Changes to the Pension Regulator's moral hazard powers are due to come into force at the end of June with retrospective effect to 14 April 2008. The "moral hazard" powers enable the Pensions Regulator to issue contribution notices and financial support directions against those involved with defined benefit occupational pension schemes to protect members' benefits or to prevent liabilities being "dumped" on the Pension Protection Fund. Changes to the regime, broadening the Regulator's powers, were announced in April 2008 and described in our October 2008 briefing. Any sponsoring employer of a defined benefit pension scheme, or any other company in its group, should familiarise itself with the new provisions and take steps from the outset of any proposed transaction or restructuring to ensure that any adverse effect on the pension scheme is properly managed to avoid a costly intervention from the Regulator.

Code of practice on material detriment test

The changes include a new "material detriment" test, which is met where the Regulator is of the opinion that an act "has detrimentally affected in a material way the likelihood of the accrued scheme benefits being received". There is a statutory defence available where person gave due consideration to the likely detriment and, if necessary, took steps to mitigate it. The Regulator is required to issue a code of practice setting out the circumstances in which it expects to issue contribution notices as a result of the material detriment test being met. The Regulator has consulted on the contents of the code and the final version has been laid before Parliament.

The circumstances set out in the code are:

  • the transfer of the scheme out of the jurisdiction
  • the transfer of the sponsoring employer out of the jurisdiction, or the replacement of the sponsoring employer with an entity outside the jurisdiction
  • sponsor support is removed, substantially reduced or becomes nominal
  • the transfer of scheme liabilities to another arrangement which leads to a significant reduction of the sponsor support or funding in relation to those liabilities
  • a business model or operation of the scheme which creates, or is designed to create, from the scheme a financial benefit for:
    • he employer; or
    • some other person

where proper account has not been taken of the interests of the members of the scheme, including where risks to members are increased.

The code sets out how the Regulator expects to act - it is possible that in exceptional circumstances it may act outside the code.

Examples of circumstances outside the new test

The Regulator has given examples of circumstances which would not normally give rise to a contribution notice under the material detriment test:

  • the payment of a routine annual dividend in the normal course of business
  • buying out pensioner liabilities with a properly selected regulated insurer
  • a new investment strategy as long as it was properly chosen in line with prudent funding assumptions
  • weakening of employer covenant due to poor trading because of market conditions

Effect on business

When the changes were first announced, one of Government's intentions was to ensure that certain new business models did not slip through the original moral hazard regime. One specific concern was non-insured buyouts of pension schemes. In consultation we, through the Association of Pension Lawyers, expressed concern that the code of practice should not be drafted too widely and those undertaking routine business transactions or restructurings should not be in danger of receiving a contribution notice. No major changes were made to the proposals as a result of representations from the pensions industry, and the circumstances in which the Regulator expects to issue a contribution notice are widely drawn. Those still concerned that their arrangements do not clearly fall outside the legislation may seek clearance from the Regulator.

What next?

The code is expected to come into force on 29 June 2009, along with the new legislation (but with many of the provisions having retrospective effect to 14 April 2008). At the same time the Regulator will also be publishing:

  • an update to the clearance guidance providing technical guidance on the new powers
  • guidance for sponsoring employers contemplating a corporate transaction
  • further developed examples.