Welcome to the May 2017 edition of our Trustee Knowledge Update which summarises recent changes in law and regulation. It is aimed at helping trustees (including trustee directors) comply with the legal requirement to have knowledge and understanding of the law relating to pensions and trusts. This edition focuses on the key legal developments over the last three months.
This is our first Trustee update since CMS Cameron McKenna merged with Nabarro and Olswang on 1 May 2017, making CMS a top 6 global law firm. Our combination further enhances our ability to provide a market leading service to pension scheme clients. Please speak to any of the pensions team if you would like further information about our new firm.
Green Paper: Security and Sustainability in Defined Benefit Pension Schemes
The Government’s eagerly anticipated Green Paper on DB pensions concludes that there is no crisis in DB pensions, and that the overall regulatory regime is satisfactory. Nonetheless, there is a case for change in a number of areas. The Government acknowledges that some of the options discussed in the Green Paper are not necessarily “viable or desirable”, but wishes to engage on a wide range of potential options for addressing existing concerns. To this end, the Green Paper is divided into four main headings.
Employer contributions and affordability:
The Government is not persuaded that there is a general affordability issue for employers, but recognises that change may be needed to help some “stressed” schemes and employers. This could take the form of intensive Pensions Regulator support for challenged schemes and sponsors, and more use of existing flexibilities such as longer recovery plans.
Other options still on the table include allowing schemes to move from RPI to other measures of inflation for pension increases, allowing indexation to be suspended for underfunded schemes with stressed employers, or making it easier to renegotiate pension benefits or transfer members to new schemes with lower benefits.
At the same time, the Government says there is evidence that many employers could afford to eliminate deficits more quickly than they are currently doing and seeks views on ways to encourage this.
Funding and investment: The Government acknowledges that a one-size fits all approach to funding may not be the best use of the Regulator’s resources. It seeks to explore whether there is scope to encourage some schemes to make more optimal investment decisions, and mitigate barriers to the greater use of alternative asset classes.
Member protection: The Government considers whether there is a case for giving the Regulator proportionate additional powers, and for imposing a formal duty on parties to co-operate and engage with the Regulator. The Green Paper also considers introducing compulsory Regulator clearance of corporate activity in limited circumstances and requiring consultation with trustees of severely underfunded schemes before dividends are paid.
Consolidation of schemes: The paper considers the pros and cons of different consolidation models and whether it should be voluntary or compulsory, with a clear preference for the former. The considerations include increasing scope to reshape benefits to simplify administration. The Government does, though, state that it will not take forward any consolidation “superfund” through a government body.
Action points: There is very little which is not up for grabs in this wide-ranging consultation, but many of the suggestions seem unlikely to be taken forward. Trustees should keep a look out for promised further announcements later in 2017.
DWP response to consultation on GMP equalisation methodology
Although November’s consultation and proposed new methodology were broadly welcomed, this is effectively a holding response. The plethora of issues being referred back to the GMP joint working group for further consideration include other suggested methodologies, the treatment of schemes that have already secured benefits, how to deal with GMPs that have been transferred out, backdating payments, data issues, the valuation method, tax issues, communications challenges, the role of the employer in conversion and the meaning of actuarial equivalence under the GMP conversion regulations. DWP raises the prospect of guidance in some of these areas.
Points on which the Government does express a view include that there will be no express ‘safe harbour’ provision for trustees following any suggested methodology, and that a unisex valuation approach would be appropriate for the process. The Government says that as soon as it is able to set out a more definite timeline for guidance and legislation, it will notify interested parties within the pensions industry.
The response also confirmed that fixed rate revaluation would fall to 3.5% for members leaving pensionable service after 5 April 2017 (not 4% as was originally proposed).
Action points: Unless trustees are securing benefits, they should continue to wait and see, given the lack of definitive answers. That said, the direction of travel, if not its speed, now seems clear and so trustees may wish to consider making provision for GMP equalisation in their next actuarial valuation.
Consultation on new Employer Debt Regulations
This is the long-delayed response to a call for evidence in March 2015 which focused on industry-wide multi-employer schemes for non-associated employers. However, the consultation is not restricted to such schemes but applies to all multi-employer DB schemes. Any changes would come into force on 1 October 2017.
The Regulations would introduce a new “deferred debt arrangement” (DDA) option which would allow an employer, on ceasing to employ its last active member in an open scheme, to defer the requirement to pay the statutory debt that would otherwise become due. A number of conditions would need to be met including satisfaction of the “funding test” under the Regulations, trustee agreement and notification to the Regulator. The DDA would be ended (so triggering the debt) in a number of circumstances such as wind-up of the scheme or insolvency of the employer. The employer would also be able to end the DDA with trustee consent. The trustees would have the power to end the DDA themselves where reasonably satisfied that the employer has failed to comply with its scheme funding obligations, or that its covenant to the scheme is likely to weaken in the next 12 months.
