Top of the agenda

1. Draft wording for the Pensions Regulator's new objective published

Draft wording has been published in the Pensions Bill 2013 in relation to the Pensions Regulator's new objective.The objective had been announced by the Chancellor in the Budget this year but the precise wording had yet to be issued.The Pensions Regulator's new objective will be to "minimise any adverse impact on the sustainable growth of an employer".The new objective will only apply in relation to the Pensions Regulator's functions in relation to scheme funding; it will not apply to other functions of the Pensions Regulator, such as its anti-avoidance powers. The wording in the Bill is subject to Parliamentary approval and the Bill is expected to receive Royal Assent this year.

Comment

It will be interesting to see how the Pensions Regulator will apply the new objective (once the objective is in force) and how it will affect its approach to funding negotiations between employers and trustees.The earliest indication will most likely be when the Regulator publishes its consultation on revisions to its Code of Practice on Scheme Funding this Autumn and its approach to the regulation of defined benefit schemes, which the Regulator has said will be published as a regulatory strategy early in 2014.

2. The Pensions Regulator's Annual Funding Statement 2013 focuses on a flexible and integrated approach to scheme funding

Two days before the text of the new objective for the Pensions Regulator was published in the Pensions Bill, the Regulator also issued its Annual Funding Statement 2013.The statement applies to schemes with defined benefits, which are carrying out valuations between 22 September 2012 and 21 September 2013.

Key themes of the 2013 statement

  • Flexibilities –  trustees are expected to make greater use, where appropriate, of the flexibilities available in the scheme funding framework.
  • The integrated approach – like last year, trustees are expected to take an integrated approach to addressing employer covenant, investment and funding risks.Trustees are expected to be in a position to evidence how this has been done.However, there is a greater emphasis in the 2013 statement on this integrated approach to managing risks (see below).

The detail

Investment returns and setting discount rates

  • Trustees can use the flexibilities available in setting the discount rates for technical assumptions (essentially the liabilities of the scheme) and the assumptions as to investment returns for recovery plans to adopt an approach that best suits the individual characteristics of the scheme and the employer.
  • Trustees should document the reason for any change in the assumptions for investment returns from the previous valuation.
  • The recovery plan contributions will be affected by the choice of investment return in the recovery plan.It is important that the assumptions for investment return are consistent with the overall risk management of the scheme.So, for instance, if there is a significant mismatch between the assumptions used for investment returns and the actual investment profile of the scheme, this needs to be taken into account in setting the contributions that may be required under the recovery plan.

Setting appropriate contributions and recovery plans

  • Like last year, trustees are expected to take into account what is "reasonable affordable" for the employer in setting contributions levels.As with the previous year, the statement emphasises again that a strong and on-going sponsoring employer is the best support for a scheme.
  • As with the 2012 statement, the starting position for trustees should be to consider whether the current level of contributions can be maintained.The 2013 statement, however, states that where there are "significant affordability issues", then lower contributions and possibly also a longer recovery plan may be considered by the trustees.Where there is a change from the previous valuation, trustees should document the reasons for it and ensure that they have due consideration of the risks.
  • Where there is a tension between the need for scheme contributions and for investment in the employer's business, the solution found should neither damage the employer covenant nor benefit other creditors at the expense of the scheme.If investment in the business is being prioritised at the expense of affordable contributions to the scheme, it is important that it is being used to improve the employer covenant.A similar statement was made in last year's funding statement.However, the wording used there was "where cash is being used within the business" as opposed to any investment being made in the business.
  • Last year's statement also stated that if by paying dividends, there is a substantial risk to the likelihood of the pension scheme delivering the benefit entitlements promised within it, then dividend payments need to be reassessed in light of obligations to the pension scheme.There is no focus on dividend payments and their impact on meeting pension scheme liabilities in this years' statement.

Use of flexibilities and understanding of risk

Trustees should seek an "open dialogue" with the employer and agree how to use the flexibilities within the scheme funding framework to most appropriately fit their individual circumstances.Important considerations will be the:

  • Size of the scheme's liabilities;
  • Deficit and exposure to risks relative to the size and riskiness of the employer's current and expected future operations.

