Pensions Regulator asks trustees to take action as definition of “money purchase benefits” changes
In the light of the modified and more restrictive definition of “money purchase benefits” which came into force on 24 July 2014, the Pensions Regulator has issued a Statement in which it is asking trustees to undertake the following actions:
- To consider whether their scheme may be affected by the revised definition of money purchase benefits – the Regulator points out that the schemes most affected are those that offer cash balance benefits and “internal annuities” – ie scheme pensions that are derived from cash balance or money purchase benefits where the scheme pays retirement income directly from its own funds
- To review the scheme’s trust deed and rules and seek independent legal advice in order to determine the character of benefits provided by the scheme in light of the revised definition of money purchase benefits
- To consider whether any hybrid benefits that have previously been treated as money purchase benefits continue to satisfy the definition of money purchase benefits; and
- If the scheme is or has been treated as money purchase and, following the review, it is found that it offers benefits that have the potential to result in a funding deficit (and therefore falls outside the amended definition of money purchase benefits), to notify the Regulator immediately so that it can amend its records
The Regulator concludes by encouraging trustees to read the Statement in conjunction with the settled legislation and the Department for Work and Pensions’ response to the consultation on draft regulations “in order to be confident that they fully understand the potential impact on their scheme”.
Comment
Whilst it is unsurprising that the Regulator has chosen to make a statement on what it calls a “fundamental concept of pensions law”, it is disappointing that it does not drill down into any of the issues to assist trustees. And it should surely not be encouraging trustees to read the voluminous legislation on this subject, much of which will not be relevant to them.
PPF decides which schemes must complete an out of cycle levy valuation
The Pension Protection Fund (PPF) has confirmed which non-money purchase schemes, affected by the revised money purchase definition, will be required to complete (by 31 March 2015) an out of cycle levy valuation.
The PPF is responding to its consultation issued in May (see Pensions Bulletin 2014/22) on the new money purchase definition as a result of the Bridge case, which brings more benefits (and potentially schemes) within PPF scope. The PPF has decided that schemes for which the change in money purchase definition causes a material worsening in their PPF levy valuation will have to produce an out of cycle valuation unless their PPF levy valuation submitted on Exchange by 31 March 2015 takes account of the amended money purchase definition.
For these purposes, material means that the amended money purchase definition reduces a scheme’s PPF levy surplus (or increases its deficit) by at least 10% in relative terms and at least £5 million in absolute terms.
The timescales for producing an out of cycle valuation are very tight. The effective date has to be on or after 24 July 2014, but the whole valuation has to be completed and submitted by 31 March 2015. This gives just over eight months to start and complete the valuation. Audited accounts are required for a PPF levy valuation, so schemes will need to produce those (bearing in mind the scheme’s standard accounting date might not be within those eight months).
Alternatively, trustees have the option to re-work a PPF levy valuation currently in progress to allow for the amended money-purchase definition.
Comment
The PPF has made some important changes as a result of the consultation, in particular not requiring an out of cycle valuation from schemes which see an improvement in their section 179 position. Evidence supplied to the PPF suggests that many affected schemes will fall into this category. For schemes where the section 179 position is expected to materially worsen but which have already submitted their section 179 valuation, they should now be able to re-work and re-submit it on to Exchange before the March 2015 deadline, provided the re-submission is still within 15 months of the effective date.
Separate to this, schemes that thought they were money purchase and, post 24 July 2014 find that they are not, will need to rush through a PPF levy valuation in the next eight months.
Pensions Regulator refreshes its campaign literature against the pension liberators
The Pensions Regulator has updated its scorpion branded materials to support its continuing campaign against the pension liberators (see Pensions Bulletin 2013/07). Two desperate situations are flagged in the Regulator’s press release along with a warning from pensions minister Steve Webb.
As before the materials comprise the following:
- A two-page warning note – that the Regulator would like to see administrators and pension providers include in the information they provide to members who request a pension transfer
- A more detailed information leaflet – that is intended to assist members in understanding what may well happen should they take up an offer; and
- An action pack for pension professionals – which includes a checklist and examples of what to look out for
The Pensions Regulator would also like administrators to send the two-page warning note to all members with their next annual statement.