The draft Regulations also propose several tweaks to other provisions under the existing employer debt provisions.
DWP consultation on early exit charges and memberborne commission
This consultation seeks views on draft regulations, intended to come into force in October 2017. The regulations will ban any “early exit charge” imposed on a member who has reached normal minimum pension age (usually age 55) who takes, converts or transfers benefits before a scheme’s normal pension age. The total ban will apply only to members joining a scheme on or after 1 October 2017. For existing members at that date there will be a 1% cap on early exit charges (or the amount provided for under the scheme as at 1 October 2017 if lower). The ban applies to all schemes providing money purchase benefits, with no exception for DC AVCs.
Member-borne commission, already banned in new contracts from 6 April 2016, will also be banned under agreements entered into before that date in respect of charges paid on or after 1 October 2017. This ban applies only to money purchase schemes (or DC benefits under a hybrid scheme) which an employer uses as a qualifying scheme for automatic enrolment.
Finance Act 2017
The Finance Bill was introduced into Parliament on 20 March, reflecting Treasury announcements made in the Autumn Statement and Spring Budget about reducing the money purchase annual allowance (MPAA) from £10,000 to £4,000, increasing the income tax exemption for employerfunded pensions advice from £150 to £500, new rules on overseas pensions and changes to the taxation of qualifying overseas pension schemes (see below).
However, at the end of April, in order to accelerate the passage of the Bill prior to the General Election, the employer-arranged pensions advice and MPAA reduction provisions were removed from the final Act (although the Financial Secretary to the Treasury has confirmed that they will reappear at the “earliest opportunity” after the election).
Pension Schemes Act 2017
The Act largely deals with the authorisation and on-going supervision of master trusts from October 2018. Much of the detail will be in regulations on which consultation is expected this autumn. The Act also contains provisions enabling the proposed changes capping early exit charges and extending the ban on member-borne commission.
BHS: Regulator settlement with Sir Philip Green
TPR has announced a settlement with Sir Philip Green in relation to the two BHS pension schemes. The regulatory action against Sir Philip and his companies has been discontinued, although the related investigation into Dominic Chappell and Retail Acquisitions Ltd is ongoing.
Sir Philip will provide funding for a new pension scheme which will provide higher benefits than PPF compensation levels because those under 60 will not be subject to the 10% reduction in starting pension that applies to PPF members; and pension for pre-April 1997 service will increase at 1.8% p.a. (it would not increase under the PPF).
£343m has been placed in an escrow account to fund the scheme, with an additional amount of up to £20m being held in other accounts to cover expenses and implementation costs. The 19,000 members of the existing schemes have the option of transferring to the new scheme, taking a winding-up lump sum or remaining in the current schemes and going into the PPF.
Consultation on monetary penalties and definition of “professional trustee”
As part of its ongoing ‘21st century trustee’ initiative, TPR is consulting on a draft monetary penalties policy which includes its revised description of a professional trustee. Professional trustees: TPR has received requests for more clarity about which trustees it might hold to higher standards, and how that translates to the level of the fines that may be levied on them. The new proposed definition for a professional trustee is any person, whether or not incorporated, who: acts as a trustee of the scheme in the course of the business of being a trustee; or is an expert, or holds themselves out as an expert, in trustee matters generally. The idea is to move away from looking simply at remuneration, on the basis that ‘lay’ trustees may often receive some form of remuneration for their services. Action points: Trustees and employers who may wish to take advantage of the DDA from October could now start to make tentative plans. However, we are not convinced that the DDA will widely be regarded as attractive in preference to other available debt options. . Action points: Early exit charges are rare in the occupational pension scheme environment but trustees who have not yet confirmed whether their schemes might be affected should do so now. Trustees should also note the promised changes to member-borne commission and check these will not cause any issues. . Action points: If trustees have notified the proposed MPAA change to members, they should now review those communications and check how the scheme administrator intends to proceed. . Action points: For noting. Action points: Trustees will note the relatively swift resolution that followed extremely high-profile exchanges in a Parliamentary committee. This is in stark contrast with some other TPR moral hazard cases, which have spent many years dragging through the courts. - 3 - Trustee Knowledge Update – Issue 39, May 2017 Monetary penalties: Generally, co-operation, early reporting and taking action to remedy the breach will result in a lower penalty. The following principles will be applied: the penalty should be proportionate to the nature of the breach and the harm caused; the amount of the penalty should aim to change the behaviour of the person in breach; the penalty should deter repetition of the breach among the wider regulated community; relevant aggravating or mitigating factors will be taken into account. Tax (www.hmrc.gov.uk/pensionschemes/index.htm) Spring Budget – changes to taxation of QROPS The Chancellor announced an overnight change to the taxation of transfers to QROPS (qualifying recognised overseas pension schemes). Prior to the Budget, all transfers to QROPS could be paid tax-free. However, transfers to a QROPS requested on or after 9 March 2017 will now be taxed at a rate of 25% unless the individual and the QROPS are in the same country after the transfer, or they are both in an EEA country after the transfer, or the QROPS is an occupational pension scheme sponsored by the individual’s employer. HMRC has also now issued a revised list of QROPS which needs to be checked before making transfers. PPF (www.pensionprotectionfund.org.uk) PPF consults on levy rules for three years from 2018 The PPF has launched its initial consultation for the next levy triennium (the three levy years commencing in 2018/19). Despite the PPF and Experian concluding that the current system is generally working well, the consultation outlines a number of proposals for change. Scorecards: some existing employer scorecards should be recalibrated to reflect actual experience, in particular for SMEs and not-for-profit employers. Measuring insolvency risk: the current single methodology for measuring insolvency risk could be varied in specific cases including the very largest schemes, schemes whose employers have “proximity to government” and schemes without a substantive employer. Use of monthly insolvency scores: the PPF seeks views on the benefits of continuing with monthly scores or moving to an assessment at 31 March each year from 2018. Guarantor strength reports: a professional adviser report may need to be submitted to the PPF before trustees can certify or re-certify PPF guarantees of “very high value”, described as those where the Realisable Recovery certified is £100m or more. Asset backed contribution arrangements (ABCs): the PPF describes its current approach to ABCs based on loan notes as “overly generous”, and is considering applying an adjustment to the certified ABC value to reflect this. ‘Good scheme governance’ discount: the PPF seeks views on whether and how this idea, pushed by the House of Commons Select Committee’s report in December, could be implemented. Smaller schemes generally: the PPF is considering ways of reducing the administrative burden for smaller schemes. Standard form contingent asset documents: the PPF is reviewing its standard form guarantees and security documents with a view to producing updated versions. In a departure from previous practice, schemes with existing contingent assets would be asked to move to the new standard form or risk losing recognition. Overall, the PPF believes almost two-thirds of schemes would see a levy reduction on the basis of its proposals. A more detailed second consultation will follow in autumn, alongside the PPF’s draft 2018/19 levy determination. Cases FDR Ltd v Dutton (Court of Appeal) The scheme originally provided for 3% compound increases but was amended in 1991 to provide for increases at the lesser of 5% and RPI for all service, and administered on that basis for 20 years. The parties accepted that the amendment was valid for service from 1991, but invalid for past service due to an amendment power proviso protecting pensions in payment and members’ accrued rights from being affected prejudicially. The question was how to calculate member rights in respect of pre-1991 service. The employer said that pensioners were now protected by an underpin by which they were entitled each year only to increases at the higher of either 3% fixed or 5%/RPI, calculated cumulatively on their initial starting pension. This would mean that members would commonly receive increases of less than 3% in respect of pre-1991 service, due to higher increases received by them in past years. However, the trustees argued that the result of construing the 1991 deed as having effect subject to the amendment power proviso was that members were entitled to the better of 3% fixed and 5%/RPI, applied on an annual basis, to pensions in payment attributable to pre-1991 service. In the High Court, Asplin J preferred the trustees’ more generous construction to the employer’s “unnatural” construction. The Court of Appeal accepted that the facts of the case gave rise to an unusual question of interpretation, but overturned Asplin J’s decision and favoured the employer’s construction, which involved the “least interference to the integrity of the modified scheme” (citing a 2009 case called Foster Wheeler v Hanley). This construction reflected the employer’s argument that the amendment power proviso was intended to preserve a pensioner’s entitlement under the old rules, but not to give them “the best of both worlds”. Action points: The professional trustee angle is particularly interesting. TPR seems keen to conflate the roles of independent and professional trustees, who may both want to watch progress on this closely. . Action points: Trustees must ensure that their administrative processes, and communications, for overseas transfers reflect the new QROPS requirements. . Action points: For noting at this stage, pending the detailed consultation in a few months’ time. Action points: It may prove significant that the Court applied the "least interference" approach to construction. There had been suggestions that this approach was restricted to equalisation cases. - 4 - Trustee Knowledge Update – Issue 39, May 2017 Thales UK Limited v Thales Pension Trustees Limited (High Court) Two sections of the scheme had two different provisions for pension increases. In the CARE section, increases were based on RPI but if the “compilation [of RPI] is materially changed” then the principal employer, with trustee consent, had to determine the “nearest alternative index”. In