As with last year's statement, trustees are encouraged to take an integrated approach to addressing covenant, investment and funding risks and be in a position to evidence how this has been done.This may require the trustees, where appropriate, to get advice on the strength of the employer covenant.The 2013 statement goes further, however, in emphasising the integrated approach, for instance in suggesting that an analysis of the chance of investment losses arising may be combined with a plan on how support from the employer could mitigate such losses if they occur (for instance through the use of contingent assets).

Integrated risk management is an area that the Pensions Regulator aims to discuss in more detail in its consultation on its scheme funding Code of Practice later in autumn.

How the Regulator will monitor scheme funding

The statement states that the Regulator is moving away from setting triggers that focus on individual items, such as technical provisions.(Last year's funding statement had an entire section on technical provisions which contained, among other things, warnings from the Regulator in relation to smoothing of discount rates.) Instead, the Regulator will build on its suite of risk indicators to filter schemes that need investigation.These risk factors include, for instance:

  • Whether recovery plan contributions and the amount of investment risk reflects the relative strength of the employer and the affordability of contributions;
  • Specific circumstances that have led to the deterioration in the employer covenant or possible avoidance;
  • The shape of the recovery plan;
  • Any major concerns the Regulator had with the previous valuation's submissions.

Where the Regulator does engage with schemes, the key area of focus will be the link between the strength of the covenant, the scheme's investment strategy and the prudence in the discount rates compared to expected investment returns.

Comment

Trustees and employers of schemes carrying outactuarial valuations between 22 September 2012 and 21 September 2013 should consider the guidelines in the Annual Funding Statement 2013 when negotiating funding for the scheme.

In the press release accompanying the 2013 statement, the Pensions Regulator acknowledged the new objective by saying that it expects to see pension trustees agreeing long-term strategies with employers that protect the interests of retirement savers "whilst also enabling viable businesses to thrive and grow".However, employer growth is not specifically mentioned as a factor to be taken into account by trustees when negotiating on-going funding and deficit recover plans with the employer, although, like last year, there is a section dealing with employer investment (see above).In light of the new objective, we may see more explicit focus on employer growth in next year's Annual Funding Statement.

Cases

3. Supreme Court refuses to set aside trustees' actions under the Hastings-Bass principle but allows the actions to be set aside under the principle of mistake

The Supreme Court has agreed with the Court of Appeal in not allowing the actions of trustees of two separate trusts to be set aside under the "Hastings-Bass" rule. The trustees of the trusts in question had set up discretionary trusts, acting on the advice of professional advisers, which had resulted in unexpected, adverse tax consequences. Broadly, the so called Hastings-Bass rule allows trustees' actions to be set aside where trustees have acted outside of their powers or where they have acted within their powers, but when doing so, failed to take into account a relevant matter or taken into account an irrelevant matter. The Court did, however, allow the actions of the trustee of one of the trusts to be set aside under the legal principle of mistake. In reaching its decision, the Supreme Court gave detailed guidance on the Hastings-Bass rule and the principle of mistake. For our earlier briefing on the Supreme Court decision,click here.

4. European Court of Justice ruling casts doubt on PPF compensation cap

The European Court of Justice has cast doubt on whether the caps applicable to compensation payable by the Pension Protection Fund (PPF) comply with the requirements of European Law.

Background

In Hogan & Others, the European Court of Justice decided that Ireland had failed to provide sufficient protection for the pension rights of employees and former employees under occupational pension schemes following the insolvency of their employer, as required by Article 8 of Directive 2008/94 (Article 8).

The case related to complaints brought by 10 members of the Waterford Crystal Limited Contributory Pension Scheme for Factory Employees and the Waterford Crystal Limited Contributory Pension Scheme for Staff.Both schemes had been wound up on 31 March 2009 with a deficit of approximately EUR 110 million, following the insolvency of their sponsoring employer. Owing to the deficit in both schemes, the Plaintiffs stood to receive payments worth only a fraction of their pension entitlements (estimated to be between 18 and 28 per cent) and brought a claim alleging failure on the part of the Irish government to take the necessary steps to ensure that employees' benefits were adequately protected in accordance with the Directive.

The Court drew heavily on its 2007 decision in the UK case of Robins and Others, which had been decided on similar facts. In that case, Mrs Robins had been due to receive 49% of her pension entitlement. The Court found that the UK had not adequately protected the interests of employees (and former employees) and it was established that Article 8, in effect, required an employee to receive at least 50% of his accrued pension rights in the event of the insolvency of his employer. (The PPF was established in the UK in response to that decision).

