Summary

Amendments to the Occupational Pension Schemes (Transfer Value) Regulations 1996 come into force on 1 October 2008. Under the amended provisions, trustees, rather than the scheme actuary, will be responsible for setting the basis for calculating pension transfer values.

The new legislation

The Occupational Pension Schemes (Transfer Values) (Amendment) Regulations 2008 come into force on 1 October 2008 and amend the Occupational Pension Schemes (Transfer Values) Regulations 1996 (the 1996 Regulations). From that date, pension scheme trustees will become solely responsible for the calculation of defined contribution (money purchase) and defined benefit (final salary) transfer values, which are known as cash equivalents under the governing legislation.

Under the current regime, which remains effective until after 30 September 2008, the responsibility for the calculation of cash equivalent transfer values (CETVs) rests largely with the scheme’s actuary, following technical guidance issued by the Board for Actuarial Standards and known as Guidance Note 11 (GN11). GN11 will be withdrawn from 1 October 2008 when the revised legislation, containing much of the GN11 detail, comes into force.

Cash equivalents

The CETV represents the expected cost of providing the member’s benefits within the scheme. For defined contribution (money purchase) schemes, this calculation is relatively straightforward and includes the accumulated contributions to the scheme from the employer and the employee plus any investment returns. For defined benefit schemes, the CETV calculation is more complex, with the value being determined on actuarial principles which require assumptions to be made about the future course of events. The amended 1996 Regulations include provisions for calculating both defined benefit and defined contribution CETVs, although TPR’s guidance covers only defined benefit cash equivalent transfer calculations.

The Pensions Regulator’s draft guidance

The Pensions Regulator (TPR) has now issued for consultation its long-awaited guidance on the calculation of CETVs. The guidance should be read in conjunction with the amended 1996 Regulations, although it does not override them. The guidance aims to assist trustees of defined benefit schemes to understand their responsibilities in relation to the calculation of CETVs. It also covers the calculation of transfers that are not classed as cash equivalents - that is, where benefits under the scheme have not vested in the member, where there is no right to a deferred pension under the scheme and the member, having between 3 months and 2 years pensionable service with that employer, wishes to take a cash transfer or a contribution refund.

The detail of the guidance is referred to throughout this briefing but it should be remembered that it may be subject to change after the consultation period ends on 19 September 2008.

Background

Most members of occupational pension schemes have a statutory right to transfer the CETV of their benefits to another pension arrangement. This right arises for early leavers who have accrued rights to benefits under the scheme rules and must be exercised on or before the later of two dates:

  • one year before the member attains normal pension age; and
  • six months after pensionable service with that employer ends.

In such circumstances, the member may transfer his CETV to:

  • another registered scheme (including an occupational pension scheme, a registered policy-based scheme or a personal pension scheme);
  • a public service pension scheme; or
  • an overseas pension scheme (subject to the regime relating to international benefits).

Although the member has a right to take his CETV out of his former employer’s scheme, there is no comparable statutory right to transfer that cash equivalent into a new employer’s scheme. Where the new employer’s scheme does not accept transfers in, the member can either elect to preserve his benefits in his former employer’s scheme (as deferred benefits) or he can request a transfer of his CETV to a personal pension scheme or a stakeholder arrangement.

Key changes under the new regime

The new responsibilities for trustees are summarised below:

  • trustees’ responsibility for the calculation basis - the basis for the assumptions used in calculating CETVs is to be set by the trustees, with the scheme actuary’s advice. Although the process will be similar to that under which the trustees are responsible for setting valuation assumptions under the scheme-specific funding regime, in the case of CETV assumptions, there is no statutory requirement to consult the sponsoring employer;
  • minimum level for transfer values - there will be a minimum permitted level for an initial cash equivalent (ICE), which is the new term under the amended 1996 Regulations for the member’s CETV before any permitted deductions are made. The trustees should aim to determine the actuarial assumptions used to calculate the CETV on a “best estimate” basis and TPR’s guidance sets out the issues trustees should consider when deciding on these assumptions. As an alternative to the “best estimate” method, trustees may use an alternative calculation method if they wish to pay CETVs above the minimum level, for example, as an inducement to scheme members to take a transfer out of the scheme. However, if the trustees make a payment higher than the minimum level, they must consider whether there is a scheme requirement to obtain employer consent. Scheme rules should be checked to see if they are silent on this issue and if amendment is required;
  • discretionary benefits and options - when calculating the ICE, the trustees must assess the member’s accrued benefits, options and discretionary benefits. Only options which would increase the value of the member’s benefits may be included in the best estimate calculation process and the trustees must take advice from the scheme actuary. Trustees must also decide the extent to which it is necessary to take into account any discretionary benefits under the scheme rules when calculating the ICE (for example, discretionary pension increases). They should have regard to any established custom there may have been in awarding the benefit in the past and also to any consent requirements. TPR’s guidance provides a list of factors trustees should take into account;
  • determination of assumptions - in determining the economic, financial and demographic assumptions to be used for the calculation of the ICE, trustees must discuss with the scheme actuary the main characteristics of the scheme’s membership profile. TPR’s guidance suggests the points trustees should discuss with their actuary. They must also take into account the assumptions used in calculating the “discount rate” for the transferring member’s CETV;
  • permitted reductions - the ICE may be reduced to allow for reasonable administration costs. TPR’s guidance does not actually clarify what may be considered “reasonable” costs, although it does state that the costs estimate may be based on past experience. However, the trustees must also offset any ongoing administrative savings that will result if the member transfers out of the scheme. Any such reductions should be shown on the “statement of entitlement” provided to the member. This is a written statement of the amount of cash equivalent at the guarantee date of any benefits which have accrued to or in respect of the member under the scheme rules;
  • allowance for scheme under-funding - where the scheme is under-funded, the trustees may offer CETVs which are less than the transfer value calculated on the best estimate basis. However, this may only be done after obtaining an insufficiency report from the scheme actuary. The amended 1996 Regulations permit the trustees to use their discretion to decide whether it is appropriate to use the last relevant GN11 report as an insufficiency report if its assumptions differ from those used in calculating members’ ICEs. However, TPR’s guidance states that trustees should not generally reduce CETVs, even if the scheme is under-funded, if the employer’s covenant is strong and any recovery period is not too long.

Compliance with the new regime

There are no transitional provisions under the new regime. Any statements of entitlement issued to members on or after 1 October 2008 must comply with the new requirements. Therefore, trustees need to plan ahead and discuss the basis for calculating future CETVs with their scheme actuary before the amended provisions come into force. However, under the new regime, there is an extension to the deadline for issuing a statement of entitlement to a member from 3 months to 6 months when trustees consider the delay is for reasons beyond their control. In some cases, trustees may be able to make use of this extension where a transfer request is received close to the cut-off date of 1 October 2008.

Disclosure obligations

When a statement of entitlement is issued to a member, the trustees must alert the member to the fact that information about transfers that may assist him is available from the Financial Services Authority, TPR and the Pensions Advisory Service. Members should also be advised to consider taking financial advice before making a final decision to transfer. TPR’s guidance states that it is good practice for trustees to disclose the transfer basis on request and to tell members what options and discretionary benefits (if any) are included in the CETV.

Comments

As there are no transitional provisions in the amended 1996 Regulations, trustees should liaise with their scheme actuary and the scheme’s administrators to agree how to deal with transfer requests received in the run-up to 1 October 2008. 

Trustees could continue to use the scheme’s current GN11 methodology for transfer requests received now, if they are confident that the statement of entitlement will be issued to the member before the new regime is in place.

Trustees need to take care with the requests made from now under the old regime if there is a risk that an increased CETV could be awarded under the new regime.

It is disappointing that TPR’s guidance has been issued so late, leaving trustees with very little time in which to implement the changes.

When TPR’s guidance is finalised after the consultation period ends on 19 September 2008, this briefing note will be updated as required.