On 15 December the Pensions Regulator published its draft code of practice relating to the ‘material detriment test’, which will be used by the Regulator in relation to the exercise of its power to issue contribution notices. Prior to 14 April 2008, the Regulator only had the power to issue a contribution notice to a sponsoring employer of a scheme if that employer had, in the opinion of the Regulator, taken deliberate action to prevent the recovery of a section 75 debt or to prevent such a debt becoming due. Provisions contained within the Pensions Act 2008 will, in addition, allow the Regulator to issue a contribution notice where action taken by an employer has ‘detrimentally affected in a material way the likelihood of accrued scheme benefits being received’. This new test, which will apply retrospectively to 14 April 2008, is thus not ‘fault based’, instead it focuses exclusively on the effect of action taken by an employer.  

The material detriment test is being introduced following the emergence of new business models which are intended to act as alternatives to normal pension scheme buy-outs. The DWP is concerned that these new business models may reduce the security provided by a scheme’s employer and ultimately lead to more calls on the PPF to provide benefits. However, the steps involved in implementing these methods of reducing an employer’s exposure to its pension scheme are, in themselves, often indistinguishable from ordinary corporate activity. This often makes it difficult for the Regulator to exercise its existing moral hazard powers. The DWP has therefore decided that amending the Regulator’s existing powers, including the introduction of the effect-based material detriment test, is the best method of ensuring that the Regulator continues to be able to prevent employers avoiding their pensions liabilities.  

The introduction of the material detriment test will significantly widen the circumstances in which the Regulator can issue contribution notices. Various objections to the new powers were raised when they were first proposed, including that they would cause uncertainty for business and could potentially stifle ordinary corporate activity. In response to these concerns, the DWP noted that the Regulator would, in due course, set out the circumstances in which it could exercise its wider powers to issue contributions notices in a Code of Practice, the draft of which it has now issued for consultation.  

The circumstances in which the Regulator expects to issue contribution notices pursuant to the material detriment test are set out in the draft Code as follows:  

  • The transfer out of the jurisdiction of the UK of the scheme in question.  
  • The transfer out of the jurisdiction of the UK of the sponsoring employer, if this leads to a material reduction in the level of employer support or legal and regulatory protection for scheme members.
  •  The severing of employer support such that employer support is substantially reduced.
  •  The transfer of liabilities to another scheme which does not have sufficient employer support or is insufficiently funded.
  •  Where the employer or some other person benefits financially from the new business model or the operation of the scheme and inadequate account has been taken of the interests of members.  

In addition to the restrictions placed upon the Regulator’s power by the Code of Practice, the Regulator must consider the reasonableness of issuing a contribution notice and there will also be a statutory defence to a contribution notice issued on grounds of material detriment contained within the Pensions Act 2008. The existing clearance regime will continue to be available to provide assurance that contribution notices or financial support directions will not be used in relation to particular events.

It is intended that the final Code of Practice will come into force at the same time as the material detriment test is introduced. Until the Code is in force, the Regulator’s statement of 25 April 2008 continues to apply in relation to the application of the new test. To view the statement go to http://www. thepensionsregulator.gov.uk/pdf/StatementOnPowers. pdf, or click here.

The closing date for submissions on the draft Code of Practice is 6 February 2009. The full document can be accessed by visiting the Regulator’s website (www. thepensionsregulator.gov.uk) or by clicking here.