Top of the Agenda
1. The White Paper and the Pensions Bill
State Pension changes and abolition of contracting-out
On 14 January 2013 the DWP published a White Paper entitled "The single-tier pension: a simple foundation for saving". This was followed on 18 January 2013 by the publication of the draft Pensions Bill. The White Paper and the draft Bill outline proposals to reform the State pension into a single-tier pension, with the existing State Second Pension being abolished.
Occupational pension schemes will no longer be able to be "contracted-out" of the State Second Pension. This will lead to increased National Insurance contributions for those who are currently "contracted-out". The DWP has proposed measures to alleviate the impact of this.
Trustees and employers of all occupational pension schemes should consider the potential impact to see whether the changes will affect them. To see our bulletin on what this means for occupational schemes, click here
Prohibition of incentives to transfer
In addition to the changes to the State pension, the Pensions Bill also gives the Government power to make regulations prohibiting a person from offering an incentive (i.e. a financial or other advantage) to induce another person to transfer out of a salary-related pension scheme. If regulations are not introduced within 7 years, this provision will lapse.
This new power follows on from Pension Regulator Guidance (most recently revised in July 2012) which is broadly of the view that inducements should be treated with caution and certain minimum standards should apply, and a code of practice developed in June 2012 by the Industry Working Group on Incentive Exercises which also suggested limits and conditions for inducements to transfer benefits. The Pensions Minister, Steve Webb, has previously welcomed the industry's code of practice and indicated that he saw some inducements as "of concern" and "bad practice".
It is thought that there are no current plans to introduce regulations under the power in the Pensions Bill, but they may be introduced if the Government perceive the current TPR guidance and industry code of practice to be ineffective.
Correction of flaw in auto-enrolment legislation
The draft Pensions Bill also corrects a flaw in the legislation where an employer postpones or defers auto-enrolment. Under the legislation, the duty to re-enrol every three years employees who have opted out of the scheme or cancelled membership could have fallen during the period where auto-enrolment had been deferred or postponed. This could have curtailed the permitted period of deferral or postponement. The Pensions Bill introduces provisions which aim to remove this flaw.
2. Report issued under s89 of the Pensions Act 2004 on the restructuring of UK Coal
The Pensions Regulator has issued a report under s.89 of the Pensions Act 2004 on the proposed restructuring of UK Coal in relation to the funding deficits of the UK Coal Sections of the Industry-wide Coal Staff Superannuation Scheme and the Industry-wide Mineworkers Pension Scheme. The UK Coal Sections have a combined funding deficit on a 'buy-out' basis of £900m, or £543m on the Pension Protection Fund's (PPF) basis, based on assets of £451m.
UK Coal Plc decided to restructure the group in order to mitigate the operating risk they were facing (the failure of a single mine could have put the entire business at risk of failure) and to facilitate the raising of funds.
An initial proposal was made to the Regulator for the liabilities of the UK Coal Sections to be wholly or partially transferred to the PPF under a regulated apportionment arrangement (RAA) whilst the group was concurrently restructured. However the Regulator did not agree that a RAA was appropriate and encouraged the parties to think of alternative solutions.
Following extensive discussions, the group, the trustees and the group's bankers agreed a plan to restructure the business:
- The group would be split into two separate ring fenced businesses: mining and property.
- Only the mining business will be liable to fund the UK Coal Sections. Payments of £30m pa will commence in 2014.
- No dividends will be payable from the mining business until the UK Coal Sections become fully funded.
- The trustees will lose creditor rights over the property side of the business but will be granted a 75.1% equity stake in the holding company of the property business. The trustees will make a £30m investment in the holding company in consideration for the equity and to provide the property side of the business with enough funding to release its undeveloped value.
- The remaining 24.9% of the holding company will be owned by UK Coal Plc.
- Active members will continue to accrue benefits in accordance with the Protected Persons Regulations, although on a reduced basis with benefits capped to limit the cost of accrual.
