Pensions Act receives Royal Assent
After a lengthy, but largely uncontroversial, passage through Parliament the Pensions Act 2014 has received Royal Assent. This landmark Act, containing legislation that brings into force the single tier state pension, ends contracting out and introduces a number of significant measures aimed separately at defined benefit and defined contribution schemes is summarised in LCP’s guide to the Pensions Act 2014.
How pensions can help meet consumer needs under the new social care regime
With the Care Act now having received Royal Assent, the introduction of a new £72,000 social care cap in 2016 has been heralded by some as a solution to the social care cost problem. But the Institute and Faculty of Actuaries has issued a timely report which notes that whilst the cap will act as a safety net preventing individuals from facing catastrophic care costs, there is still a need to fund for considerable care costs and pensions could pay a pivotal role in doing so.
How pensions can help meet consumer needs under the new social care regime highlights that there are three types of care costs:
- Daily living costs – these are general living expenses and are NOT covered by the cap. Individuals are expected to pay £12,000 per year towards these (as they would pay living costs whether they were in care or not)
- Local authority set care costs – these are the costs of caring for the individual above daily living costs, these are capped at £72,000; and
- Top-up care costs – these are additional costs, not included in the cap, if the individual would like more expensive care (eg a particular private care home)
The report’s research shows that just 8% of men and 15% of women entering care aged 85 today are likely to reach the new care cap, and those who do reach the cap will have spent an average of around £140,000 on total care costs before reaching it.
As well as noting the use of existing savings, or the value of the individual’s house to fund these costs, the report suggests several possible funding solutions:
- Protection insurance – an insurance to cover care costs usually purchased before retirement. These are currently available but not widely used or marketed
- Income drawdown – the new income drawdown provisions in the Budget allow the flexibility to draw more pension to meet care costs, but only if the individual has a substantial pension pot remaining when he or she goes into care
- Pensions Care Fund – this would be like a pension pot that the individual and his employer pay into. The individual could not access the pot until he or she was in care. If the individual never needed care, the intention is that the pot would pass on to their spouse and failing that a dependant in the next generation; in either case, for their future potential care use
- Annuities – there are several types of annuities that could meet care costs, bought before or at the time of care. These either need a great deal of forward planning or large funds at the time care is required
The report notes that the variable and potentially high cost of care makes these solutions most suitable for those with high assets and low income, or low assets and high income. High assets and high income individuals will not be worried about the expense, whilst low asset and low income individuals will have other priorities and should get Government support.
Comment
The potentially huge cost of care in later life is best planned for early. The existing pension provision regime is a good initial structure within which to provide such a facility. The report highlights some potential solutions, but also quite rightly notes how individuals’ and employers’ attitudes to saving for care will have to change for these policies to take off.
Is a Government guarantee good enough to escape PPF-eligibility?
Not if the Government guarantee comes with a get-out clause, it would seem.
This is highlighted in the High Court judgment in FSS Pension Trustees Limited vs the Board of the Pension Protection Fund (PPF). The Government-owned Forensic Science Service Limited (FSSL) was established in 2005 as a transitional step towards privatisation of the government agency. However, no further steps were taken and FSSL began winding down in 2010 after running into financial difficulties. At this point the Home Office gave an assurance that “employees’ accrued pension rights would be protected through a Government guarantee” which would pay for any shortfall on the cost of annuity purchase. The guarantee was formalised in 2012, but included clauses to enable the Home Secretary to terminate the guarantee under specific conditions.
The trustees of the FSS Pension Scheme considered that this guarantee satisfied an ineligibility criterion of the PPF Entry Rules Regulations as it is provided by a “relevant public authority”. No PPF levy should therefore be payable. However, Mr Justice Newey ruled that the regulations did not provide for a scheme with a conditional guarantee to be ineligible for the PPF.