The Court ruled in favour of the members, restating its decision in Robins and Others that the loss of more than 50% of an employee's accrued pension entitlement constituted a "serious breach" of Article 8 of the Directive. The case has been returned to Ireland's Commercial Court, which will determine the level of compensation payable to the members.

Comment

Although it appears likely that the decision in Hogan & Others will lead to further calls to establish an Irish pension protection scheme, it may also have implications for other Member States, including the UK. Currently, PPF compensation is capped at 90% of accrued benefits (for members below their normal pension age when their scheme enters the PPF), subject to an overall cap of £34,867.04 per annum at age 65.

Following the decision in this case, it is uncertain whether the overall cap applicable to PPF benefits is consistent with the Court's interpretation of the requirement of Article 8, that at least 50% of employees' pension benefits should be protected. To the extent that the cap is found not to comply with Article 8, there is a risk that it may need to be revised.

Pensions Ombudsman

5. Ex-spouse of scheme member not required to pay back substantial overpayment to Scheme administrator

In McNicholas (PO-408), the Pensions Ombudsman upheld a complaint by the spouse of a pension scheme member that the administrator of a scheme, Scottish Widows, could not recover an overpayment of approximately £97,000 made to her.

Background

In connection with her divorce proceedings, Mrs McNicholas had asked Scottish Widows for the transfer value of her husband's pension in the McNicholas Construction (Holdings) Pension Scheme. She was quoted a transfer value of £609,426.74.In reliance on this quote, she went on to negotiate the divorce settlement with her husband, receiving almost half of the value of her husband's pension (£311,473) as part of a pension-sharing order on divorce.

Later, Scottish Widows realised they had overstated her husband's pension, as a result of which Mrs McNicholas had received nearly £97,000 more than she would have under the pension sharing order, had the correct amount been quoted. Scottish Widows reimbursed the trustees of the pension scheme for the overpayment made to Mrs  McNicholas and made a claim against Mrs McNicholas, for restitution, of the amount overpaid.

Decision

The Ombudsman's starting point was that Mrs McNicholas had been unjustly enriched and that, consequently, Scottish Widows could seek restitution of the sum paid.

However, in these circumstances, Mrs McNicholas had a defence of estoppel. A defence of estoppel may arise where one party has made a clear and unequivocal promise to the other, which was intended to be acted on; the other party has acted in reliance on that promise and has acted to his detriment. Alternatively, it may arise where parties have acted on the assumption that certain facts were true; their acceptance of those facts is more than passive; and one party now wishes to ignore that assumption.

The Ombudsman held that there was a defence of estoppel available here: Mrs McNicholas had no reason to disbelieve what had been quoted to her and had entered into an irreversible divorce settlement on the basis of the valuation given. The Ombudsman thought it likely that a different settlement would have been negotiated if the pension was valued differently, as Mrs McNicholas was relying on the settlement to provide for her family.

The potential injustice to Mrs McNicholas on repayment, in the Pension Ombudsman's view, outweighed the injustice to Scottish Widows, so the latter was directed not to pursue its claim. The Ombudsman also considered that there was likely to be a claim for maladministration against Scottish Widows. He argued that it would be "unnecessarily cumbersome" to order repayment to Scottish Widows, only for Mrs McNicholas to then claim money from Scottish Widows in compensation for maladministration

Comment

The key determining factors in this decision seem to be Mrs McNicholas's reliance on the administrator's valuation and the irreversible nature of her divorce settlement. In other contexts, the defences of estoppel or negligent misstatement may not be as easy to establish.

Round up

6. Pensions Regulator publishes a further report in relation to Uniq to clarify its approach to its moral hazard powers 

The Pensions Regulator has issued a further section 89 report in relation to the restructuring in Uniq.  In its earlier report, the Regulator had stated that its view that its moral hazard powers were not available in the case of the restructuring of Uniq Plc "was informed by the fact that the key transactions and corporate events affecting the size of the group took place before those powers were in place".  (Broadly, under the Pensions Act 2004, the Regulator cannot look back to acts or omissions before 27 April 2004 in the exercise of its moral hazard powers.)  According to the Regulator, some readers have interpreted this as meaning that not only can the Regulator not use its moral hazard powers in relation to acts or events before 27th April 2004, but also cannot consider matters before this date when considering "reasonableness" in the exercise of those powers.  The Pensions Regulator has confirmed that, as far as reasonableness is concerned, it can look at acts and events before this date.  In the particular case of Uniq, the acts or events took place before 27 April 2004, and so the Regulator was outside the scope of its moral hazard powers, and therefore the issue of reasonableness in respect of those entities did not arise.