The Regulator considered the proposals and determined that it was appropriate to grant the clearances that were requested in relation to contribution notices and financial support directions, noting that:
- Substantially all of the economic interests in the group would transfer to the UK Coal Sections.
- The retention of a significant stake in the holding company was acceptable given the expertise those shareholders could bring to the property business.
- The trustees had sought advice regarding their investment in the holding company and had no conflicts of interest affecting their decision to make this investment.
- The restructuring would allow the Group to continue to trade, potentially allowing significant value to be generated for the UK Coal Sections.
- Future accrual would generally not be appropriate in these circumstances; however due the facts of this case (including the provisions of the Protected Persons Regulations) the continuation of accrual was acceptable.
The shareholders of UK Coal Plc voted in favour of the restructuring on 5 November 2012. Given the continuing risks, the trustees and Group agreed to establish a suitable monitoring plan to identify and take steps to address the risks going forward.
The Regulator re-iterated that where an employer is able to provide long term funding to support a viable recovery plan, this will be the best outcome. The Regulator is prepared to work creatively with trustees and sponsoring employers to achieve optimal outcomes where long term support for a scheme is dependent on the restructuring or reorganisation of the sponsoring business.
Arrangements similar to that initially proposed (but rejected by the Regulator) where the PPF takes the scheme liabilities have been in the news recently following the collapse of HMV and Jessops despite such arrangements being in place. It is likely that the Regulator concluded that a RAA would not be appropriate in these circumstances due to the magnitude of the deficit, and due to the prospect of improvement for the business in the future.
3. Regulator consults on draft Code of Practice and Guidance in relation to occupational DC trust-based schemes
On 10 January 2013 the Pensions Regulator published for consultation a draft Code of Practice, draft Regulatory Guidance and a document setting out its draft regulatory approach in relation to trust-based defined contribution pension schemes. The deadline for consultation responses is 28 March.
The Regulator has previously published documents showing (i) what it believes schemes should aim to achieve for members of DC schemes, (ii) six principles that DC schemes should comply with to achieve those aims (headed essential characteristics, establishing governance, people, ongoing governance and monitoring, administration and communications) and (iii) draft DC 'quality features', outlining the evidence required to support claims that the six principles are present. However, this is the first time that the Regulator has looked to introduce a regulatory framework purely for DC schemes.
The framework is intended to apply only to trust-based schemes. Although the Regulator has responsibility for certain aspects of employer-sponsored contract-based schemes (such as Group Personal Pension Plans), the framework does not cover these given the overlap with the Financial Services Authority's remit (which covers certain aspects of all contract-based schemes, including those which are not employer-sponsored). The Regulator hopes to provide analysis later in 2013 on how benefits are protected in work-based personal pensions, and has said it will work with the FSA "to achieve consistent standards and levels of protection across the DC landscape". The Regulator therefore welcomes responses to the consultation from those responsible for managing GPPs.
The framework aims to support the market to deliver good outcomes for members. Its starting point is to educate relevant parties to secure behavioural change. The Regulator intends to intervene and enforce only where the market cannot deliver good member outcomes unaided.
As part of the regulatory framework, the Regulator says it expects trustees voluntarily to disclose information under a "comply or explain" regime. In particular, it hopes they will disclose to members whether they are satisfied that the DC 'quality features' are present, and why. The Regulator has said it will use its scheme return to capture information on whether schemes adopt this regime.
As part of its enforcement approach, the Regulator intends to monitor proactively the extent to which quality standards are present in DC schemes. It will investigate situations where the monitoring reveals that a scheme may not be meeting the standards of the Code and the guidance, and will assess if there has been a breach of the law. Where the Regulator sees "poor standards and behaviours we believe pose a risk to member outcomes" it may use its enforcement options such as warning letters, requests for information, appointing trustees and imposing civil fines.
The Regulator identifies five segments of the DC market and of these focuses on "master-trusts" – i.e. segregated schemes for unconnected employers. The Regulator says it will monitor the number of master trusts which obtain independent assurance reports testing the effectiveness of control processes that underpin the DC 'quality features'.
