The Pension Regulator’s new tougher powers – what’s the latest?

The Pensions Regulator (TPR) is getting tougher powers from 1 October. We now know some of the detail, but there is still more to come, and lots for companies and trustees to consider in the run up to 1 October, including reviewing governance arrangements to ensure they can avoid the new penalties.

In this blog I comment on the most recent developments in just two new areas - the new Employer Resources Test and the latest on TPR guidance - and end with some reflections on what employers and trustees should be doing now (July 2021 onwards).

Employer Resources Test regulations

The DWP has now issued the final regulations for the Employer Resources Test. This is one of two new triggers that, if met, will enable TPR to open an investigation into using its Contribution Notice (CN) power (a CN is an imposed legal requirement for a sponsor, or related company, shareholder, or director, to contribute cash to a pension scheme with the Employer Resources Test being one of four triggers TPR could use to seek to issue one).

DWP has also issued its response to points raised on the consultation (which was issued back in March) clarifying a number of points unclear from the initial consultation but also confirming that – despite some criticism – it is not revisiting certain aspect of the original proposal, such as the much objected to choice of earnings metric for “employer resources”.

What’s in the regulations?

So, what do employers and trustees need to know about where DWP has landed with the final regulations on the Employer Resources Test? Firstly, here’s the summary of what is, and importantly what isn’t, in the regulations:

1. The regulations define employer ‘resources’ as normalised profits of the employer before tax. To ‘normalise’ profits, any one off or exceptional items will be adjusted out. These could be income or costs so the adjustment can work both ways.
2. The normalised profit before tax will then be adjusted for the effect of the act (or failure to act) and a comparison made to see if the post-act position is worse, and, if so, whether that worsening is material in the context of the scheme’s so called s75 debt (ie an estimate of the additional premium an insurer would charge if a scheme wanted to buy out).
3. TPR has the power to determine employer resources pre- and post-act.
4. The regulations don’t comment at all on how materiality will be determined, TPR has the power to determine what is material on a case-by-case basis.

Whilst clearly there are some limitations of using a profit before tax measure, we can understand the desire to keep the initial test simple and traceable to a widely reported and audited financial metric. Helpfully the consultation response recognises that where this exact figure isn’t available TPR will seek an appropriate alternative, which will of course be necessary for not-for-profit employers.

What does this mean for sponsors of DB schemes?

Many corporate actions could impact profitability, such as changes in financing arrangements, M&A activity, internal group restructuring, even changes to inter-company trading arrangements that may be required by tax authorities – something that is beyond an employer’s control.

In many cases such corporate activity will possibly trigger the initial Employer Resources Test because profits are reduced. As there’s not expected to be any guidance on what constitutes a ’material reduction’ to profits (and so when TPR is likely to deem that the trigger has been breached), employers will need to make their own determination – assuming they wish to have some confidence about avoiding regulatory intervention, including the possible threat of a criminal offence.

Also, given that a scheme’s insurance buyout deficit is the reference point (rather than the normal scheme funding deficit), even where a scheme is very well funded and the covenant remains relatively strong, the test could theoretically be breached, which is a departure from the way most of TPR’s powers have worked historically.

Put simply, what this means is that if a company’s profits go down, TPR may have the power to demand that additional contributions are paid into a DB pension scheme.

To mitigate this risk, it will be really important that employers keep an audit trail of their own assessments of the impact of business decisions and events, as measured by the ‘employer resources’ test (and also by the other new CN test – the ‘insolvency test’[1]). To mitigate the risk further, this would also be supported by independent covenant advice where there’s any doubt over whether the impact could be perceived as negative. The sponsor may need to, or wish to, share these assessments with TPR and/or the trustees of the scheme, to demonstrate that the scheme has been considered at the planning stage of corporate activity and how the risk of adverse impacts on the pension scheme have been considered and (if potentially material) then appropriately mitigated.

Having said all that, triggering the test is just a starting point and TPR will still have to consider whether it’s reasonable to use its powers. Our current understanding is that this ‘reasonableness argument’ will need to take into account all the circumstances of the scheme and so there may be situations where the tests are triggered but where on balance it would not be ‘reasonable’ for TPR to impose a CN. So as part of the sponsor’s impact assessments, it will also be important to build a pension scheme focussed case as to why any proposed actions are reasonable, and why it would therefore be unreasonable for TPR to take regulatory action.

Is there any further guidance which might help sponsors and trustees?

It seems a lot rests in TPR’s remit, so clear guidance on how it intends to use its new tougher powers would be really helpful. However, unfortunately, it seems we won’t be getting this in the short term.

TPR’s consultation on a revised Code of Practice 12: Contribution Notices: Circumstances in relation to the material detriment test, the employer insolvency test and the employer resources test (COP 12) has just closed. The current version of COP 12 is probably the shortest code of practice and the least enlightening as to when and how TPR would seek to use its existing two CN powers. Possibly everyone’s lack of interest in this particular COP in the past is reflective of how little used the CN powers have been over the last 15 years.

Many in the industry were hoping that the new COP 12 would add some colour to the new regulations and provide some clarity on the situations which might trigger one of the new CN tests, and scenarios where TPR might expect to investigate. But unfortunately, the proposed new Code remains short, its examples of when TPR would and wouldn’t use powers too extreme, and so it doesn’t provide much help at all.

Hopefully new Clearance guidance – which we hope will be out in the Autumn – will shed some more light on TPR’s view on materiality for the new CNs and the boundaries within which it will seek to use its new powers. Otherwise there’s the risk of a massive increase in Clearance applications to deal with the uncertainty and I doubt TPR will have the resources to deal with that in the midst of managing the likely fall out as the Government’s Covid support schemes wane in the Autumn and dealing with distressed employers.

What should employers and trustees be doing now?

The intention is that these new CN tests – along with a raft of other new requirements and TPR powers - will come into force on 1 October 2021. Employers will wish to assess the impact of a business decision or event against these new hurdles in advance of the corporate activity (ie in the planning stage) – to identify the potential impact on the scheme and whether this could be perceived to be ‘material’ by TPR. New governance processes may be required to identify potentially relevant events, assess them, and consider next steps.

Whilst TPR has confirmed that the new CN tests will not be applied retrospectively to acts that took place before 1 October, I would expect TPR to still look back at corporate behaviour prior to that date when it is considering any reasonableness case and in practice we’re already seeing many trustee boards ask employers now how they think their business plans stack up against the new tests.

Also, much business activity currently under consideration – from refinancing to M&A activity – won’t be completed until after 1 October anyway so all parties need to get on board with this new world of regulation as soon as possible.

In summary, there’s still lots of detail to come, but everyone involved in sponsoring or managing a DB pension scheme should start to get familiar with the new tougher TPR powers now, to ensure employers and trustees manage their regulatory risks and avoid a shock come October.

[1] The insolvency test is the other new CN test which can be triggered if an act (or failure to act) results in a scheme’s recovery in the event of the employer’s insolvency being materially reduced. The test is a simple before / after analysis isolating the impact of the act and factors such as the likelihood of insolvency are not taken into account.