The judgment hinged on the words “for the purposes of securing that the assets of the scheme are sufficient to meet its liabilities” in the ineligibility criterion. Although the construction of the regulation may be viewed as ambiguous, Mr Justice Newey ruled that in terms of both language and the original Parliamentary intention, any guarantee must meet this requirement. But the termination clauses built into the guarantee provide for the possibility that it may be withdrawn, and so prevent it from objectively satisfying this requirement, however unlikely it is that the power to withdraw it might be used by the Home Secretary.
Comment
It seems that, in this case, the only way for the guarantee to be good enough for the PPF is for the Home Secretary to remove the termination clauses. So until this is done, the scheme is to pay PPF levies for an insurance cover inferior to the guarantee that it is very unlikely to be able to utilise.
Some form of Government guarantee on pension rights may often be sought as part of public sector outsourcing activities. Although these are often valuable to trustees and members alike, those involved with negotiations should still remember the cost of PPF levies going forward if the guarantees are not unconditional.
Contracted-out rights – a “no change” consultation
In addition to the draft employer override regulations published last week (see Pensions Bulletin 2014/19), the Department for Work and Pensions (DWP) is also consulting on draft regulations that will lay down the rules to be followed by current salary-related contracted-out schemes once contracting-out has been abolished in April 2016 as the single-tier state pension comes into effect.
These draft regulations are intended to replace the existing 1996 Occupational Pension Schemes (Contracting-out) Regulations (SI 1996/1172). The intention is to ensure that member entitlements from contracted-out employment continue to be preserved and that schemes previously contracted-out are appropriately operated.
Amongst other things, the draft Occupational Pension Schemes (Schemes that were Contracted-out) Regulations 2014 provide for:
- The continuation post 5 April 2016 for schemes and the Pension Protection Fund (PPF) to pay Contributions Equivalent Premiums (CEPs) in some narrowly prescribed circumstances
- The retention of requirements to protect the value of contracted-out benefits earned after April 1997 when changing scheme rules and restrictions on when a scheme can pay a lump sum instead of a pension from such rights
- The continuation of the requirements protecting guaranteed minimum pensions (GMPs) from scheme rule changes
- The continuation of the requirement for “actuarial equivalence” when a GMP is converted into other benefits
- The continued prescription of when a widow/widower/surviving civil partner’s GMP is payable and the lump sums that can be paid instead of GMP benefits
- Detailed provisions regarding the revaluation of GMPs, which include requiring all leavers to receive the same method of revaluation unless GMP benefits are being secured with an insurer
Consultation closes on 2 July 2014 and the intention is to bring most of the regulations into force on 6 April 2016, at the same time as most of the 1996 regulations are revoked.
Latest scheme funding analysis – Regulator test runs its covenant groupings
The Pensions Regulator has published its latest analysis of scheme funding valuations and recovery plans (see Pensions Bulletin 2013/28 for last year’s report). It shows that for the schemes in question the average funding level on the scheme funding (technical provisions) basis was higher than three years earlier (ie at the previous valuation for these schemes), but that they also received higher deficit reduction contributions in nominal terms. These schemes also appear to have made use of recovery plan flexibilities, with the average recovery period lengthening by around a year and a half.
For the first time the analysis also splits some of the statistics to illustrate how they are impacted by employer covenant by assigning the reporting schemes in deficit to one of the four covenant groups which are a feature of the proposed new framework within which the Regulator intends to regulate the funding of defined benefit pension schemes (see Pensions Bulletin 2013/50).
Although bearing in mind that the groupings used are those assigned at the point of initial recovery plan reviews (so that they may not be the same as those used by the Regulator if intervening on specific cases, where a wider range of information is taken into account) it is interesting to note that 37.7% of all tranche 7 schemes reporting in deficit have been assessed to be in covenant group 2 (“tending to strong”), with 22.6% in group 1 (“strong”), 21.5% in group 3 (“tending to weak”) and 18.1% in group 4 (“weak”).
When looking at all tranche 7 schemes, perhaps unsurprisingly, average funding levels on the technical provisions basis increase and average length of recovery plans shorten as the covenant strengthens.