The Regulator's regulatory approach document analyses how its six DC principles and DC 'quality features' manifest in work-based personal pensions which are regulated by the FSA.
Code of Practice
The Regulator's Codes of Practice are intended to provide "practical guidance on the requirements of pension legislation" and to set out "standards of conduct and practice expected of those who must meet the requirements." The Code of Practice is not itself legally binding on trustees - i.e. there is no penalty for them failing to comply with it. However, the Code will be referred to by the Regulator when deciding on appropriate regulatory action, it is admissible as evidence in any legal proceedings and if relevant it must be taken into account by a court or tribunal.
To some extent the Code of Practice overlaps with other Codes which have been issued by the Pensions Regulator in relation to all occupational schemes (i.e. not just DC schemes). For example, the existing Code in relation to internal controls overlaps with the draft DC Code.
There are some aspects of the Code which are not entirely clear as to what is expected of trustees. For example, when considering scheme investments, the Regulator suggests trustees should communicate to members the level and nature of protection available. It is suggested this may cover whether compensation is available under the Financial Services Compensation Scheme, and if not the trustees should undertake additional due diligence and document their decision. It is not clear how much information the trustees must provide to members, or how far they must go to investigate the protection offered (other than give the usual warnings that investments may not be fully protected and may go down as well as up), particularly given that the trustees will wish to avoid giving investment advice to members.
The guidance is intended to set good practice standards in certain areas. The Regulator envisages that the guidance will be read in conjunction with the Code of Practice.
There is some overlap between the two documents, but much of this is only in the background sections. While the code focuses on:
- Trustee knowledge;
- Internal controls/risks;
- Conflicts of interest;
- Investment matters; and
the guidance focuses on:
- Member communications;
- Value for money;
- Transparency of costs and charges for both members and employers;
- Flexible contribution structures; and
The Regulator does not specify why it is necessary to introduce two documents instead of one, although it has done this on other matters. This could be because of difficulties for the Regulator of amending a Code once implemented (it must be laid before Parliament for 40 days). Such difficulties do not apply to its guidance which may be revised at any time.
This is the first time the Regulator has focused exclusively on regulating DC schemes. The prompt for this interest appears to be the introduction of auto-enrolment, which is expected to expand the membership of DC schemes by 6 million to 9 million new members over the next few years. The Regulator notes that auto-enrolment means many employees will join a scheme without choosing to do so – i.e. they will join due to apathy and should not be assumed to be "engaged investors". In the Regulator's view, this lack of interest by individuals places greater importance on the good governance of DC schemes, and means the Regulator has to reassess how it regulates them. It will be interesting to see how far this "apathy" by members is taken into account in future and how far it shifts a burden on to trustees or providers – e.g. in Pensions Ombudsman's cases - where this apathy means members were not aware of benefit restrictions or fund charges which they subsequently complain about.
It is expected that the Regulator will avoid using its enforcement powers where possible. It should be noted that some of its powers (e.g. imposing fines) can be used only where there is a breach of the law.
The Regulator says that where schemes offer both DB and DC benefits, it is not enough to devote a short amount of time to DC matters at the end of a trustee meeting. Instead, the draft Code says trustees should "set aside full meetings to address DC issues in detail." The Regulator clearly expects trustees of schemes offering both DB and DC benefits (such as AVCs) to spend more time looking at DC benefits. Such trustees already have a lot to consider, and this will add another burden on them. However, it is one to which, in many cases, they perhaps should be paying more attention.
4. High Court considers terms of a "mirror" scheme and legislative requirement that benefits are "no less advantageous"
In Industry-Wide Coal Staff Superannuation Scheme Co-Ordinator Ltd v Industry-Wide Coal Staff Superannuation Scheme Trustees Ltd and Terence Fox  EWHC 3712 (Ch) the Court considered the terms of a scheme, the draft rules of which had been set out in legislation, which was intended to "mirror" a public sector scheme.