The Pensions Regulator says that the amount of funds known to have been paid into pension scams now stands at £495m, but that it is suspected that the actual amount is likely to be substantially higher.
Comment
As with all campaigns there is the need to update the literature from time to time. But as there is no movement on the regulatory front, trustees and their administrators should not need to adjust their current due diligence procedures save using the new leaflets where appropriate.
Do annuities still have a place in the retirement market post 2015?
A new report published by the International Longevity Centre UK adds to this ongoing debate. The main conclusion is that, despite a significant worsening in annuity rates over recent times, many annuity products offer fair value for money, whilst nonetheless being perceived as a poor investment.
It comes to this conclusion through unpacking the determinants of annuity rates, observing first of all that a worsening in annuity rates associated with increasing life expectancy does not equate to a reduction in value for money; rather it represents a spreading of value over a longer period. But it does accept that a worsening in annuity rates associated with a fall in interest rates does result in annuities being unattractive as an investment if the interest rates being locked into at purchase may be expected to increase at some point in the future.
The report also says that the protection against longevity risks offered by an annuity product should not be overlooked in any guidance given to individuals approaching retirement, especially by those with a high level of risk aversion.
The report’s other findings include:
- The average cost for a 65-year-old man to buy a single life level annuity of £10,000 pa has increased from around £65,000 in 1990 to around £175,000 in 2013. 97% of this increase is down to increased life expectancy and the fall in interest rates
- Apart from those male annuity purchasers who end up on the worst rates, open market annuities generally provide good value for money. However, there is a substantial gap between the best and worst rates available in the market
- The perceived value of annuities is often much lower than its actuarial fairness would suggest because investors tend to consider only investment risk (as they may have been accustomed to doing during the accumulation phase) and at the same time consider the cost of protection against longevity risk in the early years of decumulation too expensive
Comment
After the damning review by the FCA on the annuity market (see Pensions Bulletin 2014/07), it is refreshing to see a defence for annuity providers, although the report also agrees with the FCA’s conclusion that shopping around before retirement can add significant amounts to one’s annuity income.
Annuities may not die in 2015, but this longevity risk transfer market is likely to look very different to what has gone before.
Annual Allowance “fixed” for bulk transfers et al? Maybe, but some work still to be done
Long-running attempts to address a number of snagging issues with the 2011 Finance Act annual allowance provisions moved on a step this week with the publication of drafts of an Order, explanatory memorandum and pages of modified guidance covering a multitude of issues.
The Order includes provisions (amongst other things) addressing the following – almost all relating to defined benefit or cash balance arrangements:
- To ensure that where defined benefit or cash balance transfers occur there is no unintended use of a member’s annual allowance as a result – this is the most eagerly awaited provision, more on this below
- To extend the circumstances (the so called “deferred member carve-out”) where deferred benefit rights do not use up any of a member’s annual allowance (the proposed changes parallel those made to limit circumstances where deferred pension rights might lose a member’s Fixed Protection)
- To correct an anomaly relating to any individual who became a deferred member of a scheme before 6 April 2006, that meant that if they had any further accrual in the scheme, the annual allowance used up reflected the whole benefit, not just the accrual; and to address a similar anomaly (newly exposed) potentially impacting individuals with Enhanced Protection who have had any accrual since 5 April 2011; and
- To address a number of “scheme pays” issues – ie where an individual exercises a right to instruct their scheme to pay HM Revenue & Customs (HMRC) an annual allowance charge from their benefits, rather than the member paying it directly – including
- Correction to an anomaly (see Pensions Bulletin 2012/12) that meant in some circumstances using scheme pays reduces the annual allowance charge
- For a member taking all their benefits from a scheme (ie in their “year of retirement”) the date of doing so becoming the deadline for election to use scheme pays for any outstanding annual allowance charge (potentially perhaps three tax years’ worth); and
- Whenever a member has a right to use scheme pays in one scheme, but transfers his benefits to another scheme, ensuring that the right transfers to the new scheme
Several of the provisions have retrospective effect from the pension input period ending in 2011/12. The scheme pays changes generally have effect for charges arising/ elections made/ transfers after a future date.
Attempted solutions at most of the issues listed here first saw light in a draft Order back in November 2012 (see Pensions Bulletin 2012/48) that was withdrawn.
