The DWP has issued its response to its consultation in relation to the change to the statutory definition of 'money purchase benefits', together with finalised regulations. The Regulations, The Pensions Act 2011(Transitional, Consequential and Supplementary Provisions) Regulations 2014 were laid before Parliament on 6 May 2014 and are expected to be in force in July this year. The DWP has, it seems, listened to the concerns of the pensions industry and for the most part, the effect of the changes is going to be prospective. In two narrow circumstances, however, the Regulations require that an employer debt triggered before the Regulations come into force be recalculated. In this briefing, we consider the effect of these developments on pension schemes.
The existing definition of "money purchase benefits" in the Pensions Schemes Act 1993 is a "payments"-based definition – benefits are money purchase if they are calculated by reference to payments made by or in respect of a member.
In the case of Bridge Trustees v Holdsworth 2011, the Supreme Court determined that certain benefits, principally where a money purchase pot is converted into a scheme pension (rather than secured through an annuity) or where a money purchase pot is subject to a guaranteed rate of investment return, are still money purchase benefits, despite the fact that a deficit could arise in relation to them.
The Court stated that:
“Equilibrium of assets and liabilities is not a requirement of the statutory definition of a money purchase scheme (and similarly for money purchase benefits)" but "Parliament has enacted primary legislation, and the Secretary of State has initiated secondary legislation, on that assumption".
On 27 July 2011, the same day as the judgment, the DWP stated it would amend the statutory definition of ‘money purchase benefits’ so that Bridge-type benefits would fall outside the money purchase definition.
The changes were set out in section 29 of the Pensions Act 2011, which is expected to be brought into force at the same time as the Regulations. Section 29 will change the definition of "money purchase benefits" retrospectively from 1 January 1997. A benefit will be a 'money purchase benefit' if it is calculated solely by reference to the assets, so that the assets must always be sufficient to meet the liabilities; in other words, a benefit in relation to which a deficit cannot arise.
Notwithstanding that the change is to be retrospective, the Regulations introduce transitional provisions so that for the most part, it will not be necessary to revisit how benefits have been treated in the past. The Regulations provide that the past treatment of the following benefits as money purchase benefits will be validated:
- cash balance benefits treated as money purchase benefits; or
- pensions derived from money purchase benefits or cash balance benefits.
The consultation response refers to these benefits as "Affected Benefits" (i.e. those that have to be re-categorised as non-money purchase when Section 29 comes into force). Additionally, the Regulations provide that the treatment of the following benefits which are not affected by the Bridge judgment but which the Court saidcould be money purchase benefits will also, for certain purposes, now be validated:
- Underpin benefits – where an occupational pension scheme provides a money purchase underpin in relation to a defined benefit and the underpin does not "bite at the point the underpin is tested". In these circumstances the past will not need to be revisited except in two circumstances.
- Top-up benefits – where a money purchase benefit falls short of a promised defined benefit and a top-up is given to bring the benefit up to the level of the promised defined benefit. Past actions will also be validated here except in two circumstances.
- AVCs – treatment of AVCs and benefits derived from them as money purchase are validated in the context of scheme wind-ups outside the PPF.
- Protected rights
These benefits were not initially within the scope of the transitional protection but brought within scope following concerns raised during the consultation process as to their status.
The Regulations do not impact on schemes that have treated the above benefits as defined benefits and only provide protection in the above circumstances. The DWP has refused to give a blanket protection for any (other) money purchase benefit where some form of guarantee was given.
Employer debts have to be re-visited in two circumstances
Where a scheme has benefits that fell outside the current definition of money purchase benefits and were not affected by the Bridgejudgment i.e. top-up benefits or underpin benefits, there are two circumstances where past decisions have to be revisited:
- If a scheme is still in wind-up as at the date the Regulations come into force – the employer debt has to be recalculated as if the top-up benefit, the underpin benefit and also any Affected Benefits were defined benefits;
- In a multi-employer scheme, where an employer has left the scheme before July 2014. Here the employer debt has to be re-calculated unless:
- the scheme carries out an actuarial valuation "as soon as reasonably possible" with an effective date ("Effective Date") of 12 months from the date the Regulations come into force and this valuation shows that the statutory funding objective is met as at the Effective Date. If the valuation shows that the scheme is unable to meet the statutory funding objective, a recovery plan must be put in place within six months of the Effective Date to avoid having to re-calculate the employer debt; or
- the employer is insolvent or, in a multi-employer scheme, all the employers are insolvent.