On privatisation of the coal industry, the Industry-Wide Coal Staff Superannuation Scheme (IWCSSS) was introduced to replace the British Coal Staff Superannuation Scheme (BCSSS). The Industry-Wide Coal Staff Superannuation Scheme Regulations 1994 contained the terms of the IWCSSS draft trust deed and rules. The Coal Industry Act 1994, under which the Regulations were made, provided that the new scheme must provide benefits which were "no less advantageous" than the benefits being provided under the BCSSS.
The BCSSS, the draft trust deed attached to the Regulations and the IWCSSS rules which were ultimately executed all contained provisions allowing for annual pension increases by reference to the cost of living index. However only the BCSSS contained a provision for pro rata increases in the first year of payment.
The employers contended that the increase rule in the draft trust deed attached to the Regulations and the IWCSSS rules should be read to provide for pro-rating of the first year's increase. They contended that the omission of these words was a drafting mistake, and they relied on various evidence to support this, including statements made in Parliament that the IWCSSS would be a "mirror" of the BCSSS and would provide equal benefits.
The Court noted that the intended purpose of the Regulations was to give effect to the 1994 Act and provide benefits in the IWCSSS "no less advantageous" than those under the BCSSS. The Court noted that the absence of pro-rating for the first increase following the pension coming into payment was beneficial to IWCSSS members and was therefore not prevented by the words "no less advantageous" which did not mean 'the same as'.
The Court found that there was nothing in the 1994 legislation which supported the argument that the omission of a pro-rating provision from the draft rule was a mistake. The Court contrasted the case with those where there was inconsistency, ambiguity or an element of absurdity; given that the rules of the IWCSSS were 'workable' as drafted, the Court could not be "abundantly sure" there was a mistake in this case.
This case will be of interest to other employers and schemes of privatised industries. Although the Court accepted that the change may have been unintentional, it felt unable to correct it as it 'worked' as drafted.
This may seem unfair to employers who thought (and indeed had been told by the Government) that they were providing a "mirror image" scheme to the public sector scheme which employees were leaving, but where the drafting in fact requires them to give something more generous. This is particularly the case given that the terms of the industry-wide scheme originated in legislation drafted by the Government, and over which the employers may have had little if any influence.
It should be noted that this was ultimately a case of legislative interpretation, which may have resulted in the Court taking a more cautious view.
5. High Court considers interpretation of policy documentation
In Phoenix Life Assurance Ltd v FSA  EWHC 60 (Comm), the provider, Phoenix, sought a declaration about the proper interpretation of a form of single premium with-profits policy known as the "Freedom Bond", which was sold to policyholders between 1986 and 1992. The Freedom Bond promised three minimum benefits, including a guarantee of "nominal capital sum" (NCS) and a "GMP guarantee" which was a guarantee for the policyholder and his surviving spouse of no less than amounts stated as a GMP revalued to State Pension Age and a spouse's GMP.
The case concerned a provision dealing with the NCS which said that Phoenix "guarantee this amount to be sufficient to cover any GMP for the Annuitant and his widow as described below". The court was asked to determine whether Phoenix: (i) guaranteed that the GMPs would be covered by the amount of the NCS, stated in the schedule to the Freedom Bond (the "initial pot"), or; (ii) as Phoenix contended, that GMPs would be covered by that amount together with any bonuses allotted to the Freedom Bond (the "enhanced pot").
The Court found in favour of Phoenix's interpretation of the policy that the GMPs would be covered by the enhanced pot in addition to the NCS. In coming to a conclusion the Court said on contractual interpretation: "Each provision should inform the proper interpretation of the other, and the parties' intention is ascertained by seeking from the start a harmonious interpretation of the contract as a whole, rather than managing to reconcile discordant interpretations of different provisions".
This case shows the Court's willingness to look at the contract as whole instead of looking at individual provisions in isolation. It is interesting that the Court favoured Phoenix's interpretation and not that favoured by the FSA on behalf of policyholders (the FSA was acting instead of a representative policyholder due to the urgency required for a decision).