With more people expected to hit the Annual Allowance, HMRC extends its toolkit
There has been more development of HM Revenue & Customs’ (HMRC’s) web tools to help individuals work their way through their obligations to monitor their own Annual Allowance (AA) position and report and pay an AA charge when it arises.
We have already noted (see Pensions Bulletin 2014/15) that HMRC’s (original) “Pensions Savings Annual Allowance calculator” could be extremely useful (indeed is essential) but that it is a shame it is flawed.
That tool has now been renamed the “enhanced” version. A new limited “standard version” has been created specifically for individuals who are facing their first tax year of having made pension savings that exceed the year’s AA. As far as we can see, its use is specifically for such individuals to reassure themselves, based on the information they can garner (which may be limited, but enough for the purpose), that they do not have an AA charge as they have enough unused AA to carry forward.
Comment
The further reduction in AA to £40,000 will undoubtedly see more individuals hitting it (some unintentionally from misunderstanding the complex AA rules). So a tool that helps members work out quickly with what data they have that they do not have a charge perhaps justifies HMRC resources being put to creating a new limited version of the calculator. But trustees might be reluctant to point members to it until the accompanying wording shows better what it is not for (for example, if the user does put in limited data, output that says there is a tax charge should not necessarily be believed); and if used for forward planning it should be used with extreme care. And other aspects could be improved.
Pensions Policy Institute suggests annuities will adapt and survive
The Pensions Policy Institute (PPI) has published research which suggests that the doom and gloom over the future of the annuity might be premature.
The PPI’s Briefing Note “Freedom and Choice in Pensions: comparing international retirement systems and the role of annuitisation” highlights a number of factors that affect the demand for annuities across different countries. Countries with higher levels of annuitisation all offered higher annuity rates than would be expected given the market conditions – this was often due to some government intervention or price regulation in the markets. Importantly, these annuity products were perceived as “good value”, which they are not currently in the UK.
Without that sort of intervention it was expected that the following groups of people might still purchase annuities:
- The risk-averse, particularly if additional guarantees were built into annuity products
- “Partial annuitants” – ie those who look to secure a minimum level of income and then spend the remaining savings at a time of their choosing
- Those qualifying for higher annuity rates, (eg enhanced annuities) who still want longer-term security; and
- Those for whom an annuity may be more tax efficient than taking out a lump sum at marginal tax rates
The PPI suggests that innovations in the market, for example annuities that can also provide elements of insurance for health, disability or long-term care needs during retirement, and deferred annuities that can be combined with income drawdown products to provide insurance against very long life, could provide features that consumers value as the industry responds to the new flexibilities in the Budget.
Comment
The PPI is right to focus on the innovations that can replace the standard annuity. Whilst there is little doubt insurers will see a fall in annuities purchased, they have an opportunity to make up much of that lost business with products such as healthcare insurance and later age annuities.
Charity Commission reminds charities to talk about pensions risks in their reports
The Charity Commission has warned that charities with pension scheme deficits should be doing more to explain in their accounts how they are tackling them.
A review of 97 randomly selected charities with pension scheme deficits found that only 31 of them had explained the financial implications and trustees’ plans to deal with deficits in the Trustees’ Annual Report. This is despite the requirement within the Charities’ Statement of Recommended Practice (SORP) to include a review of their general financial position.
The report acknowledges that the trustees of charities with relatively small deficits may have decided that this was not a significant financial risk and did not merit inclusion in the annual report. But the report says that others with significant deficits missed the opportunity to demonstrate to donors and beneficiaries that they were tackling the problem appropriately.
Combined pension statements guide published
The Department for Work and Pensions (DWP) has published a guide that explains what Combined Pension Statements are, how they can benefit pension scheme members and how to provide them.
A Combined Pension Statement consists of the DWP giving a State Pension estimate for each scheme member or employees which can then be used within scheme-based annual benefit statements.
This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.
