare that the scheme meets all the conditions to be a registered pension scheme. The RPSM now emphasises that this declaration must state "in particular" that the scheme "is established for the purpose of providing benefits in respect of persons" in certain circumstances (specifically people who are in retirement; have reached a particular age, suffer from serious ill-health or incapacity and the beneficiaries of people who have died, or people in similar circumstances).
- In addition to stating that to the best of their knowledge or belief the information in the application is correct and complete, scheme administrators must now state that "they understand they are responsible for providing any further information and declarations reasonably required by HMRC in order to consider the application".
- The RPSM now requires scheme administrators to declare that the scheme instruments and agreements do not grant any "indirect" entitlement to unauthorised payments (the former provisions did not distinguish between direct and indirect entitlements to unauthorised payments). Moreover, scheme administrators must now declare that the way the scheme is to be administered "will not knowingly entitle any person to unauthorised payments".
Finally, a paragraph has been added to the RPSM summarising the intentions behind the amended declarations. The declarations are intended to ensure that:
- the scheme administrator provides all of the necessary information and that information is correct;
- the scheme will not facilitate unauthorised payments;
- the scheme administrator will discharge its functions properly and understands the penalties if it fails to do so; and
- the scheme administrator understands it may be liable to a penalty and the scheme may be de-registered if a false statement is made on the application or in respect of any information provided in the application.
Grant of registration
When HMRC grants registration, it will issue a paper notification of registration and must state the date on which registration is granted. Any contributions made before registration is granted will not be able to take advantage of tax reliefs available to contributions to registered pension schemes. Transfers from registered schemes into the scheme before registration is granted will be unauthorised payments.
Transfer requests—confirmation of registration status
HMRC has also changed its process for confirming that a receiving scheme is a registered pension scheme. It will now only confirm that a receiving scheme is a registered scheme if "the receiving scheme is registered and the information held by HMRC does not indicate a significant risk that the scheme was set up, or is being used, to facilitate pension liberation". If HMRC does not give confirmation, its response will set out the conditions for confirmation of registration status and explain that these conditions are not satisfied.
The new process was introduced in response to growing concern over pensions liberation and was announced recently in a joint update from HMRC and the Pensions Regulator. It will give more comfort to trustees when making transfers to another scheme that certain checks have been made at the registration stage that the scheme is a legitimate pension scheme and was not set up for pensions liberation.