6. Court holds that rectification does not contravene preservation requirements
In Konica Minolta Business Solutions (UK) Limited v Applegate and Others  EWHC 3741 (Ch), the High Court had been asked to consider a case for rectification which would have required removing or amending a 'preservation underpin'. As a preliminary issue, the Court first considered whether the rectification, if successful, would breach the statutory preservation requirements of the Pension Schemes Act 1993. In this instance it decided that it would not.
Konica had acquired a pension scheme as a result of a share purchase in 1987. In 2002, the benefits of that scheme were transferred into another pension scheme, on the basis that the same benefits were to be provided. A definitive deed was executed in 2006.
Under the original scheme, benefits were provided on the basis that a member with over 10 years' service received a pension equal to 2/3 of his final salary. Members with under 10 years' service received benefits as a fraction of their final salary in accordance with a table in the rules. Deferred members' benefits were reduced using the ratio of completed service to potential future service (commonly called the N/NS formula).
Konica contended that the 2006 definitive deed contained a mistake in that it inadvertently increased the benefits of deferred members of the transferred scheme. This is because instead of benefits being automatically reduced by the N/NS formula, they became the higher of (a) the normal active member leaving service benefit and (b) benefits reduced by the N/NS formula. Konica contended this was a mistake which went beyond the intention to replicate the rules of the previous scheme and it accordingly sought rectification. As a preliminary issue the Court considered whether the removal of (a) above would cause the scheme to contravene preservation requirements.
In this case, an exemption from the preservation legislation set out in s 74(3) of the Pension Schemes Act 1993 for "so much of any benefit as accrues at a higher rate, or otherwise more favourable, in the case (a) of members with a period of pensionable service of some specified minimum length…" was held to apply to benefits such as those in this scheme (i.e. a 2/3 pension after 10 years). As such the scheme would not contravene the preservation legislation if the underpin contained in (a) above were removed.
It is interesting to see another case on preservation and rectification so soon after the IBM case, which was considered by the Court in Konica (see our bulletin on IBM here). It is also interesting that the Court held (and the parties apparently had not disagreed) that it had power to make an order for rectification on terms that a more limited underpin could be introduced. This would give the Court the ability to re-write the provision and order a different underpin to be put in place, instead of simply removing the underpin in its entirety.
Pensions Ombudsman Determinations
7. Another example of refusal to uphold a complaint over a switch from RPI to CPI
In Houghton (88880/2) Mr Houghton complained that the trustees of the Innospec Ltd Pension Plan changed the measure used to calculate annual pension increases from the Retail Price Index (RPI) to the Consumer Price Index (CPI) without prior consultation and despite the fact that plan information referred to RPI.
The deputy Pensions Ombudsman held that the plan documentation did not specify a particular index, only that increases would be in line with the cost of living. Therefore it was for the trustees to decide what this meant. To follow the Government's decision to interpret the cost of living by the change in CPI was not unreasonable, and there was no requirement to consult the members first.
The employer had not contractually agreed to apply RPI and the doctrine of estoppel did not apply in the member's favour as there was no statement that RPI would always be adopted, and there was no reliance by Mr Houghton. Therefore the member's complaint was not upheld.
8. Trustees not liable for "lost" benefits which may have transferred to their scheme
In Waterton (84096/3), the Pensions Ombudsman dismissed a complaint of maladministration brought by a member who sought to have the custodians and/or the trustees of two schemes accept liability for his deferred pension benefits, the whereabouts of which had become unknown after a complicated sequence of bulk transfers and company takeovers.
Mr Waterton had preserved benefits in the Selincourt Group Pension Scheme. Following several bulk transfers of the benefits in that and in subsequent schemes, it became apparent that his benefits had become 'lost'.
Mr Waterton argued that he had never transferred his benefits from the various schemes, and that the custodians or the trustees of one of the two possible schemes where his benefits could have been transferred to by way of bulk transfer should now accept liability for his preserved benefits. The custodians and the trustees of the two schemes each said they had no record of Mr Waterton ever being included in the bulk transfer to their scheme.
