Top of the Agenda

  1. Further quality requirements proposed for DB schemes to qualify for auto-enrolment purposes

Following its consultation last year on measures to simplify the automatic enrolment regime, the Government has issued a memorandum setting out its proposals for further quality requirements in relation to defined benefit (DB) schemes for employers who are using or wish to use their DB schemes for auto-enrolment purposes.

The position at the moment

Currently, separate quality requirements exist under the auto-enrolment legislation depending on the type of benefits that schemes offer:

  • For money purchase arrangements, the scheme rules must (subject to transitional rates through to 2018) provide contributions at least equal to a total of 8% of qualifying earnings (as defined), at least 3% of which has to be contributed by the employer. There are also alternative requirements, which arrangements may satisfy if contributions are at least equal to certain percentages of basic salary or total earnings.
  • For defined benefit arrangements, broadly, the employee must be in contracted-out employment or the scheme must satisfy what is called the “test scheme standard”. The test scheme standard is that the DB scheme must provide a pension at the age of 65 or higher at an annual rate of 1/120th of average qualifying earnings in the last three tax years before the end of pensionable service multiplied by the number of years of pensionable service (capped at 40 years).

The consultation

The consultation last year asked whether there may be a simpler way to determine whether a DB scheme is good enough to be used for auto-enrolment purposes, given in particular that when contracting out on a final salary basis ends in April 2016 (as a result of reforms proposed to the State Pension under the current Pensions Bill), schemes that currently satisfy the quality requirement because they are contracted-out will have to show that they meet the test scheme standard instead.

The new alternative quality requirement

A new alternative requirement for DB schemes is therefore being proposed that is based on the cost of funding the future accrual of active members’ benefits. The new test will require that this cost must be at least a prescribed rate, the rate to be expressed as the prescribed percentage of the members’ relevant earnings over a relevant period either on an aggregate (scheme) level or, if the scheme cannot satisfy the test at that level, at an individual level for at least 90% of the relevant members.

The Government will consult further on what the prescribed rate should be as well as on the terms such as “relevant earnings” and “relevant members”. (The initial proposals here are that relevant members should apply to the jobholder concerned and all active members who are jobholders of the same employer, but the Government wishes to consult whether the alternative tests should apply separately to members in different sections or benefit categories of the scheme.)

Schemes with “Bridge” type benefits

When the amendments to the definition of “money purchase benefits” are introduced under the Pensions Act 2011 (intended to be 6 April 2014), certain benefits that were the subject of the decision of the Supreme Court in Holdsworth & Another v Bridge Trustees Limited and Another (2011) will be classed as defined benefits and not “money purchase benefits”. The Government recognises that for auto-enrolment purposes, however, it would be difficult or impossible for such schemes to show that they satisfy the test scheme standard for DB schemes because of the lack of certainty over the benefits being accrued and easier for such schemes to meet or continue to meet the money purchase qualifying scheme requirements because of the contribution rate. The schemes currently identified by the Government for such purposes are schemes that have a defined contribution structure but provide guarantees in respect of the fund size or investment performance. However, the Government will consult further on whether schemes with other features should be allowed to rely on meeting the money purchase quality requirements.

Comment

The proposals regarding schemes with “Bridge”-type benefits to satisfy the money purchase qualifying requirements are to be welcomed.

Regarding the other new quality requirements for DB schemes, it is not entirely clear from the memorandum how the cost of providing active members’ benefits is to be measured, although the memorandum suggests that the method may draw upon the costs of accrual of benefits of current members calculated by schemes under the scheme funding regime. The key challenge of course for the Government is to ensure that these new provisions do in fact simplify the regime. The memorandum states that the detail will be “very technical and complex” and set out in regulations; the challenge therefore will be for the Government to tread the fine line between providing sufficient detail and keeping the new requirements simple (as was the intention).

Pensions Ombudsman

  1. Pensions Ombudsman rules that BBC is not in breach of its implied duty of good faith

The Pensions Ombudsman has ruled that the BBC was not in breach of its implied duty of good faith to the complainant, Mr John Bradbury, in relation to changes to his pension arrangements that involved placing a 1% cap on future increases to pensionable pay in the DB section of the scheme of which he was a member.

Background

Mr Bradbury first made his complaint against the BBC to the Pensions Ombudsman (the "Ombudsman") in 2011. The Ombudsman did not uphold his complaint and on appeal to the High Court, the Court found that the BBC’s changes in relation to Mr Bradbury’s pension arrangements were effective. However, the High Court’s decision was stayed, pending the determination of the issue of whether the BBC had breached its implied duty of good faith to Mr Bradbury. For our briefing on the High Court decision, click here.

