Pensions Bulletin 2014/46

FCA’s turn to consult on charges

The Financial Conduct Authority (FCA) has launched a consultation on proposed new rules regarding charges for firms providing workplace personal pension schemes (including stakeholder schemes) used for auto-enrolment.

In it, the FCA proposes the following measures:

• A cap on the charges within default funds equivalent to 0.75% pa of funds under management – from April 2015
• The prevention of firms from paying or receiving so-called “consultancy charges” – also from April 2015
• The prevention of firms from paying commission or other charges for advice which is not initiated by scheme members – from April 2016; and
• The prevention of firms from using differential charges based on whether the member is currently contributing or not – also from April 2016

Consultation ends on 31 December 2014, with the FCA expecting to publish a policy statement in February 2015 and the proposed rules coming into force from 6 April 2015.

Comment

The FCA’s proposals on charge caps and differential charges are the contract-based scheme equivalent to the Department of Work and Pension’s (DWP) draft regulations published earlier in October aimed at trustees of money purchase occupational pension schemes (see Pensions Bulletin 2014/44). The DWP will issue further draft regulations on consultancy and commission charges, which will bring the DWP’s regulations completely in line with the FCA’s rules.

Although these are two separate consultations, given that the DWP and FCA are working closely together to deliver a joined-up set of policies for all pension providers, it is likely that results from one consultation will transfer across to the other.

Purple Book hints at stabilising DB pensions landscape

Although trends in de-risking and scheme closures seen in the last few years continue into 2014, latest figures show that these are levelling off and could point to the end of a long term trend. There has also been substantial improvement in scheme funding over the year to March 2014, backed by a strong UK economic recovery.

So says the Pension Protection Fund (PPF) in introducing the ninth edition of the “Purple Book”, published jointly with the Pensions Regulator. This substantial compendium, which analyses risks faced by defined benefit (DB) pension schemes, reports that over the year to 31 March 2014:

• Schemes closed to future accrual increased from 30% to 32%, whilst the proportion of schemes still open continues to edge down from 14% to just 13%
• Scheme funding has improved from 84% to 97% on a section 179 basis and from 61% to 67% on a full buyout basis. However, the section 179 funding level decreased by around 8% for the six months since 31 March 2014 due to lower gilt yields
• Asset allocation and de-risking changes have slowed down, with the equity share levelling off at 35.0%, the gilts and fixed interest share reversing an increasing trend since 2006 to fall from 44.8% to 44.1%, and the hedge fund share continuing to rise from 5.2% to 5.8%

Much of the analysis of the 2014 Purple Book is based on information from 6,057 scheme returns issued in December 2013 and January 2014 and returned to the Pensions Regulator by the end of March 2014, representing 99.8% of PPF-eligible schemes.

For a comparison with last year’s report see Pensions Bulletin 2013/46.

Holiday pay and overtime ruling could have knock-on effect for pension calculations

In its widely publicised judgment, the Employment Appeal Tribunal has held that non-guaranteed, but compulsory, overtime is part of “normal remuneration” and as such must be included in calculating holiday pay so that employees receive their full normal remuneration during their paid holiday (when, obviously, they would not actually be working any overtime).

The ruling applies from the date of the judgment and also retrospectively, but only to the extent that reduced holiday pay had been made no more than three months apart. As such, it is likely to have a limited retrospective impact. However, if a worker always took regular short holidays (say one week every three months) there is a potential that retrospection could go as far back as the late 1990s, when the Working Time Directive came in.

Following the ruling, the Department for Business Innovation and Skills is setting up a task force to look at the possible impact on employers.

Comment

This is the second case in recent months where the treatment of variable pay in the context of paid annual leave has come under scrutiny. In Lock v British Gas Trading (see Pensions Bulletin 2014/24) the Court of Justice of the European Union also ruled in favour of the employee.

As with Lock, the implication for pension schemes is that those which use variable pay (rather than basic pay) in their definition of pensionable pay might have been using too low an amount in relation to the period in which the employee was on paid annual leave with potential implications for contributions which ought to have been paid and benefits which ought to have accrued. Schemes with pensionable pay formulae based on basic pay only will be unaffected.

In the light of this judgment, trustees of schemes with variable pay formulae should review how these work and take legal advice if appropriate.