The Ombudsman noted that while he was "sympathetic" to Mr Waterton's position and that there may have been maladministration by one of the schemes somewhere in the past, there was no evidence that the liability now lay with either of these two schemes.
This case is very unfortunate from the member's point of view and shows the problems involved in poor record keeping for bulk transfers and transactions dating back several years. The Ombudsman was clearly unhappy with the result and stated that his office had gone "substantially beyond the limits of Mr Waterton's complaint" in trying to find out where his benefits now might be, but unfortunately its efforts had been fruitless "in this very unsatisfactory case".
9. Charges imposed on a small self-administered scheme (SSAS) totalling 40 per cent of contributions were not unlawful
In McCabe (84395/3), Rev McCabe was the sole member and a managing trustee of the scheme established in 1997. He entered into a policy, on standard terms, with Scottish Equitable (now AEGON) under which his consultancy business would pay annual premiums of £9,000. Rev McCabe's financial adviser, Rickards, stated that they gave a verbal instruction to change the policy to a single premium contract but AEGON said they had no record of such instruction.
By September 1999 total contributions of £31,852.40 had been made. Around that time Rev McCabe stopped his consultancy work and as a result the contributions ceased. Under its terms, the policy became paid up because regular payments were not paid when due. This meant that a "specific member paid up policy charge" (SMC) of between £1,000 and £1,360 a year was applied.
In 2008 and 2010, AEGON sent Rickards, at their request, details including the structure for charging for the policy although they did not specify how the SMC calculated. Up to July 2010, £12,828 of SMC charges had been taken (40% of the contributions made by the company), in addition to other charges which totalled £2,968 (about 9% of contributions).
Rev McCabe complained to the Ombudsman that the SMC was unjustifiably large, and was not adequately explained to him at any stage. AEGON said that the SMC was fully detailed in the policy literature, and was reasonable for a paid-up plan.
The Ombudsman commented that Rev McCabe had "plainly" applied for an annual premium contract. It was "hard to understand" why Rickards believed that a verbal instruction should have given effect to any change in the contract, without written confirmation from either side. To the extent that Rev McCabe considered he was not adequately advised by Rickards, he might have a claim against them, although this would be outside the Ombudsman's jurisdiction.
In accordance with the policy terms and conditions, AEGON was entitled to impose the paid-up charges – even though they were "undoubtedly high". However, by failing to provide explicit details of how the SMC was calculated when originally asked (this was eventually provided following an application by the Ombudsman's office), AEGON had supplied Rev McCabe with an inadequate response to his concerns. This would have caused him "modest inconvenience" and the Ombudsman ordered AEGON to pay Rev McCabe £250 in recognition of this.
This case shows the importance of understanding the charges of such schemes. It should be noted that this was a SSAS, and it is unlikely such high charges would be considered acceptable in an occupational or other private pension scheme, particularly given that charges in such schemes (see our bulletin here) and defined contribution schemes generally are currently under the spotlight (see above on the Regulator's consultation on a new regulatory framework for DC schemes).
10. Income Drawdown
On 17 January 2013 HMRC published draft legislation to allow income drawdown pensioners to receive an authorised pension from their registered pension scheme of up to 120% of the "basis amount" (broadly the amount of income that would be payable from a level, single-life annuity without a guaranteed term). This proposal was mentioned in the Chancellor's autumn statement (see our bulletin here).
At present the maximum drawdown allowed under the Finance Act 2004 is lower, namely 100% of the "basis amount".
It is proposed that this amendment will have effect for drawdown years beginning on or after 26 March 2013.
Prior to the tax year 2011/12 income drawdown up to 120% of the "basis amount" was permitted. The effect of this amendment, therefore, is to restore the position as it was before 6 April 2011. Some individuals close to retirement have been advised to postpone taking income drawdown until after the change comes into effect so they can take advantage of the higher rate.
11. International Focus – USA
In the USA, a new law by the State of Rhode Island to overhaul its pension plan has led to a dispute between the State and the five public sector unions which has now been referred to mediation. For more information, see the bulletin by our New York office here.