That 2012 draft exposed a serious problem typically for “bulk transfers” (as arise often as part of corporate transactions and scheme rearrangements) which HMRC has since been working on to repair (see, for example Pensions Bulletin 2013/30). HMRC's reading then was that the tax law meant that an individual having mirror image defined benefits transferred from one scheme to another as part of a business transaction would use up some annual allowance if the transfer was an “underfunded amount” – clearly an inappropriate impact on members.
Our initial reading of the new draft Order and accompanying notes is that the drafting has some important rough edges that must be tidied; but the intent seems clear, the language is helpfully broad and (with a little more work on the law and the guidance) it may solve the issue satisfactorily for most cases – and not just for bulk transfers involving mirror image benefits, but also where the benefit granted is adjusted but still equal in value (or “virtually equal”) to pre-transfer expectations. “Value” involves using “normal actuarial practice” – taken in the guidance as allowing for the specific circumstances.
On the whole the changes are retrospective to 2011/12 unless they worsen a member’s tax position (and maybe retrospective to the 2008/09 to 2010/11 years for carry forward purposes, but definite confirmation would be welcome). As always the devil is in the detail and the language is tricky, but we are hopeful. It will be important to check whether there are any surprises for individual transfers, and there will be real pitfalls to handle/avoid for any bulk transfer where members are granted a “better than value” benefits.
Consultation on the new drafts closes on 27 August 2014.
Comment
Getting the annual allowance to work closer to the policy intention is important, so as to reduce as much as possible anomalous impacts on members, unintentional burdens on administration and unnecessary blocks to trustee/employer exercises. So we are pleased to see the revised draft emerge at last. But the fact that it has taken so long shows that the provisions are not easy to get right per se, nor easy to design to satisfy all stakeholders.
The new drafts merit very careful scrutiny by schemes interested in particular issues and by industry bodies. The changes are detailed and intricate with potential for error – it is a pity that the consultation window is short. We hope that HMRC, clearly very busy just now, will have time to properly consider representations made to make this Order operate as well as it should.
When the provisions are finalised (and depending what is), some revisions to past work may be needed (minimal we hope); and some changes in practice will result.
Draft regulations set down mechanism for achieving separation of pension obligations within the banking sector
Long-awaited details of how pension obligations are to be separated within the banking sector have been published by the Department for Business Innovation & Skills. This is one of the consequences of the Financial Services (Banking Reform) Act 2013, which requires the retail (deposit taking) operations of banks – known as “ring-fenced bodies” – to be separated from their non-retail operations from the start of 2019, as part of a number of reforms being made to the banking sector (see Pensions Bulletin 2013/44).
The Banking Reform Act enables regulations to be made that require ring-fenced bodies not to be liable to meet, or contribute to the meeting of, the pension liabilities of a non-ring-fenced body which arise after a specified date.
The draft Financial Services and Markets Act 2000 (Banking Reform Pensions) Regulations 2014 give effect to this by requiring that from 1 January 2026 (or, if later, five years after the day on which a body becomes ring-fenced), no ring-fenced body may be an employer in relation to a multi-employer scheme (or a section of a segregated scheme) unless the only other employers are its wholly owned subsidiaries or other ring-fenced bodies in the same group or their subsidiaries.
The effect of this is that the employees of organisations outside this ring fence cannot be part of the ring-fenced bank’s pension scheme or section of a segregated scheme. Therefore, all future accruals must relate to employment with the ring-fenced bank(s).
In addition, from the same date, no ring-fenced body may continue to be or become a party to a “shared liability arrangement” – this means that it will not be possible to provide a guarantee, indemnity or bond in respect of pension arrangements relating to companies outside the ring fence (for example a PPF type A contingent asset).