Comment

In its statement, the Regulator states that it can look back to matters before 27 April 2004 when considering "reasonableness" in the context of its "moral hazard powers"(implying that this applies to both the issuing of Contribution notices and Financial Support Directions).  However, in the reasons of the Determinations Panel of the Pensions Regulator in relation to financial support directions imposed on companies in the ITV Group in connection with the Box Clever Group Pension Scheme, the Determinations Panel had stated that when considering reasonableness in exercise of FSDs, the Regulator could look at the period before 27 April 2004 but that this was not the case in relation to Contribution Notices.  The Regulator's recent statement in Uniq would seem to be wider in scope, therefore.

7. Pensions Regulator's key aim over next 3 years is to ensure employers comply with their auto-enrolment obligations

The Pensions Regulator has published its Corporate Plan for the next three years.  One of its key aims for the next three years is going to be to ensure employers comply with their auto enrolment obligations.  To this end, it will continue to focus  on "educating" and enabling" employers in relation to their automatic enrolment obligations, though writing to employers 18 months before their staging dates, webinars, seminars and face-to-face meetings where appropriate.  The Regulator has also summarised it approach to compliance as set out in its compliance and enforcement strategy in relation to auto-enrolment, published in June 2012.

Other aims of the Regulator over the next 3 years will be:

  • Working closely with trustees of defined benefit schemes in relation to scheme funding. Its key aim here will be to promote an integrated approach to risk management, which will take account of funding, employer covenant and investments.  Its annual funding statement (see above) and its revised code of practice on scheme funding , on which it is going to consult this autumn, will form a key part of achieving this aim.
  • Achieving better outcomes for defined contribution (DC) members, given in particular that the use of DC Schemes is expected to rise in light of auto enrolment.  The Regulator will focus on the six principles for good work – based DC schemes, which the Regulator published in the December 2011.  In January this year, the Regulator also consulted on its regulatory approach to DC Schemes, a Code of Practice in relation to DC schemes and accompanying guidance.  The Regulator expects to finalise its regulatory approach to trust – based DC schemes later this year.  The Regulator has also issued a reminder that DC schemes should not be used for auto enrolment where value for money for members, taking into account charges and services provided, is poor.  The Regulator considers this to be a particular risk with small schemes.
  • Improving governance and administration of schemes. The Regulator's strategy to improvements in this area involve focusing on educating trustees through its trustee toolkit, raising awareness over Pensions Liberation fraud, improving internal controls including record keeping and preparing for its new role in relation to Public Service Pensions. (Following the recent enactment of the Public Service Pensions Act 2013, the Pensions Regulator's role has been extended to cover governance and administration of the reformed public service pension schemes.  For a summary of the provision in the Act, click here).

8. Proposals relating to solvency of occupational pension schemes dropped from IORPs Directive review (for now)

The European Commission has decided to drop pension fund solvency from its current review of the IORP Directive.The Commission had begun its review in 2011 and issued a "Call for Advice" from the European Insurance and Occupational Pensions Authority (EIOPA) on, among other things, whether the extent to which provisions in Solvency II, relating to the valuation of assets and liabilities, should be extended to occupational pension schemes under the IORP directive.

The proposals had been met with overwhelming opposition from pension groups, such as the NAPF, concerned that if adopted, the proposals could significantly increase the liabilities of defined benefit schemes and result in employers closing and/or winding up those arrangements.

The European Commission has decided that further technical work is necessary on the issue of insolvency, and that as long as more data is needed and given that Solvency II is not yet in force,the review of the Directive will not cover solvency of occupational pension schemes.(For the firm's recent briefing on Solvency II, click here). The Commission will, however, be including measures to improve transparency and reporting requirements for occupational pensions in its review of the Directive – these proposals will be published in the autumn.

Comment

Employers with defined benefit schemes will no doubt breathe a sigh of relief that the solvency proposals for occupational pension schemes have been dropped from the current review of the IORP Directive. However, the Commission has said that that the situation should be re-examined once more data is available.