During the High Court proceedings, the BBC had argued that as Mr Bradbury had not raised the issue of a possible breach of the implied duty to the Ombudsman, he should not be allowed to raise it before the High Court. Warren J, however, said that Mr Bradbury had probably raised the issue, albeit in layman’s terms, when in his complaint to the Ombudsman, he had stated that BBC’s conduct was a “travesty of trust and decency”. However, he accepted that the BBC had not had an opportunity to submit its defence in relation to the issue as the issue had not been ‘live’ before the Ombudsman. The High Court decision was therefore stayed pending determination by the Ombudsman on the implied duty point.

  1. Did the BBC breach its implied duty of good faith?

The Ombudsman stated that there is an implied term that an employer will not exercise a power or discretion in an employment contract in an irrational or perverse manner. To breach the duty of good faith or of trust and confidence, the employer must have acted without reasonable and proper care in a way calculated or likely to destroy or seriously damage the relationship of trust and confidence. The conduct must be very serious and the breach must necessarily be a repudiatory breach that entitles the employer (or employee) to terminate the contract summarily without notice. The test was most recently expressed in these terms in the case of Prudential Staff Pensions Limited v the Prudential Insurance Company Limited and Others [2011].

The Ombudsman also highlighted the following points from the Prudential decision:

  • The employer’s discretionary powers are non-fiduciary and the employer can take into account its own interest; the employer’s conduct does not have to be “fair”
  • The circumstances in which a decision could be said to be “irrational” or “perverse” are severely limited. Members’ interests and expectations may be of relevance when assessing “irrationality” and “perversity”
  • The manner in which an employer arrives at its decision and evidence relating to its internal decision-making process are also relevant when considering if the duty has been breached.

The Ombudsman then considered the following questions:

  • Did the BBC breach the duty?
  • Did it act in a way that no rational employer could have done?
  • Did the BBC’s conduct fall a long way short of reaching the required threshold?

The Ombudsman found the answer to all these questions to be "no".

The BBC’s decisions to change members’ pension arrangements, including giving Mr Bradbury an option to stay in the DB section of the BBC scheme but subject to a cap of 1% on future increases to pensionable pay, was “reasonable” in light of the huge pensions deficit in the Scheme. If the BBC had done nothing to limit the deficit, its contributions to the pension scheme would need to have been increased from 3.5% to 10.10% of licence payers’ fees, which was clearly an unsatisfactory outcome for the BBC and the license payer.

The BBC had embarked on an initial 90 day employer consultation with the unions in relation to its original proposals and a subsequent 90 day employer consultation in relation to revised proposals with the unions; it had also subsequently discussed the proposals with the pension scheme trustees. On the facts, therefore, the Ombudsman held that the consultation with the unions was “genuine” and not a “sham” as Mr Bradbury had tried to argue.

The BBC could, like many employers facing considerable pension deficits in their defined benefit schemes, have closed its scheme to future accrual but it did not; instead it had found a middle path and the options it had offered to its members, after extensive consultation, were generous.

Mr Bradbury was not entitled to a pay rise. If BBC had not offered him a pay rise, it would not have been in breach of its implied duty; consequently it followed that by capping future increases to pensionable salary, the BBC was not in breach of his duties either.

  1. Was there coercion?  

As regards Mr Bradbury’s complaint that he had been “coerced”, the Ombudsman held that Mr Bradbury had been offered a number of options, albeit ones he was not happy with. There may have been coercion if Mr Bradbury had been forced to make a decision as a result of economic duress applied by the BBC. This would require pressure that was illegitimate. In considering whether such pressure had been applied, the courts will consider various factors including whether the party exerting the pressure acted in good or bad faith, how bad the behaviour was and whether the victim had any realistic practical alternative. As Mr Bradbury had options, albeit limited ones requiring him to make choices, the BBC had not applied improper coercion.

  1. Were the proposals age discriminatory?

With respect to Mr Bradbury’s assertions that the cap was age discriminatory against younger employees as they had more time left before retirement and would potentially be subject to the cap on pensionable salary for longer, the Ombudsman said that he was not tasked with considering if the proposals were age discriminatory. Nor had Mr Bradbury, who was over 40 years old, argued that the cap was age discriminatory against him personally (only that it was age discriminatory, generally, against younger members). The Ombudsman consequently declined to make any further comment on the issue.

Comment

The determination highlights issues that can arise when adopting the contractual route to making changes to pension schemes as opposed to by way of a formal amendment to the scheme rules. Where the contractual route is to be adopted, the employer may consider seeking an amendment to the scheme rules where this is viable to avoid the type of complaints and criticisms raised by Mr Bradbury in this case. Although Mr Bradbury did not succeed in his argument that the cap on increases to pensionable salary were age discriminatory, the case also illustrates the importance of ensuring that any proposals regarding changes to members’ benefits and to pension scheme design do not result in indirect or direct age discrimination against employees and members.