The draft regulations go on to:
- Give trustees a statutory power to modify schemes (in a number of potential ways), with the consent of the employer, to comply with the regulations. If trustees or any of the employers unreasonably refuse, or unreasonably withhold their consent, to modify then the ring-fenced bank may apply to the court to remove these obstacles
- Require the ring-fenced bank to apply to the Pensions Regulator for clearance, where there is a corporate reconstruction or other arrangement for the purposes of complying with the regulations
- Require the trustees to provide certain information to scheme members about any proposed modifications
The Government anticipates that re-structuring will occur, or a new pension scheme will be created to enable the ring-fenced bank to comply with the regulations. However, and importantly, the draft regulations do not prescribe how this outcome is to be reached, still less how assets and liabilities will be allocated for past service. This will be for trustees and the banks to determine. In theory the scheme relating to the ring-fenced bank could assume 0% or 100% of the past service liabilities, or somewhere in between.
Consultation closes on the draft regulations on 15 October 2014.
Comment
2026 is a long way off but banks subject to ring-fencing will already be planning for what is a fundamental reform to banking regulation. Indeed, these draft pension regulations come into force next year to allow trustees and banks time to plan and implement the major steps that may be required.
Liabilities will need to be allocated between ring-fenced and non-ring-fenced banks within multi-employer schemes and decisions about de-merging schemes and allied re-structuring will need to be taken and driven through. This will likely involve negotiating complicated agreements about the ownership and financing of legacy defined benefit obligations.
Will the National Insurance Fund go bust?
This is addressed in the Government Actuary’s latest five-yearly review of the National Insurance Fund, which indicates that perhaps we should more appropriately be asking when the Fund is likely to go bust!
The Fund is financed in such a way that the bulk of national insurance contributions paid in a year are used to meet benefit outgo such as that on the State pension. However, this essentially “pay as you go” Fund is also intended to maintain a working balance to guard against unexpected falls in contributions or increases in outgo. Since 2000 the Government Actuary has recommended that this should be at least 1/6th of annual benefit expenditure.
At the previous review (as at April 2005, published in March 2010) it was anticipated that the balance of the fund would not reach zero by the end of the review’s projection period (2070). However, in the latest review, even allowing for the measures in the Pensions Act 2014 (new State Pension, cessation of contracting-out and increase in State Pension Age to 67 between 2026 and 2028), the Fund is expected to be exhausted by 2035.
This dramatic shift is in most part attributable to the recession and financial downturn since the last review. In 2005 the review projected that the Fund balance at the end of 2012-13 would be £103.3bn but the actual Fund accounts at that date showed a balance of just £29.1bn, with £68.4bn of the £74.2bn disparity due to lower contributions received than had been expected.
But what will interest most is the future sustainability of national insurance contributions. And it is here that the report’s findings are stark. Whilst the current rates appear to be supportable through to the end of the next Parliament, thereafter the “break even” contribution rates steadily rise, with minor pauses as each State Pension Age increase kicks in.
Comment
The radical overhaul of the State pension system and acceleration of the increases to state pension ages do not seem to have stabilised and reduced the national insurance burden over the long term as hoped. Not only has the National Insurance Fund suffered from the recession and financial downturn, but looking forwards, the ageing population with the benefits bill increasing at a faster rate than contributions, brings its own relentless pressure.
The difficulty facing a future Government is that, if the State pension is to continue to offer a meaningful subsistence retirement income for all and remain payable over a third of an individual’s adult life, there is no obvious alternative to requiring contributions (whether through national insurance or general taxation) to rise.
Government Actuary reports on actuarially fair rate of increments for those choosing to defer their State Pension after 2016
Following last week’s announcement of the lower uplift factors for deferral of the single-tier state pension (see Pensions Bulletin 2014/30), the report from the Government Actuary which helped inform the decision is now available. It sets out in some detail the range of results that could be deemed to be “actuarially fair” whilst making it clear that the decision as to the suitable actual rate lies with ministers.
Comment
It is now apparent that the 1% for each nine weeks settled on by the Government is at the lowest end of the actuarially fair range outlined by the Government Actuary.
Scheme Funding Code of Practice comes into force
An Order has been laid before Parliament that brings into force the revised Code of Practice on Scheme Funding (see Pensions Bulletin 2014/24).
The Pensions Act 2004 (Code of Practice) (Funding Defined Benefits) Appointed Day Order 2014 (SI 2014/1926) sets 29 July 2014 as the day on which the Pensions Regulator’s revised Code of Practice No. 3: Funding defined benefits comes into force.
This coming into force date has also been announced by the Pensions Regulator, which is now able to make available the code in its final form.
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.