Kodak – keeping most of the scheme out of the PPF (for now)

The Pensions Regulator has published a section 89 report on its activities around the Kodak insolvency which began in early 2012. Although the Regulator stresses that each case is unique, there may still be pointers for distressed UK businesses with big defined benefit pension liabilities, especially where there is an overseas parent company guarantee involved.

What happened in the Kodak case was this:

• Eastman Kodak Company (EKC) filed for Chapter 11 bankruptcy protection in the United States in January 2012. EKC was not expected to come out of Chapter 11; other companies within the group were also likely to become insolvent as a result
• EKC’s UK subsidiary, Kodak Limited (Kodak) sponsored a big, mature defined benefit pension scheme, the Kodak Pension Plan (KPP), which it lacked the financial resources to support. In recognition of this EKC had previously guaranteed the KPP buyout deficit. This guarantee formed the basis of the KPP trustees’ claim in the US bankruptcy court. While this was an unsecured claim it was a very big claim indeed; $2.837bn (being the scheme’s buyout deficit)
• This meant that EKC couldn’t come out of Chapter 11 without doing a deal with the KPP trustees. What was eventually struck was that the trustees bought two viable Kodak businesses, now collectively known as Alaris, for a big discount. In return the KPP trustees released EKC and Kodak from future claims. Alaris is expected to generate enough cash flow each year to meet a substantial part of KPP’s benefit payments
• The KPP was closed and is entering the Pension Protection Fund (PPF). The innovative part of all this is that a new defined benefit pension scheme (KPP2) has been set up. This scheme has no sponsor support. Its benefits are less valuable than those in the KPP, but are worth more than members would receive in PPF compensation should they remain in the KPP. There is also the prospect of these new scheme benefits being improved at some point in the future
• KPP members were given the right to vote on whether to transfer to this scheme. The vast majority of members who voted (90% plus) voted in favour. Members who voted against, or did not vote, remained in KPP and so will enter the PPF

Normally the KPP would have just been wound up and entered the PPF. However, the Pensions Regulator and the PPF Board agreed to the deal entered into, using the regulatory mechanism of a “regulated apportionment arrangement” (RAA) under the UK employer debt regulations. The interesting thing about the section 89 report is that it gives some insight into the authorities’ rationale for their agreement. After all, there is a significant risk that KPP2 may end up in the PPF, with a bigger deficit than there would have been before if the investment strategy, and in particular the performance of the Alaris businesses, failed.

Whilst it is clear that approval in this case is “exceptional”, the Regulator states that it took the following into account when assessing whether or not to approve the RAA:

• Whether the insolvency of Kodak was otherwise inevitable
• Whether the scheme might receive more from an insolvency; and
• Whether a better outcome might otherwise be attained for the scheme by other means including the use of the Regulator’s moral hazard powers

It could have said “no”, but concluded otherwise and therefore approved the RAA. In doing do it set great store in a governance framework to mitigate the risks to the PPF and its levy-payers in the future. The features of this framework involve:

• Regular, scheduled monitoring of the performance of the Alaris businesses and KPP2’s funding position
• Restrictions on the augmentation of benefits
• Restrictions on investments; and
• Triggers for the winding up of the scheme, based on the position of the scheme

Comment

Without being privy to the behind the scenes detail we wonder about the rationale behind officialdom buying this. This would have been the biggest PPF entrant ever, so you can see why they would have wanted to keep them out. But there is a risk that KPP2 will end up in the PPF with a bigger deficit than if the bullet had been bitten at the time. An awful lot rests on the “governance framework” giving early warning of trouble ahead if the Alaris businesses do not perform as hoped. We wish all concerned well.

UK Coal take two – events force PPF entry

In the second section 89 report published this week the Pensions Regulator sets out the reasoning behind its agreement to the July 2013 restructuring which resulted in the pension obligations of UK Coal Operations Limited being replaced by compensation from the Pension Protection Fund (PPF).

The July 2013 restructuring was necessitated by a major fire at Daw Mill – one of UK Coal’s three deep mines (see Pensions Bulletin 2014/16). The financial consequences of the fire undermined the December 2012 restructuring (which separated UK Coal’s property business from its mining operations) whose object had been to keep UK Coal’s pension liabilities outside the PPF.