the TOPS section, a final salary section, increases were based on RPI but if RPI was “otherwise altered” then the trustees could determine a new base, having regard to the alteration made to RPI. The employer argued that various events in the history of the compilation of RPI triggered these powers. The judge, Warren J, said that in considering whether there had been a “material change” in the compilation of RPI under the CARE section: changes should not be looked at cumulatively; routine changes adopted to keep RPI fit for purpose should be ignored; it is the change in compilation which must be material, not the effect of a change; a change is material if it results in the RPI operating in a way which either does not fulfil its original purpose (providing a measure of inflation for the typical household) or does so in a way which is materially different from the way it did so before the change. Applying these principles, he found that the 2017 introduction of a new UK House Prices Index (UK HPI) into the RPI had materially changed RPI’s compilation. This gave rise the question of the “nearest alternative index”. A central consideration was whether the compilation of the new index was the nearest to that of RPI before the change. As a matter of principle, ‘new’ RPI could not be automatically excluded as a candidate. The employer could not select the most appropriate index: it had to be the one closest to old RPI. The judge went on to find that, on the basis that the introduction of UK HPI to RPI was the only material change to its compilation, RPI with that change was the nearest alternative index. Warren J also found that RPI had been “otherwise altered” for the purposes of the TOPS section rules. However, the trustees’ power to select a new basis was constrained by the wording of the scheme rules that they must “have regard to the alteration”. The most material alteration to the RPI was the introduction of UK HPI and RPI, as varied by that introduction, was the nearest alternative index. It was not open to the trustees to adopt any other index. A notable feature of the case was that the parties presented extensive evidence from experts, including Paul Johnson (the Government’s independent reviewer of UK consumer price statistics). Helpfully, the judge indicated that employers and trustees were not expected to go to such lengths, or to drill down into the detail that was before the court, each time they had to consider whether a change to the RPI resulted in a material change or alteration. A broadbrush and commercial approach would be appropriate. Ombudsman (www.pensions-ombudsman.org.uk) For the latest on The Pensions Ombudsman and his work, please ask your regular CMS contact for a copy of our quarterly Pensions Ombudsman Update. Miscellaneous State Pension age independent review: final report – Headline recommendations of the independent reviewer’s final report include increasing state pension age (SPA) to 68 between 2037 and 2039; giving at least 10 years’ notice of any future increases in SPA; removing the triple-lock in the next Parliament and increasing state pension in line with earnings; and introducing incentives to defer drawing beyond SPA and allow partial draw down from SPA. The review also recommends that SPA should remain “one size fits all” (there should not be a variable SPA). The Government is not bound by the recommendations. It had said that it would respond to them by May 2017, but this has now been postponed following the announcement of next month’s General Election. Dates for diaries: Trustee training remains one of the most important ways of ensuring that trustees have the knowledge and understanding required to perform their duties. We will be holding trustee training courses on 13 June 2017 and 17 October 2017. If you have any enquiries about these courses or would like to reserve a place, please contact Kieron Mitchinson – E: email@example.com. If you are interested in any additional trustee or employer training, please contact Kieron Mitchinson who can provide you with a list of our current training topics or discuss any particular training needs you might have. General: For further information on our pension services, please contact Mark Grant – E: firstname.lastname@example.org, T: +44 (0)20 7367 2325 or your usual pension partner. Please also visit our website at www.cms.law. The Pensions team is part of the CMS Financial Markets and Pensions group and advises employers and trustees of schemes varying in size, from a few million pounds to several billion pounds. Additionally, we act for some of the largest firms of administrators, actuaries, consultants, brokers and professional trustees. We provide a full range of services in connection with occupational pension schemes, including all aspects of employment and EU law. The team also works closely with our corporate lawyers, providing support on mergers and acquisitions, insolvency lawyers supporting us on employer covenant issues, and the financial services team which specialises in regulatory and fund management matters. The information in this publication is for general purposes and guidance only and does not purport to constitute legal or professional advice. It is not an exhaustive review of recent developments and must not be relied upon as giving definitive advice. The Update is intended to simplify and summarise the issues which it covers. It represents the law as at 11 May 2017. CMS Cameron McKenna Nabarro Olswang LLP is a limited liability partnership registered in England and Wales with registration number OC310335. Action points: Like all cases on RPI, this turned on the wording of the specific scheme rules but was the first case to consider rules referring to the compilation of RPI. Trustees whose schemes have such rules should consider its lessons further.