The Ombudsman’s determination provides a useful summary of the law on the employer’s duty of good faith. There have in recent years been a number of cases and Ombudsman’s determinations in relation to the duty – for our update on these, click here.

The High Court’s decision in the IBM “Project Waltz” case, where it is understood that the breach of implied duty is a key issue, is still awaited. The case has been brought by scheme members in relation to changes made in 2009 to IBM’s UK pension plan (known as ‘Project Waltz’), claiming that the changes breached the employer’s duty of good faith. The amendments were introduced for the purpose of reducing liabilities under the IBM scheme in order to address a deficit in the scheme of £890 million. It has been reported that the changes reduced retirement benefits for about 4500 workers and closed the defined benefit section of the plan to future accrual for most employees.

The Pensions Regulator

  1. More information required in the Scheme Return 2014  

The Pensions Regulator has issued a guide setting out the information (including additional information) that will be required in the scheme return for 2014. The new information required includes:

  • Information about hybrid schemes, including details of the structure of the scheme, whether the scheme includes any Additional Voluntary Contributions ("AVCs") for defined benefit members, any DC benefits as a top-up to the main DB benefits and whether the scheme has any underpins applying to active members’ benefits. Information as to how the funds are invested with investment managers, whether any DC scheme members’ contributions are invested in a default fund and, if so, what proportion of members and the value of the total DC AVCs paid in the year is also required.
  • Asset-backed contributions – where schemes have an asset-backed contribution arrangement in place, further information is required as to how the scheme’s interest in the venture has been funded (i.e. whether the assets are gifted from the employer or are made by way of a special contribution from the employer), the time-period within which the arrangement provides an income stream for the pension scheme and how its net value is presented in the scheme accounts.
  • Information in relation to incentive exercises inviting members to transfer or modify their scheme benefits in the twelve month period up to the latest scheme year end date in exchange for an incentive is also now required, including details of the type of incentive exercise i.e. whether it was an enhanced transfer or a pension increase exchange exercise.

Comment

The additional information being required in the scheme return ties in with the areas that the Regulator has been focusing on over the previous year, for instance further information required in relation to DC benefits under hybrid schemes (given the increased use of DC schemes following the introduction of the auto-enrolment regime) and asset backed-funding (its guidance in relation to which the Regulator revised last year).

The Pension Protection Fund

  1. PPF compensation cap to go up for 2014/15 and PPF bulletin (No 15) issued

The PPF compensation cap is to be increased for 2014/15. The compensation cap is a limit on the compensation that can be paid by the board of the Pension Protection Fund to a single member who is under the normal pension age at the date on which the scheme enters a PPF assessment period. The cap is to be increased from its current level of approximately £34,867 to £36,401. Members are entitled to compensation that is capped at 90% of this level. In other words the upper limit of compensation payable to a single member who is under the normal pension age at the date at which the scheme enters a PPF assessment period will be £32,761 (i.e. 90% of the 2014/15 cap).

The PPF has also published Issue 15 of its PPF bulletin. Among other things, the bulletin sets out the key dates and deadlines for next year as follows:

  • Information from scheme returns submitted by 5pm on 31 March 2014 will be used to calculate individual scheme levies. The Pensions Regulator’s Exchange system will continue to be the sole point of data submission for the purposes of the PPF levy.
  • Insolvency risk will be measured using the average failure score of each sponsoring employer measured on the last working day of each month, from 30 April 2013 to 31 March 2014.
  • The deadline for certification and/or re-certification of contingent assets will be 5pm on 31 March 2014.
  • Deficit reduction contributions that have been made up to and including 31 March 2014 must be certified by 5pm on 30 April 2014.
  • Full block transfers that have taken place up to and including 31 March 2014 must be certified by 5pm on 30 June 2014.

Comment

Schemes should ensure that they submit information by the published deadlines, as the timescales are strict and generally the PPF will not consider information submitted out of time.

Round-up

  1. Pensions Minister confirms that Government plans to impose a cap on administration charges will be delayed by a year

Following reports in the mainstream and pensions press that the Government was planning to postpone its plans for placing a cap on administration charges for at least a year, the Pensions Minister Steve Webb has confirmed that the proposals will be delayed at least until April 2015. The proposals, which included a proposal to cap scheme charges to between 0.75% and 1% of funds under management, had been set out in a consultation document last autumn. For our update on the consultation, click here.