The July 2013 agreement reached with the Regulator resulted in the Daw Mill part of the mining operations being separated from the other mining operations, with the remaining mining operations transferred to a new group of companies owned by a new entity – UK Coal Production Limited. The pensions liability was then transferred into the PPF in July 2014 following an assessment period triggered by a controlled insolvency of UK Coal Operations Limited.

In order to facilitate the restructuring, the trustees released part of their claim against UK Coal Operations Limited as an unsecured creditor. In return, the PPF secured significantly all of the economic interest and value in the non-Daw Mill mining group through a series of debt instruments held in UK Coal Production Limited. The interests in the new group are expected to be more valuable than the portion of the claim which was given up.

The risks inherent in the mining business were also mitigated by ring-fencing the non-Daw Mill mines from each other, providing greater protection to the wider group (and so to the value of the PPF’s interest) against future catastrophic events in any single mine.

Comment

This outcome seems to have been the best that could have been achieved in the circumstances. The pension liabilities go into the PPF, which retains an interest in the future cash flows of the mining business, which has been secured for the time being.

Disclosure of information changes proposed – mainly for public sector schemes

In a short consultation from the Department for Work and Pensions (DWP), proposals are made to make technical amendments to the Disclosure of Information Regulations (see Pensions Bulletin 2013/46) to ensure that they work as intended in relation to the new public service pension schemes being introduced from April 2015 under the Public Service Pensions Act 2013.

However, as part of the consultation, the DWP asks whether a non-public service pension scheme that issues a benefit statement in relation to non-money purchase benefits voluntarily should not be required to issue a further one at the member’s request within 12 months. This is because, as from 1 April 2015, public service schemes will have to provide active members with an annual “benefit information statement” and so as a consequence it is now being proposed they should be exempt from providing similar information on request where a benefit information statement has been issued to the member within 12 months of the request.

Consultation closes on 28 November.

Comment

This would appear to reveal a misunderstanding as to the intended operation of Regulation 16 of the 2013 Disclosure of Information Regulations. It is generally accepted that where a benefit statement is issued annually on a voluntary basis (as is the custom in relation to active members), the individual cannot request a further one within 12 months. But the DWP don’t seem to think that the regulations are saying this. If so, they need to be fixed straight away.

More evidence of the positive impact of auto-enrolment

The Office for National Statistics (ONS) and the Department for Work and Pensions (DWP) have issued several reports and press releases in the past week highlighting the success of auto-enrolment in workplace pension schemes.

Following on from the 2013 Occupational Pension Schemes Survey (see Pensions Bulletin 2014/40), the ONS has updated its Pension Trends: Private Pension Scheme Membership data series. The 2014 edition shows that:

• Active membership in private sector schemes has increased from 2.7m in 2012 to 2.8m in 2013, equivalent to an increase from 31.8% to 35.8% of private sector employees, reversing a long term trend since the data series began in 1997. This increase is spread across all pension types, with highest increases in defined contribution arrangement and group personal pensions, and modest increases in defined benefit arrangements
• The gender gap in the proportion contributing to private pensions between men and women has narrowed from almost 20% in 1996/97 to just 3% in 2012/13
• Although the rate of participation in a workplace pension arrangement increases with employee earnings, the increase between 2012 and 2013 is highest in the lowest earnings band at around 7%

The DWP has published a report on workplace pension participation and savings trends setting out an analysis of employees eligible for auto-enrolment. This shows that:

• There is an increase in workplace pension participation across most occupations and industries, with highest increases seen in the sales and customer services. The majority of this increase comes from employers with over 5,000 employees
• There is a more significant increase in participation rates of part-time employees compared to full-time employees

The DWP has also published a report on auto-enrolment opt out rates of employers staging in 2014. 46 employers and 7,200 workers were included in the analysis. 12% of workers opted out after being automatically enrolled, which is equivalent to 4% of all workers included in the study. Overall participation rate in a workplace pension has increased from 44% to 76% for these employers.

Comment

There is a myriad of data contained within these three reports, all pointing to the success of auto-enrolment. It is encouraging to see that, with medium to smaller companies starting on the path of auto-enrolment, the trend of low opt-out rates seems not to have increased for the time being. Auto-enrolment also seems to be reaching the target population, with more significant increases in participation rates of lower earners, women, and part-timers.

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.