While this requirement to revisit the past creates an additional burden for schemes, it is a considerable improvement on the draft Regulations, which provided that the past decision need not be revisited from 1 January 1997 until 27 July 2011; thereafter, wind-ups commenced after that date and completed before that date and employer debts triggered after that date had to be revisited. For our update on the consultation, click here.
Section 67 of the Pensions Act 1995
Where schemes have made a "detrimental modification" for the purposes of Section 67 of the Pensions Act 1995 and which would be classed a "protected modification" if the benefits were to be re-categorised as a result of section 29, the Regulations provide that schemes will not need to revisit that change. The concern is that if that change were now treated as a protected modification, members' consent to the change would be needed. An example of this is where a guarantee was removed from a cash balance benefit.
Going forwards, where a modification might adversely affect the defined benefit minimum in an underpin benefit, or a defined benefit top-up, the change is to be treated as a detrimental modification. These benefits will also be 'subsisting rights' for the purposes of section 67, and so be subject to the section 67 regime. The reason for protecting changes to these benefits in this way is that members' entitlement to money purchase or non-money purchase is not clear until the point at which they are paid.
The Pension Protection Fund
Schemes that are eligible for the PPF for the first time from 1 April 2015 because they provide money purchase benefits some or all of which will be reclassified as defined benefits must submit their first Section 179 valuation to the PPF by 31 March 2015.
Schemes will also have to pay a PP levy in respect of those benefits from 1 April 2015; however, past levy calculations will not need to be re-visited.
Schemes which entered an assessment period before the Regulations come into force will not have to unpick the basis on which benefits have been assessed.
The PPF compensation provisions have also been tidied up by the Regulations so that they apply to Bridge-type benefits. There were concerns that the current provisions, which, broadly, apply to schemes with an accrual rate, will not be suitable for Bridge benefits, such as where a scheme has self annuitised a money purchase pot.
Implications for pension schemes
Schemes that have treated benefits as money purchase in the past will need to address the impact of section 29 going forwards and may need to re-categorise them as non-money purchase.
In particular, some schemes with such benefits will have to comply with the statutory funding obligations for the first time from July 2014 by producing an actuarial valuation with an effective date of July 2015 (at the latest). Schemes will have another 15 months within which to comply with other scheme funding requirements, such as putting in place a schedule of contributions. Where schemes have previously carried out valuations but have not included benefits affected by Section 29, they will need to include them in the next scheme valuation. Any valuation completed before the coming into force date will, however, continue to be valid.
Those eligible for the PPF for the first time should submit their section 179 valuations by 31 March 2015. For schemes that are already covered by the PPF, the PPF may require an ‘out of cycle’ valuation reflecting the new benefits from the scheme. The PPF is currently consulting on proposals as to when it will require such a valuation, where there is a material effect on a scheme's funding position. The consultation is on the PPF website:
Schemes with top-up benefits and underpin benefits, will going forwards, need to treat them in accordance with the Regulations. This means that in relation to a money purchase underpin benefit, at the point of testing, if the underpin does not bite, the benefit should be treated as a defined benefit; otherwise, the benefit will be money purchase. Top-up benefits should be treated as defined benefits, where the money purchase pot is lower in value than the promised defined benefit.
Schemes with top-up benefits and underpin benefits that are in wind-up or where an employer in a multi-employer scheme with such benefits has left the scheme will need to conduct an actuarial valuation and if the valuation shows that the scheme is unable to meet its statutory funding objective at the effective date, put in place a recovery plan to avoid having to revisit the employer debt.
Schemes which self annuitise should be aware that the benefit will be regarded as a defined benefit when it is converted into a scheme pension. Some schemes use the option to deal with small pots. However, given the increased limits for trivial benefits following the Budget 2014 measures and other proposals floated in the Budget in relation to accessing money purchase benefits, there may be other ways of dealing with small pots rather than paying them as a pension out of the scheme. For our summary of the Budget measures, clickhere